There's a new area of controversy at the Internal Revenue Service, and it surrounds the recently released 2005 annual report from the Taxpayer Advocate Service -the independent organization within the IRS designated as the liaison between the IRS and taxpayers with problems.While the Taxpayer Advocate is required to identify at least 20 serious problems in her annual report, particular attention has been given to one topic in this year's report: the IRS's Criminal Investigation Questionable Refund Program.

The point of the QRP is to identify potentially fraudulent tax returns and intercept the refunds claimed on those returns before they get sent to the taxpayers. The criminal investigation division at the IRS uses a computer program to cull out the tax returns that meet certain characteristics, then the refunds from those returns are frozen while an investigation ensues.

The IRS claims that identified fraud has jumped by 322 percent in the past six years. The agency also estimated that fraudulent returns cost the government more than $500 million per year in unpaid taxes.

If the investigation proves fruitless and no fraud is found, the refunds are eventually returned to the taxpayers. However, no notice is sent to taxpayers advising them that their refunds have been frozen.

The National Taxpayer Advocate, Nina Olson, is concerned about the number of refunds being frozen that actually come from non-fraudulent tax returns, and the fact that these taxpayers are not advised of the refund freeze. In addition, she has expressed concern that a great percentage of the taxpayers whose refunds are frozen are low-income taxpayers on whom "the financial impact was substantial."

While noting that she understands the need for enforcement, Olson indicated that she thinks there are several "significant problems with the program."

Among those problems, she observed that:

* The fraud detection methods do not effectively screen out non-fraudulent returns. Approximately two-thirds of a sample of returns with frozen refunds examined by the TAS were found to be non-fraudulent.

* Taxpayers aren't notified that their refunds are being frozen, causing confusion and preventing effective fiscal planning. In addition, since taxpayers aren't advised of the frozen refunds, they are not given an opportunity to come forward and defend their tax returns.

* Refunds are being frozen in some cases for longer than six months, even on non-fraudulent returns. In part this is due to the fact that the IRS investigation division has limited resources to investigate all of the returns being frozen.

* Future returns of taxpayers found guilty of filing a fraudulent return are automatically frozen for an undisclosed period of years, even when there is little evidence that the fraud will be repeated.

* The IRS examination division does not have the resources to effectively deal with the spillover from these fraud cases.

It should be noted that the sample from which Olson drew her conclusions is a sample of returns that were fielded by the TAS. These are tax returns for which taxpayers have come forward and questioned the status of their refunds.

The IRS points out that "innocent taxpayers are much more likely to contact the TAS than those who have filed false or fraudulent returns," and the TAS acknowledges that its conclusions are unreliable.

Olson pointed out that the median adjusted gross income of the taxpayers in her sample who were found to be without fraud was $13,330, and the median refund received was $3,519. Seventy-five percent of taxpayers in her total sample had claimed the Earned Income Tax Credit.

The IRS has estimated that it loses from $6.5 billion to $10 billion per year due to amounts paid out erroneously under the EITC program. Various attempts in recent years to require proof of eligibility to claim the credit have not yet resulted in a permanent program.

EITC residency and qualifying child certification tests have been administered on a trial basis for the past two years, and are ongoing for the 2005 tax year.

Ending the big freeze?

The IRS said that refund fraud has increased significantly in recent years, and the agency estimates that false claims exceed $500 million each year, and that the computerized Questionable Refund Program holds for further scrutiny less than 1 percent of more than 100 million refund returns annually.

But the agency did move quickly to combat one of the major complaints outlined in the Jan. 10 report.

Shortly after the release of the report, the IRS announced new steps to improve the Questionable Refund Program and reduce the number of taxpayers subject to frozen refunds.

"The actions we're announcing constitute significant improvements to an important program," said IRS Commissioner Mark W. Everson, in a statement.

Changes include:

* Improvements to screening procedures in the coming months, with the agency working to improve the accuracy of filters in the program to reduce the initial number of valid refund claims held;

* Notification to taxpayers whose refunds are frozen, beginning this tax season; and,

* Earlier release of refunds, with the IRS expediting the review of returns.

Register or login for access to this item and much more

All Accounting Today content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access