IRS needs stronger security for foreign tax credit

The IRS has let Americans living abroad wrongly claim tax credits on their foreign income, according to a new report from the agency's watchdog.

The Department of Treasury's inspector general for tax administration said the IRS allowed taxpayers to wrongly claim around $95 million between 2010 and 2012 in foreign tax credits, because the agency doesn't have enough security in place to weed out erroneous claims.

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The foreign credits are in the tax code to offset any double taxation, from both the U.S. and the home country, that happens on income Americans earn abroad. Unlike many other industrialized nations, the U.S. taxes its citizens and resident aliens on income made anywhere in the world. 

The inspector general's audit found more than 65,000 returns that improperly claimed the foreign tax credit. 

Around 16,000 taxpayers also claimed both a tax credit and a deduction for their foreign income, even though they're only allowed one or the other. Those taxpayers claimed almost $3 million worth of the foreign tax credit.

And the inspector general said the IRS allowed almost $40 million more in tax breaks to be claimed on more than 188,000 returns, even when the taxpayer didn't submit needed supporting documents.

In all, that means the IRS improperly allowed the foreign tax credit on almost 270,000 returns. Of those returns, almost three-quarters were completed by paid preparers.

That still means that the vast majority of the foreign tax credit claims were likely legitimate. In just 2013, for instance, more than seven million returns claimed some $16.7 billion worth of foreign tax credits.

The IRS agreed with the inspector general's recommendations, which included updating any training materials and finding new strategies to improve compliance by paid preparers. Both the agency and Congress have been looking at ways to crack down on unscrupulous tax preparers.

The inspector general also urged the IRS to do a better job tracking statistics surrounding the tax credit — an area where the IRS said it was limited due to budget restrictions.