While the Internal Revenue Service is working overtime to send tax cheats to prison, officials at the tax service are discovering that a considerable portion of them are already behind bars.During hearings before the House Ways and Means Oversight Subcommittee, IRS officials confirmed that illegal tax return filing activity by prisoners in state and federal penal institutions has become a rapidly growing problem for the service in the past few years.

Calling the increase in prisoner tax fraud "dramatic," IRS criminal investigation chief Nancy J. Jardini told Congress that although prisoners represent less than one half of 1 percent of all individual federal income tax returns filed in 2004, inmates now account for a whopping 15 percent of all fraudulently filed refund returns detected by the agency.

Worse yet, filing fraud by prisoners is rising at an alarming rate. In 2001, the service identified approximately 1,500 fraudulent tax returns filed by inmates, but last year the number detected reached 18,000, Jardini said.

The good news is that the IRS told Congress that the service was able to identify 78 percent of the fraudulent filing in 2004 and stop refund checks before they were mailed. But even so, the IRS concedes that about $15 million "fell through the cracks" and was erroneously refunded to prisoners last year.

Some members of Congress suspect that the actual drain on the Treasury due to tax fraud by inmates may be considerably higher than the IRS has acknowledged.

"In reality, no system can be 100 percent effective in detecting all of the fraud that occurs, and consequently prisoners throughout the country are likely going undetected in their schemes," Rep. Tom Feeney, R-Fla., told the subcommittee.

Although he declined to speculate about how much inmate tax fraud goes undetected each year, Feeney said, "It is difficult to imagine criminals engaging in such an activity unless success was a possibility."

Part of the challenge posed by the upsurge in prisoner tax filing fraud is the fact that the schemes employed by inmates are "constantly evolving," Jardini said.

"Schemes can be as simple as false wage and Earned Income Tax Credit claims using a cellmate's Social Security number, or as complex as a prisoner, in concert with outside co-conspirators, filing false income tax returns online utilizing stolen identities, followed by sophisticated financial transactions intended to disguise the true source of the funds," she told the subcommittee.

Of the 18,000 fraudulent prisoner returns detected in 2004, a number of different fraud schemes were utilized, including identify theft, and filing numerous false forms including Schedule C, Form 1099, Miscellaneous Income, Form W-2, and Form 4852, Substitute for W-2, Jardini explained.

Additionally, "numerous tax credits to which the prisoners were not entitled were also claimed, including the EITC, the Advanced Earned Income Credit, the Child and Dependent Care Credit, the Education Credit, the Child Tax Credit, and the Adoption Credit," she testified. "In perpetuating these schemes, many prisoners received outside assistance from family or friends," and, in at least one case, from an IRS employee.

Bureaucratic battles

Another reason for the upsurge in illegal tax filing scams by inmates, however, may be a bureaucratic turf war that has made tracking down phony prisoner tax returns more difficult than it should be.

"With very little left to lose, prisoners with long sentences are taking advantage of a tax system" that appears to be working at cross-purposes with investigators from Congress and state agencies, Rep. Jim Davis, D-Fla., said.

Besides sending congressional investigators on "a bureaucratic merry-go-round" that ultimately had to be resolved by the Treasury Department's Inspector General, the IRS also failed to cooperate with state prison officials to curb these tax abuses, Davis said.

"It befuddles me that the IRS refuses to work with the state prison systems, as they are the two players that will find the solution to these fraudulent claims," he told Congress.

There are indications, however, that the bureaucratic backbiting cuts both ways. Rep. Feeney, for one, said that officials with some state penal systems are refusing to help the IRS crack down on inmate tax scammers.

"It is unacceptable that state prisons receive federal funding, yet some are unwilling to cooperate with the IRS to prevent inmates from defrauding the federal government," he said.

Feeney called on Congress to consider providing incentives that would encourage the states to provide federal authorities with "basic information about inmates," including the identity of prisoners, payroll information about prison employment, and routing numbers for prison bank accounts that could help the IRS identify fraudulent tax returns.

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