Internal Revenue Service and Treasury officials faced questions from Congress on Thursday over how well the IRS is responding to taxpayer identity theft concerns and efforts to close the growing tax gap.
IRS Deputy Commissioner Steven T. Miller revealed at a hearing of the House Oversight and Government Reform Subcommittee on Government Organization that the IRS general counsel has given permission to the agency to finally share information with taxpayers whose identities have been stolen about how the tax refund money was used so victims can then bring the evidence to local law enforcement.
Members of Congress have been pushing the IRS to share more information with local law enforcement authorities, but up to now taxpayer privacy protections have gotten in the way. By providing the information to the affected taxpayers, the IRS will be able to help more identity theft victims.
Miller noted that the IRS has been putting in place identity theft filters to screen out more returns that show signs of identity theft (see IRS Steps up Efforts to Combat Identity Theft). Since 2008, the IRS has marked the accounts of more than 460,000 taxpayers who appear to have had their identities stolen outside the tax system. These are taxpayers who have filing requirements and who are or may be affected by the theft. He noted that this year, the IRS protected at least $1.4 billion in refunds from being erroneously sent to identity thieves.
“Various new identity theft screening filters have been put in place to improve our ability to spot false returns before they are processed and before a refund is issued,” he said. “For example, new filters were designed and launched that flag returns if certain changes in taxpayer circumstances are detected. As of March 9, 2012, we have stopped 215,000 questionable returns with $1.15 billion in claimed refunds from filters specifically targeting refund fraud.”
Miller noted that this filing season the IRS has also expanded its work on several fraud filters that catch not only identity theft but other types of fraud. The IRS has also implemented new procedures for handling tax returns that it suspects were filed by identity thieves.
“Once a return has been flagged, we will correspond with the sender before continuing to process the returns,” Miller added.
Identity theft filters are not ideal, however, and were one of the prime causes of tax refund delays this tax season (see 7.8 Million Tax Refunds Delayed This Season at IRS). Witnesses at the hearing testified that taxpayers may need to get used to longer wait times for tax refunds if they want to be sure their refunds are kept away from identity thieves.
Fraudulent tax returns are identified through the IRS’s Electronic Fraud Detection System as well as through the manual screening of paper tax returns. Individual tax returns are sent through the EFDS and are scored based on the characteristics of the tax return and other data, according to Treasury Inspector General for Tax Administration J. Russell George. “The higher the score, the greater the probability that the tax return is fraudulent,” he said. “For those tax returns meeting a certain score, the tax return is sent to an IRS employee to be screened for fraud potential. For the 2012 filing season, the IRS has developed new filters to better identify identity theft before issuing fraudulent tax refunds. As of March 7, 2012, the IRS had identified 128,242 tax returns involving identity theft with $793 million in associated fraudulent tax refunds.”
Miller testified that the IRS has also pulled some of its employees from other service areas in order to focus them on helping with identity theft cases. During the hearing, he also said that the IRS is having ongoing discussions about how to catch identity thieves who are using prepaid debit cards for depositing the fraudulent tax refunds, but he noted that it is difficult in many cases to trace the accounts.
The IRS has also accelerated the availability of information returns in order to identify mismatches earlier, to enhance its ability to spot fraudulent tax returns before they are processed, he noted. In addition, the IRS has coded accounts of decedent taxpayers whose Social Security numbers were previously misused by identity thieves to prevent future abuse. The IRS is also identifying the tax returns of recently deceased taxpayers to determine if it is the taxpayer’s final return, and then marking the accounts of deceased taxpayers who have no future filing requirement.
So far this filing season, 66,000 returns have been stopped for this type of review. The IRS has expanded the use of a list of prisoners to stop them from filing problematic tax returns. Miller said the IRS has stopped 135,000 questionable returns this filing season. For the fiscal year, the agency has prevented nearly $800 million in refunds, an 80 percent increase in refunds stopped over the same period last year.
More Identity Theft Help Needed for Victims
The IRS’s Criminal Investigation division is also involved in efforts to combat tax-related identity theft and has established an Identity Theft Clearinghouse, a specialized unit that became operational in January, to work on identity theft leads. The ITC receives all refund-fraud-related identity theft leads from IRS-CI offices. Its primary responsibility is to develop and refer identity theft schemes to the field offices, facilitate discussions between field offices with multi-jurisdictional issues, and provide support for ongoing criminal investigations involving identity theft. So far in fiscal 2012, the IRS Criminal Investigation division has initiated 258 cases and recommended 150 cases for prosecution.
Indictments in identity theft cases total 167, with 49 individuals sentenced and average time to be served at 45 months. The IRS also conducted a coordinated identity theft sweep with law enforcement during the week of January 23 (see IRS and DOJ Bust Identity Thieves Across U.S.). “It was an outstanding success,” said Miller. “Working with the Justice Department’s Tax Division and local U.S. Attorneys’ offices, the nationwide effort targeted 105 people in 23 states.”
National Taxpayer Advocate Nina Olson noted, however, that many taxpayers who have been victimized by identity theft are still having trouble getting help from the IRS.
“I am pleased that, this filing season, the IRS has established a dedicated Taxpayer Protection Unit to answer phone calls from legitimate taxpayers who have been caught up in identity theft filters and to try to assist them,” she said. “Initially, the TPU was woefully understaffed to handle the volume of calls that came in. For the week ending March 10, the level of service on this unit’s phone line was 11.7 percent, meaning that only about one out of every nine calls was answered. In the following weeks, the IRS provided additional staffing for the TPU, and the level of service for this line has improved. For the week ending April 14, the TPU achieved a 35.3 percent level of service, with the average wait time remaining at one hour and six minutes. This performance is unacceptable; the TPU clearly requires more support. I note, however, that in a zero-sum budget environment, providing more resources for this unit means another unit in the IRS will have less. And those callers that did get through had to wait on hold an average of an hour and six minutes!”
