The Internal Revenue Service’s efforts last year to safeguard against identity theft by asking employers to file W-2 forms earlier and holding tax refunds longer if taxpayers claimed the Earned Income Tax Credit or the Additional Child Tax Credit did not always work, according to a new report.

The report, from the Government Accountability Office, noted that the PATH Act of 2015 moved up the deadline for employers to file W-2’s with the Social Security Administration to January 31, which was about one to two months earlier than in previous year. Also under the law, starting in 2017, the IRS held all refunds for taxpayers claiming the EITC or the ACTC until February 15 to subject them to extra verification since those returns have traditionally been exploited by identity thieves. But the IRS wasn’t able to verify over half the returns until February 15 before issuing the refunds, the GAO found.

Part of the problem was the IRS received W-2s on a daily basis but its information technology systems processed them on a weekly basis. In response to the GAO's review, the IRS said it’s planning to look at options for processing W-2s on a daily basis. In addition, some employers submit their W-2s forms late, but the IRS didn’t track the extent to which late W-2s are associated with fraud or noncompliance. The IRS hasn’t assessed what options it has for enforcing late W-2 penalties earlier.

Image: Bloomberg News

On top of that, approximately 9 percent of W-2s were filed on paper (around 23 million of them), which the IRS does not begin to receive from the Social Security Administration until March. By law, employers who file 250 or more W-2s are required to file their W-2s electronically, but those who file fewer than 250 W-2 forms can opt to file them on paper. That reduces the IRS’s access to W-2 data on a timely, limiting its ability to prevent fraud and reduce noncompliance before issuing refunds, while costing the agency an estimated $9.7 million to $11.3 million per year to process W-2 forms filed on paper.

The IRS received over twice as many (more than 214 million) Forms W-2 by February 15 last year compared to the same time in 2016. It reported that the early W-2 data was responsible for improving fraud detection and reducing taxpayer burden.

The IRS's preliminary and final analyses of the February 15 refund hold showed the IRS could have detected significantly more in potential fraud and noncompliance if it held all refunds until late February, when it had more W-2 data available. In its final analysis, the IRS estimated it could have protected $100 million in fraud and noncompliance had it held all taxpayer refunds until February 15, $35 million more than it protected by holding refunds claiming either the EITC or the ACTC. The IRS also estimated that moving the refund hold to March 1 for all taxpayers could protect $895 million compared to $533 million if it only held refunds with EITC or ACTC until that date. The GAO founds some limitations in the IRS’s analysis, though.

The GAO recommended the IRS collect data to keep track of late W-2 filing penalties and assess options for earlier enforcement. It suggested the IRS should also assess the benefits and costs of using its existing authority to hold refunds longer, hold all refunds, or both, and expanding systemic verification to other areas.

In response, the IRS said it couldn’t enforce penalties earlier, but it does plan to take some actions based on the GAO’s recommendations and its own analyses.

“We are leveraging the results of our systemic verification analyses of the 2017 filing season results to further refine fraud detection models and improve our ability to detect and stop more attempted identity-related refund fraud and noncompliance in 2018,” wrote Kiersten Wielobob, deputy commissioner for services and enforcement at the IRS.

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Michael Cohn

Michael Cohn

Michael Cohn, editor-in-chief of AccountingToday.com, has been covering business and technology for a variety of publications since 1985.