Senate Seeks Ways to Fight Tax Fraud and Identity Theft

The Senate Finance Committee held a hearing Tuesday on moving forward with solutions to tax fraud and tax identity theft as they grappled with an expanding problem that has plagued recent tax seasons.

“Identity theft is a serious problem that is growing at epidemic proportions—especially tax-related identity theft,” said Senate Finance Committee chairman Max Baucus, D-Mont.  “According to the IRS Taxpayer Advocate, tax-related identity theft jumped more than 650 percent between 2008 and 2012. Last year alone, there were 1.8 million incidents of identity theft and fraudulent refunds.”

He told the story of one of the victims, a constituent from Baucus’s own state. Kipp Saile, a 48-year-old horseback outfitter in Pray, Mont., who was in the process of refinancing his home when he got a call from his tax preparer. When the preparer tried to submit Saile’s tax return to complete his refinancing, it was rejected by the IRS. According to IRS records, Saile had moved more than 2,000 miles to Maryland, taken up a new wife and no longer cared for his children.

[IMGCAP(1)]“In reality, of course, Kipp still lived on his 10 acres in Pray with his wife of 11 years, Heidi, and their three children,” said Baucus. “Someone had stolen Kipp’s identity and filed a false tax return using his Social Security number. That is where the nightmare began. Kipp has since been forced to spend every day trying to repair the damage to his name and credit. Needless to say, it has been a stressful experience. It has cost Kipp many a sleepless night and quite a bit of money. The refinance has been put on hold, costing him an additional $500 a month he would have saved with a lower mortgage. Instead of helping Kipp clear up this mess, the IRS has made a bad situation even worse. Kipp has been told twice by IRS employees that he wasn’t defrauded—the U.S. government was. And at least one IRS employee hung up on Kipp while he was trying to make his case. It’s outrageous. I won’t stand for a Montanan, or any American taxpayer, to be treated with that kind of disrespect by an agency that is supposed to serve them.”

One of the witnesses at the hearing was IRS Acting Commissioner Steven T. Miller. “I’m going to say this very clearly, Mr. Miller,” Baucus told him. “Never forget that you and everyone else at the IRS work for Kipp Saile, and all American taxpayers. Your job is to serve them. I certainly hope this was an isolated incident that does not reflect the type of service provided by the IRS. But there is no excuse for even one rude employee like this, and I intend to find out what you’re doing to make sure this type of behavior is not repeated. It’s critical that the IRS is ready and equipped to handle cases like Kipp’s, because they are increasingly common.”

He pointed to a story in last week’s USA Today highlighting egregious examples of tax ID fraud, including a case where one address in Michigan was used to file 2,137 tax returns. In another case, a single bank account was used to receive 590 direct-deposit refunds from the IRS totaling more than $900,000.

In recent congressional testimony, the IRS reported it had identified more than 900,000 fraudulent returns and stopped more than $6.5 billion in fraudulent refunds in 2011. The Treasury Inspector General for Tax Administration also recently reported that another 1.5 million fraudulent returns went undetected in 2011, potentially allowing $5.2 billion in refunds to be paid, Baucus noted. TIGTA estimated that if tax identity theft were not addressed, it could cost the IRS $21 billion in fraudulent refunds over the next five years.

“Enough is enough,” said Baucus. “It is time to act.”

Three weeks ago, members of the Senate Finance Committee were briefed on tax reform options that included proposals to help combat tax fraud and tax ID theft. Senator Bill Nelson, D-Fla., joined by Senators Benjamin Cardin, D-Md., Charles Schumer, D-N.Y., and Diane Feinstein, D-Calif., introduced comprehensive tax fraud legislation last week.

Baucus noted that the Obama administration has also included several significant tax fraud prevention proposals in its fiscal year 2014 budget, including limiting access to death records and omitting Social Security numbers on wage statements.

“But there is still much more that can be done,” said Baucus. “We know tax fraudsters have easy access to taxpayers’ Social Security numbers through online databases, hospitals and other businesses that store personal information. We need tougher controls on access to private information, but it needs to be done efficiently without adding more paperwork to the process.”

Baucus called for enabling the IRS to match a W-2 filed by an employer with a tax return before issuing a refund to help screen out fraudulent returns. “Right now, that is not happening,” he said. “We need to cut through the red tape and ensure this information gets to the IRS quickly.”

Baucus said he is worried about reports from the National Taxpayer Advocate that it takes, on average, more than 180 days to close cases. “That is unacceptable,” he said. “The IRS needs to step it up and improve the way it handles tax ID theft once cases are identified. Victims of ID theft—people like Kipp Saile—are forced to put their lives on hold while their cases languish in red tape. The IRS needs to speed up prosecution through better communication with federal, state and local law enforcement.”