Subcommittee chairman Todd Russell Platts, R-Penn., complained about the long hold times for identity theft victims. “That is not how you treat the victim of a crime!” he said.
Closing the Tax Gap
The hearing also looked at ways to close the tax gap, estimated at $380 billion to $450 billion in 2006. The net tax gap of $380 billion is defined as the amount of true tax liability that is not paid on time and is not collected subsequently, either voluntarily or as the result of enforcement activities, while the gross tax gap of $450 billion is defined as the amount of true tax liability that taxpayers do not pay on time.
Treasury Inspector General of Tax Administration J. Russell George testified that he believes that those numbers underestimate the true size of the tax gap and added that he believes it is growing. Much of the tax gap stems from unreported tax liabilities. Of the $450 billion gross tax gap in tax year 2006, $376 billion (or approximately 84 percent) is estimated to result from the underreporting of tax liabilities. “Compliance is far higher when reported amounts on tax returns are subject to information reporting and withholding,” said George. “For example, when there is substantial information reporting and withholding, the compliance rate is 99 percent. For amounts subject to substantial information reporting but not withholding, the rate is 92 percent. For amounts subject to little or no information reporting, such as business income, the rate is only 44 percent.”
He recommended that the IRS beef up its compliance research and strategies to address the areas of highest risk of noncompliance. “The IRS’s systems that identify returns for examination need improvement,” he said. “IRS examinations continue to result in no change to the return, resulting in an inefficient use of examination resources and increased burden on compliant taxpayers. In addition, IRS collection activity that extends for years has a lower rate of collection for delinquent liabilities.”
George noted that investments in technology should result in efficiency gains and better targeting of examination efforts. He also believes the IRS should improve its document-matching programs to match tax returns against third-party information returns such as W-2 and 1099 forms.
“The IRS does not have reliable third-party data for all taxpayer sectors and for all types of tax returns, most notably income earned by the self-employed,” he said. “The IRS reported that, without this data, it cannot easily detect errors or potential fraud except through expensive and intrusive examinations.”
He added that the IRS also has insufficient enforcement resources to handle a growing caseload of noncompliance and potential fraud cases. In fiscal year 2010, the IRS’s Collection function was unable to work all of the existing accounts in the queue with its current staffing, and the number of new taxpayer delinquent accounts was outpacing closures. If changes do not occur, a significant number of cases will continue to not receive additional contact to resolve the tax delinquency, he added,
The Government Accountability Office also submitted a report on the sources of taxpayer noncompliance behind the tax gap and how to reduce them.
“Noncompliance does not have a single source but occurs across different types of taxes and taxpayers,” said the report. “For example, individual income tax accounts for the largest portion of the tax gap, but corporate income tax and employment tax are also significant. Further, misreporting by individuals involves business income, non-business income, deductions, and credits.”
The extent of misreporting depends on the extent to which income tax is withheld or reported to the IRS by third parties. For example, nearly 40 percent, or $179 billion, of the 2006 gross tax gap is due to misreporting of non-corporate business income and related self-employment taxes.
“Much of this misreporting can be attributed to sole proprietors underreporting receipts or over-reporting expenses,” said the report. “Unlike wage and some investment income, sole proprietors’ income is not subject to withholding and only a portion is reported to IRS by third parties.”
The GAO noted that enhancing information reporting by third parties to the IRS could reduce tax evasion and help taxpayers comply voluntarily. However, identifying additional reporting opportunities can be challenging because third parties may not have accurate information available in a timely manner. In addition, adding reporting requirements creates burden for both third parties and IRS.
National Taxpayer Advocate Nina Olson commented that the IRS would have to require households to report on the person cutting their grass in order to get third-party information reports on the self-employed. However, she noted that the IRS is trying to do more “behavioral modification” this year to drive more taxpayers into self-reporting their extra income, for example, by including new lines on some of the tax forms.
GAO director of strategic issues James White recommended getting more information on sources of income such as from rental properties as one way to help close some of the tax gap. He noted that receiving information from third parties earlier would also help the IRS pre-match information with the 1040.
The GAO report also recommended providing high-quality services by telephone and correspondence or online to help taxpayers who wish to comply with tax laws but do not understand their obligations. However, the report added that tax law changes and funding priorities have recently affected the IRS’s ability to provide quality taxpayer services.
Devoting additional resources to enforcement would enable the IRS to contact millions of potentially noncompliant taxpayers it identifies but cannot contact, the GAO noted. To determine the appropriate level of enforcement resources, policymakers would need to consider how to balance taxpayer service and enforcement activities and how effectively and efficiently IRS currently uses its resources.
Expanding compliance checks before the IRS issues refunds would involve matching information returns to tax returns during, rather than after, the tax filing season, according to the GAO report.
This approach would require a major reworking of some fundamental IRS computer systems but could help address identity theft-related fraud and allow the IRS to use enforcement resources on other compliance problems, the GAO noted.
Leveraging external resources, such as paid tax return preparers and whistleblowers, could also help improve tax compliance because paid preparers’ actions have an enormous impact on the IRS’s ability to effectively administer tax laws, and whistleblowers provide IRS information on suspected noncompliance.
Modernizing information systems would allow the IRS to post more comprehensive tax return information to its computer systems, which could facilitate the examination process and expedite taxpayer contacts for faster resolution. Simplifying the Tax Code would also help taxpayers understand and voluntarily comply with their tax obligations and limit opportunities for tax evasion, the GAO noted.
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