A new report from one of the Internal Revenue Service’s main advisory panels says the IRS needs to expand its efforts to fight identity theft-related tax fraud, among other recommendations.

The IRS Advisory Council’s 2012 annual report contains a number of suggestions, starting with the battle against identity theft.

“The IRS must continue to diligently look for ways to combat identity theft which leads to tax fraud,” said the panel. “The IRSAC commends the IRS on its two-pronged effort, but is concerned that both taxpayers and the tax system will suffer if appropriate measures are not taken quickly and effectively to control this fraud.”

Identity thieves continue to become more proficient in devising schemes to steal identities in their attempt to file fraudulent refund claims, the report noted.

The thief uses stolen Social Security numbers to prepare fraudulent Form W-2s, file tax returns and obtain refunds based on the fraudulently prepared Forms W-2 and 1040, generally very early during the filing season. Populations that have no tax filing requirements such as the elderly, children and the deceased are often the targets, making this particularly difficult to identify as an accurate return is often never required to be filed,” said the report. “Thieves may obtain jobs with hospitals, schools or nursing homes in order to acquire thousands of SSNs and market this information or use it themselves,” the report noted. “Despite the fact that these thieves steal the information from sources outside of the tax system, the IRS is sometimes the first to inform an individual that identity theft has occurred, and in some cases the IRS and the individual are never aware of the fraud, leading to multiple years of fraudulent returns being filed.”

The report acknowledged that the IRS has the goal of preventing identity theft and detecting refund fraud prior to its occurrence, as well as assisting taxpayers who are victims. A number of enhanced fraud protection processes for the 2012 filing season were implemented, including filters developed to stop suspect returns and contact the taxpayer before the return is processed, new tools to identify taxpayers with changed circumstances (such as a new job, a new bank account or debit card for the refund deposit), and enhanced use of the functionality of the Identity Protection Personal Identification Numbers (IP PINs). The IRS also developed procedures for handling taxpayer personal information that law enforcement officials discover in the course of investigating identity theft schemes or other criminal activity and is accelerating the matching of information returns to identify mismatches earlier.

In 2011, the IRS identified and prevented the issuance of over $14 billion in fraudulent returns, the report noted, and identity theft is a subset of this total. From 2008 through the middle of 2012, the IRS has identified more than 600,000 taxpayers who have been affected by identity theft. With respect to these taxpayers, during 2011 the IRS protected $1.4 billion in refunds from being erroneously sent to identity thieves. Through mid-April 2012, the IRS had stopped over 325,000 questionable returns with $1.75 billion in claimed refunds using filters specifically targeting refund fraud.

While the advisory group applauds the IRS’s continued efforts to assist identity theft victims and for assigning them special PIN numbers to help resolve issues with their accounts, it offers a number of recommendations, including that the IRS should strongly consider delaying refunds until after verification of the taxpayer’s identity. “For taxpayers that rely on an early refund in January, the IRS should consider a process under which 25 percent of the refund is issued prior to verification, and the remaining 75 percent issued after verification,” said the report. “The increased use of refund anticipation loans needs to be considered if refunds are delayed.”

The group also recommended that the IRS should continue to work with the banking industry to find and prosecute the perpetrators who use debit cards  Authentication procedures should continue to be studied so that refunds can be processed more quickly for those taxpayers whose identity is authenticated, including by a third party. The IRS should also publicize the protections it has in place and the need to slow down tax refunds until information returns can be matched and verification can occur. The report also recommends expanding the IP PIN program for taxpayers who have had their identities stolen and perhaps for all taxpayers who request refunds before verification.

“There also needs to be a method of connecting a child’s identity to their parent’s return to protect the child’s SSN from identity theft,” said the report. “The IRS needs to continue its Criminal Investigation Division work with and prosecution by the Justice Department, making results public so that the consequences of identity theft are understood by the public.”

Tax Preparer Regulation
The report also contains a number of recommendations regarding the IRS’s expanded regulation of tax preparers, including making them more aware of their ethical obligations.

“With the extension of the application of Treasury Circular 230 to paid tax return preparers, an additional 500,000 unlicensed individuals who have registered as tax return preparers are now subject to the conduct rules of Treasury Circular 230 Subpart B,” said the report. “As we noted in our 2011 IRSAC Report, many of these newly designated practitioners may be unfamiliar with the ethical and professional obligations under Treasury Circular 230 and the Internal Revenue Code. We believe that the IRS should continue its efforts to expand and improve the guidance available to all tax practitioners concerning their ethical and professional obligations under both Treasury Circular 230 and the Internal Revenue Code.”

The panel also recommended specifically enumerating tax return preparation and tax advice as constituting “practice before the IRS.” In addition, it suggested adding a section on competency requirements to Circular 230.

IRSAC also made recommendations in several other areas, including streamlining the audit process, managing knowledge in the issue practice groups and international practice networks, improving lien withdrawal processing, enhancing the availability of electronic completion and filing for form 1099-miscellaneous, increasing BMF electronic filing and enhancing the reporting of dispositions of capital assets on various forms.

“IRSAC members provide valuable feedback on products, programs and services of the IRS,” said Acting IRS Commissioner Steven T. Miller in a statement. "We welcome their perspectives as we address future challenges."

IRSAC draws its members from the tax professional community and members of academia. The Commissioner’s Advisory Group was established in 1953 and renamed IRSAC in 1998 to focus as an advisory body to the entire IRS.