Finance Committee Staffers Victimized

Sen. Orrin Hatch, R-Utah, ranking Republican member of the Senate Finance Committee, agreed with Baucus that the rapidly-growing crime of tax fraud by identity theft is a serious matter that deserves careful attention.  “I share the concerns of many throughout our country regarding tax fraud by identity theft,” he said. “From 2010 to 2011, the number of these crimes nearly tripled, going from about 440,000 to over 1.1 million.”

[IMGCAP(2)]Hatch noted that two senior members of the Finance Committee staff have been the victims of tax fraud by identity theft. “In both cases, criminals obtained their Social Security numbers, filed fraudulent returns, and collected refunds,” he said. “For both staffers, this began a nightmarish scenario in which they had to spend days on the phone and filling out paperwork just to be able to file their own tax return. And, in the end, they have to live with the fact that their Social Security numbers are out there and they can only hope that they aren’t used to commit another fraud.”

Hatch said the IRS has adopted a three-pronged approach to combating identity theft. The first is prevention, which means stopping this type of tax fraud from being successful in the first place. “Clearly, given the prevalence of this crime, much more work needs to be done in this area,” said Hatch. “The second prong is providing taxpayer services for those who have been the victims of identity theft. This is a significant focus of the IRS, but it appears that the agency is falling woefully short in some instances.”

He noted that an audit by the Treasury Inspector General for Tax Administration sampled 17 different identity theft cases and found that the average time it took for these cases to be resolved was 414 days. 

“That is simply too long a wait for taxpayers who have been the victims of identity theft,” said Hatch.

The third prong of the IRS’s approach is catching and convicting the criminals who have committed these crimes. “This is a critically important step,” said Hatch. “If we can step up enforcement, many would-be criminals would likely decide that it’s not worth the risk to commit these crimes.”

IRS Acting Commissioner Miller acknowledged that tax refund theft caused by identity theft is one of the biggest challenges facing the IRS. “The agency’s work on identity theft and refund fraud continues to grow, touching nearly every part of the organization,” he said. “For the 2013 filing season, the IRS has expanded these efforts to better protect taxpayers and help victims. More than 3,000 IRS employees are currently working on identity theft—more than double the number at the start of the previous filing season. We have also trained 35,000 employees who work with taxpayers to recognize identity theft and help victims. Since the beginning of 2013, the IRS has worked with victims to resolve more than 200,000 cases."

[IMGCAP(3)]"Our fraud detection efforts have increased as well," Miller added. "We expanded the number and quality of our identity theft screening filters, and we have suspended or rejected more than 2 million suspicious returns so far this filing season. The number of identity theft investigations by our Criminal Investigation division continues to rise, with more than 800 investigations opened so far this fiscal year.”

Barriers to Progress
However, Miller acknowledged that there were barriers to making further progress in the effort, including the sheer volume and complexity of the crimes, as identity thieves continue creating new ways of stealing personal information and using it for their gain. “Another [barrier] is the need to further upgrade our technology in order to implement improvements such as more sophisticated filters and better taxpayer authentication procedures,” he said. “Yet another barrier to further progress is the difficult budget environment. The work we are already doing on refund fraud and identity theft involves a difficult balance of resources and staffing at a time when our budget has been reduced by $1 billion over the last two years. We will continue to dedicate staff to resolving identity theft cases, even at the cost of having fewer people on our toll-free taxpayer service line or on our automated collection program that help us collect past due taxes.”

Miller urged the Senate to provide more resources for the agency, noting that the IRS spent approximately $328 million on refund fraud and identity theft efforts in fiscal year 2012.

The Obama administration’s fiscal year 2014 budget request proposes $101 million to support IRS efforts to prevent identity theft-related refund fraud, protect taxpayers’ identities, assist victims of identity theft, and enhance the revenue protection strategy implemented in fiscal 2013, Miller noted. The funding level proposed will permit the hiring of more than 800 additional full-time employees dedicated to identity theft work. “The administration’s budget request also provides $18.3 million to support continued implementation of the return preparer program, the goal of which is to increase competency levels of tax return preparers,” Miller said. “This program complements the IRS’ efforts on refund fraud and identity theft, given that these crimes often involve individuals who prepare tax returns on behalf of others to obtain fraudulent refunds.”

AICPA Recommendations
A representative from the American Institute of CPAs suggested a number of solutions to the problems of identity theft and tax fraud during the hearing.

“One of the most important topics for our members is identity theft,” AICPA Tax Executive Committee chairman Jeffrey A. Porter told the members of the Senate Finance Committee. He said the AICPA supports the IRS’s proposal to allow truncated Social Security numbers on some information reporting forms, but that it would be more effective if Congress changed the law in order to expand the initiative. For example, employers are required to provide employees a W-2 with their full Social Security number.

