Identity theft is having a much larger impact on tax administration than the amount the Internal Revenue Service detects and prevents, according to a new report.

  1. The report, by the Treasury Inspector General for Tax Administration , noted that the IRS reported that it detected 938,664 tax returns totaling $6.5 billion in fraud for processing year 2011 tax returns. Using the characteristics of confirmed identity theft, TIGTA identified approximately 1.5 million additional undetected tax returns with potentially fraudulent tax refunds totaling in excess of $5.2 billion. TIGTA estimates that the IRS could issue $21 billion in fraudulent tax refunds over the next five years.

TIGTA Inspector General J. Russell George noted that the IRS has expanded its efforts to detect and prevent identity theft, but added that the report found multiple reasons for the IRS's inability to detect billions of dollars in fraud. "As identity theft is the most frequent consumer complaint, and at a time when every dollar counts, these results are extremely troubling," he said. “Undetected tax refund fraud results in significant unintended federal outlays and has the potential to erode taxpayer confidence in our nation's system of tax administration.”
TIGTA initiated its audit at the request of the chairman of the Senate Finance Committee's Subcommittee on Fiscal Responsibility and Economic Growth. The overall objective of the review was to evaluate the effectiveness of the IRS's efforts to identify and prevent fraudulent tax refunds resulting from identity theft.

The reasons TIGTA found that the IRS did not detect billions of dollars' worth of identity-theft-related tax refund fraud include delayed access to third-party income and withholding information.

These delays make it difficult for the IRS to detect fraudulent tax refunds at the time tax returns are processed. Third parties are not required to submit income and withholding documents to the IRS until March 31, yet taxpayers can begin filing tax returns in mid-January.

The report also found that the IRS has not developed processes to obtain and use the third-party information that is available at the time tax returns are filed. The use of direct deposits, including debit cards, to claim fraudulent tax refunds increases the risk that the IRS will not detect identity theft. The IRS continues to allow multiple direct deposits to the same bank account.

Congressional Reaction
After seeing the report, House Ways and Means Oversight Subcommittee Chairman Charles Boustany Jr., R-La., sent a letter to the IRS demanding a full accounting for the agency’s continued inability to stop tax fraud related to identity theft.

“This report raises serious questions regarding the IRS’s ability to detect tax fraud and whether they are allocating their resources effectively to detect frauds," Boustany said in a statement. "We’re learning that the IRS paid multiple refunds totaling nearly a million dollars to a single bank account. That is the kind of red flag that ought to draw more scrutiny. We need to know why the IRS is not catching this fraud.”

Boustany noted that the report identifies numerous examples from around the country where criminals used a single physical address from which to file hundreds of tax returns and received significant taxpayer dollars: 2,137 returns resulting in $3.3 million in refunds sent to a home in Lansing, Mich., 765 returns resulting in $903,084 in refunds to a home in Chicago, Ill., 741 returns resulting in $1 million in refunds to a home in Belle Glade, Fla., 703 returns resulting in $1 million in refunds to a P.O. box in Orlando, Fla., and 518 returns resulting in $1.8 million in refunds to a home in Tampa, Fla.

IRS Response
An IRS spokesman sent a statement to Accounting Today in response to the TIGTA report. "The growth of tax refund fraud committed by identity thieves is one of the IRS’ most significant challenges and we continue to devote significant resources to combat it," said the IRS. "Identity theft and the harm it inflicts on innocent taxpayers is a problem we take very seriously. The IRS has a comprehensive identity theft strategy comprised of a two-pronged effort that focuses on fraud prevention and victim assistance.  The IRS agrees with TIGTA that additional legislative authority from Congress could help combat identity theft, including expanding the use of the National Directory of New Hires database.

"The IRS believes that TIGTA’s five-year estimates are far too high. The estimates simply project 2010 figures into the future without properly accounting for significant improvements already implemented by the IRS," the statement continued. "This filing season, IRS expanded screening filters to address each of the areas that contributed to TIGTA’s estimate. Our increased compliance and prevention efforts mean we are stopping more refund fraud than ever before.  These efforts are not nearly adequately reflected in the five-year projection by TIGTA. For example, this year we have stopped for review almost double the number of returns stopped last year—and prevented billions in refunds using new anti-fraud capabilities. To date for this year, almost $12 billion in confirmed refund fraud has been stopped, and at least half of this is confirmed identity-theft. The amount stopped will continue to grow, and the IRS is on pace to significantly exceed the amount of confirmed refund fraud prevented compared with prior years."

TIGTA made seven recommendations to the commissioner of the IRS’s Wage and Investment Division, Peggy Bogadi, suggesting the IRS develop or improve processes that will increase the IRS's ability to detect and prevent the issuance of fraudulent tax refunds resulting from identity theft. In addition, TIGTA recommended that the IRS seek legislation to expand its access and authority to use the National Directory of New Hires database for the purposes of identifying identity theft.

IRS management agreed with TIGTA's recommendations and has taken or plans to take corrective actions.

“The theft of individuals' Social Security Numbers and other personally identifiable information happens outside the tax system, but is fueling an increase in tax refund fraud,” Bogadi wrote in response to the report. “As your report acknowledges, the IRS tripled the number of identity theft incidents that we detected in a single calendar year. We are devoting significant resources to combat tax refund fraud using stolen identities and have already taken action with respect to issues identified in the report. The IRS has a comprehensive identity theft strategy comprised of a two-pronged effort that focuses on fraud prevention and victim assistance.”

However, in view of its ongoing efforts to improve the detection of identity theft, the IRS did not agree with TIGTA's estimate of $21 billion in potentially fraudulent refunds as a result of identity theft over the next five years.

“It is important to note that this report generally analyzes the results of the 2011 filing season, and in some cases by using data that was not available to the IRS at the time that tax returns were processed,” Bogadi wrote. “For the 2012 filing season, the IRS put in place several measures to improve detection of potential fraud. The estimate of undetected fraudulent refunds in the report was based on four potentially fraudulent criteria reflected on 2010 tax returns. The IRS has already taken steps to address each of these areas. The IRS put new filters in place during the 2012 filing season, which among other things, address the fraudulent schemes identified in the report. In addition, the IRS dramatically accelerated the speed at which we make information returns available to our processing functions which allows more timely matching of income. The IRS also has implemented procedures to analyze case inventory to identify certain returns with fraudulent refundable credits. Because of these actions, we believe that the report's projection of undetected fraudulent refunds over the next five years is significantly overstated."

TIGTA said it agrees that the IRS's ongoing efforts will help reduce fraudulent refunds. As such, TIGTA's estimate of $21 billion includes an annual reduction factor to reflect the dollar amount that the IRS estimated it protected by implementing new filters. Without the reduction factor, TIGTA's estimate would exceed $26 billion.

“The IRS has also taken a number actions in additional areas not addressed in the report,” Bogadi noted. “The IRS has enhanced our return processing filters to improve our ability to identify false returns and stop the associated refunds from being issued. Our improved filters flag returns for additional review if certain changes in taxpayer circumstances are detected. The IRS is continuously working to strengthen and refine filters, but challenges do exist given the regular changes that many taxpayers experience.

“Our development and implementation of the Identity Protection Personal Identification Number has been a successful effort to both stop fraud and assist victims,” Boogadi added. “Identified victims of identity theft are provided PINs as a means by which to stop the fraudulent use of the victim's identity in the future, as subsequent tax returns are filed.  The PIN provides the victim with the ability to identify their subsequent returns to the IRS as being the true returns that should be processed.”

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