The Internal Revenue Service should be subjecting tax returns filed by prison inmates to greater scrutiny for fraud, according to a new government report.

While the IRS has improved its ability to identify fraudulent tax returns and stop improper refunds, better access to wage and withholding information would help it prevent more tax fraud, according to a new report by the Treasury Inspector General for Tax Administration. The IRS identified 249,185 fraudulent tax returns and prevented the issuance of $1.48 billion in fraudulent refunds during the 2010 filing season, a 50 percent increase over the number of fraudulent tax returns identified during the 2009 filing season, the report found.

Yet the report also found that the returns of those most likely to commit fraud are seldom screened by the IRS. TIGTA’s analysis found that the majority of tax returns the IRS identifies as being filed by prisoners are not being screened to assess their fraud potential. The review found that 253,929 (88 percent) of the 287,918 returns filed by prisoners as of March 24, 2010 were not selected for screening. Of those, 48,887 who claimed refunds totaling more than $130 million had no wage information reported to the IRS by employers.

While some of the potential fraud may have been caught by other IRS programs, the report concluded that giving the IRS expanded and expedited access to wage and withholding information during the filing season would significantly increase the IRS’s ability to more efficiently and effectively verify wage and withholding information reported on a tax return at the time a tax return is processed.

TIGTA’s analysis of the 151,776 tax year 2008 tax returns sent to an examiner for screening and then released for processing identified that 96,178 (63 percent) of these tax returns had valid wages reported. TIGTA estimates that the IRS needlessly expended 22,110 hours screening these tax returns. 

“While the IRS is identifying larger numbers of fraudulent returns, improvements must be made to its screening processes to ensure that returns filed by prisoners get adequate scrutiny,” said TIGTA Inspector General J. Russell George in a statement. “Unscrupulous individuals, including prisoners, continue to submit tax returns with false income documents to the IRS for the sole purpose of receiving a fraudulent refund. Expanded and expedited access to wage and withholding information would significantly increase the IRS’s ability to verify information reported on a tax return when processed, and prevent fraud.”

The IRS uses data mining to identify potentially fraudulent tax returns using formulas based on specific characteristics of the tax return. TIGTA assessed the IRS’s processes to identify potentially fraudulent tax returns for screening.

Existing law limits IRS access to wage information submitted by federal agencies and state workforce agencies to the Department of Health and Human Services. Only individuals claiming the Earned Income Tax Credit have their wage information submitted to the IRS. In addition, the IRS could benefit from expediting the use of wage and withholding information it receives from the Social Security Administration.

TIGTA made four recommendations to the IRS, including: seeking increased access to HHS data; verifying whether the 48,887 tax returns with tax refunds that were filed by prisoners with no reported wages were fraudulent; and identifying revisions that could be made to data mining criteria to better identify fraudulent tax returns filed by prisoners.

In response to the report, IRS officials fully agreed with three recommendations and partially agreed with the other. The IRS disagreed with the amount of potential savings from expanded and expedited access to SSA data and improving verification of prisoner tax returns. However, the IRS said it was evaluating an improved process for to acquire and manage prisoner information from federal and state prison systems.

IRS Wage and Investment Division Commissioner Richard Byrd Jr. said his division would work with the Small Business and Self-Employed Division to review the 48,887 tax returns with refunds filed by prisoners for potential inclusion in IRS post-refund compliance efforts.

“It should be noted that our data mining models and Internal Revenue Manual procedures currently give special scrutiny to prisoner returns,” he noted. “We also appreciate your support for legislation giving IRS access to up-to-date prisoner information that will further enhance these efforts.”

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