The Internal Revenue Service has inadequate controls over dishonored checks from taxpayers, putting millions of dollars at risk, according to a new report.

The report, from the Treasury Inspector General for Tax Administration, found problems in the IRS’s handling of taxpayer payments that are subsequently dishonored by the banks in which they are deposited. Dishonored payments are not processed by banks for a variety of reasons, the report noted, including insufficient taxpayer funds. The IRS occasionally issues a refund to a taxpayer who had submitted an overpayment of taxes before the IRS realizes that the taxpayer's check has been dishonored by the bank. This results in the taxpayer receiving an erroneous refund.

Between Jan. 1, 2008, and July 17, 2008, the IRS generated refunds as a result of dishonored check overpayments totaling approximately $53 million. TIGTA estimates that the IRS was unable to stop more than $20 million in refunds from being erroneously issued to nearly 14,000 individuals.

Further complicating the processing of dishonored checks was the issuance of economic stimulus payments in 2008. According to the IRS, some taxpayers who were entitled to receive an economic stimulus payment stopped payment on their checks, anticipating the stimulus payment would satisfy their tax liability. However, in some instances, the economic stimulus payment was refunded to the taxpayer before the IRS processed the dishonored check. As a result, taxpayers received economic stimulus payments that should instead have been used to offset their tax liabilities.

"The IRS must develop an effective system to prevent refunds for overpayments from being generated until it knows that the original payments have cleared the bank," said TIGTA Inspector General J. Russell George in a statement. "This would protect approximately $102 million over the next five years from being issued to taxpayers in error.”

TIGTA recommended that the IRS develop a process to identify and stop refunds on dishonored check overpayments; identify erroneous refunds issued in 2008 and 2009 that were not properly referred to its Erroneous Refund Unit for recovery; initiate recovery of those refunds; and modify the payment-processing modernization project to include converting paper checks to electronic fund withdrawals. The IRS agreed with three of the four recommendations, but did not agree with the recommendation to convert paper checks to electronic fund withdrawals, citing limitations with its current system.

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