Some of the tax returns selected by Internal Revenue Service examiners showing signs of potential fraud didn’t have millions of dollars in refunds held last year as they were required to be, according to a new report, and in other cases the required notifications weren’t sent to taxpayers.

The report, from the Treasury Inspector General for Tax Administration, looked at the IRS’s Integrity and Verification Operation function, which screens and verifies potentially fraudulent tax returns to stop improper tax refunds from being issued. Tax examiners who work for the IVO function review the income and withholding amounts on tax returns looking for possible inconsistencies. In some cases, they contact employers to confirm the income and withholding amounts. Taxpayers’ refunds are usually delayed while the IVO function finishes this work.

However, TIGTA found that refund holds weren’t always placed on tax accounts, leading to erroneous release of tax refunds associated with potentially fraudulent tax returns. TIGTA reviewed 236,097 tax returns screened by the IVO function between Jan. 1 and April 21, 2016, and identified 1,333 potentially fraudulent tax returns. Nevertheless, tax refunds totaling $7.3 million were erroneously released as a result of the programming errors.

On top of that, TIGTA found the IRS didn’t issue notifications to 15,877 of the 90,660 taxpayers (18 percent) whose income documents were sent to a tax examiner for verification during the same period. The tax code requires the IRS to notify a taxpayer in advance before contacting a third party, such as an employer or bank, to help resolve questionable items on the taxpayer’s return, because taxpayers have a legal right to know before the IRS contacts third parties to verify information on the return.

IRS management pointed out, though, that for the 15,877 taxpayers who didn’t receive the required notice, only 4,918 involved the IRS actually contacting a third party to verify the income and withholding. For the other 10,959 taxpayers, the IRS said it used internal data to verify the income and withholding amounts on the tax return.

Internal guidance for the verification process says the IRS is required to notify a taxpayer in advance that a third party may be contacted to help resolve their account. But because the IRS was unaware whether third-party contact was needed at the time the income documents were sent for verification, it should have issued the notice to all 15,877 taxpayers regardless of whether the third party was contacted, according to TIGTA.

TIGTA recommended the IRS develop processes to hold refunds associated with identified first-time filers of potentially fraudulent tax returns and make sure the refund hold marker is put on tax accounts to stop refunds from being mistakenly issued while under review.

The IRS agreed with both of TIGTA’s recommendations and said it has made programming changes that address the issues identified in the report.

“The IRS is committed to protecting U.S. taxpayers by proactively detecting potentially fraudulent refund claims and preventing their payment,” wrote Kenneth C. Corbin, commissioner of the IRS’s Wage and Investment Division, in response to the report. “These protection processes save billions of dollars annually by stopping the issuance of potentially fraudulent refunds.”

IRS headquarters in Washington, D.C.
Andrew Harrer/Bloomberg

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