Thousands of individuals claiming the first-time homebuyer’s federal $8,000 tax credit may have been attempting to scam the system, including purported four-year-olds and illegal immigrants, according to a watchdog report released on Thursday.

Nearly 74,000 individuals who claimed the tax credit did not appear to qualify for it, at a cost of half a billion to the government, the inspector general for tax administration for the Treasury Department said in a report to be delivered to lawmakers on Thursday.

“Some of our findings, while preliminary, are somewhat disturbing,” inspector general Russell George said in an interview. Among the most striking instances of fraud include those claiming to be four-year-olds, apparent non-U.S. citizens and IRS employees inappropriately claiming the benefit, he said.

The report comes amid a heated debate about the popular credit, which the real estate and homebuilding industry is fiercely lobbying to protect. It expires at the end of November, and some say it simply doles out cash to those who would have purchased a home without it.

A subcommittee of the tax-writing Ways and Means Committee in the U.S. House of Representatives is hearing from IRS, IG and other officials on Thursday.

“Anytime there is an opportunity to receive cash back it tends to attract people who might have an intent to defraud the government,” Linda Stiff, the IRS deputy commissioner for service and enforcement, told the panel.

She said the agency is committed to rooting fraud out of the program and had opened 8,000 fraud-related criminal probes.

The IRS was charged with implementing two different homebuyer credit programs during 2009, while at the same time processing 140 million individual returns.

The initial credit was approved in February 2008, in the middle of the tax filing season.

About 1.5 million tax returns have been filed to take advantage of the credit at a cost to the government of about $10 billion. Many powerful lawmakers want to extend it, including some that back broadening it to all homebuyers and doubling its benefit.

The agency has opened 107,000 civil cases related to the credit. Also, they have selected thousands of returns for those claiming the credit for deeper audits.

The watchdog report finds that 582 taxpayers under the age of 18 claimed about $4 million using the credit, with the youngest being 4 years old.

“It’s always been my experience that the IRS was tough,” panel Democrat Danny Davis said. “It seems that in this instance … that toughness was not there.”

The report further faults the IRS for failing to take its advice that documentation be provided by individuals claiming the credit actually purchased a home.

The IRS Now supports such documentation. The agency had balked earlier because it would have had to open a full audit on all questionable claims.  Continued…