[IMGCAP(4)]“We urge Congress to permit truncation of Social Security numbers on all copies of W-2s other than the copy filed with the Social Security Administration,” Porter said. “We also urge you to consider extensive legislation to allow truncated Social Security numbers on all types of tax forms and returns provided to a taxpayer, employee or other recipient.” 

One of the contributing factors to making this tax filing season so challenging was the late issuance of corrected 1099 forms by brokerage firms, Porter noted. He explained that generally a 1099 form must be furnished to taxpayers by February 15. However, brokerage firms can amend a 1099 at any time. 

“Over the last few years, we’ve noticed more brokerage firms issuing corrected 1099s, sometimes issuing multiple corrected forms on the same account,” Porter said. “These forms create anxiety, confusion and for some taxpayers, an increase in tax preparation fees. As a result, many taxpayers now have a tendency to wait until they have received their anticipated corrected 1099s before providing the records to their CPA.”

“We recommend that you consider legislation that would permit taxpayers to report corrected 1099 de minimis changes in their income in the year of receipt.” Porter told the lawmakers. “It would streamline the tax return reporting process for both the government and taxpayers.”

Late Legislation Leads to Late Tax Season
The other major contributor to a difficult tax filing season, Porter said, “was the late enactment of legislation and the resulting delay in the release of 31 tax forms.” 

“Our members essentially lost the first half of filing season because the IRS could not accept tax returns that included certain forms until February or early March," Porter said. "Nevertheless, we believe the IRS did an outstanding job under difficult circumstances.  They maintained an open dialogue with stakeholders and were responsive to our concerns. Earlier this year, we submitted a letter to IRS Acting Commissioner Steve Miller on the delayed release of forms. Within days, the IRS issued a notice, which provided the relief requested from late-payment penalties.”

Porter singled out tax penalty reform as an important area for Congress to consider because the United States’ tax system depends on voluntary compliance by taxpayers. 

“Tax penalties should deter bad conduct without deterring good conduct or punishing the innocent,” he said. “Targeted, proportionate penalties that clearly articulate standards of behavior and are administered in an even-handed and reasonable manner encourage voluntary compliance with the tax laws. On the other hand, overbroad, vaguely defined and disproportionate penalties, particularly those administered as part of a system that automatically imposes penalties or that otherwise fails to provide basic due process safeguards, create a perception of unfairness that are likely to discourage voluntary compliance.”

Porter said the AICPA has “consistently supported tax reform simplification efforts because we are convinced such actions will reduce taxpayers’ compliance costs, encourage voluntary compliance, and facilitate enforcement actions.”

Among the most important tax reforms supported by the AICPA, Porter said, are repeal of the alternative minimum tax, the harmonization of education incentives, the enactment of consistent definitions in the Tax Code, wherever possible, the repeal of unused provisions and the simplification of the Kiddie Tax rules. “We also believe in the simplification and harmonization of retirement planning vehicles,” he said.

Budget Cuts
National Taxpayer Advocate Nina Olson pointed out that the deep cuts in the IRS’s budget since 2010 are harming the agency’s ability to combat tax-related identity theft and help taxpayers.

“Tax-related identity theft continues to impose significant burdens on taxpayers and the IRS,” she said. “While the IRS is taking the problem very seriously and has made some meaningful improvements in its processes, I remain deeply concerned that victims often have to wait in excess of six months to have their cases resolved and receive their refunds, and the IRS has yet to implement an effective program for overseeing cases with multiple issues that require coordination among functions, thereby allowing too many victims to fall between the cracks of IRS bureaucracy.”

Olson recommended that Congress, the Treasury Department, and the IRS develop a long-term plan to enable the IRS to process information returns, particularly W-2 forms, before it processes tax returns and issues refunds. “Front-end data verification would go a long way toward eliminating tax fraud and identity theft and could substantially reduce taxpayer burden,” she said. “I originally recommended these measures in my 2009 Annual Report to Congress, and the IRS has since taken some steps to move forward. One obvious requirement will be for Congress to move up the statutory deadlines by which employers and other payors of income must file information reporting documents with the government. Some significant issues, including taxpayer rights concerns, remain to be studied and overcome, but I believe the benefits of front-end data verification justify making this a near-term priority.”

Olson also recommended that Congress take steps to restrict immediate public access to the Death Master File. “The DMF is one source of information that identity thieves use to victimize taxpayers,” she pointed out. “Several proposals have been made that would allow DMF data to be made available to entities that have a legitimate business need for the information while curtailing general public access for several years.”

[IMGCAP(5)]Olson noted that as part of the law enforcement response to tax-related identity theft, the IRS has embarked on a program of sharing taxpayer return information with state and local authorities to facilitate prosecutions. “While this information-sharing program has certain benefits, I am deeply concerned that the Internal Revenue Code Section 6103 rules that require IRS employees to keep taxpayer return information confidential do not apply to state and local authorities,” she said. “With hundreds of smaller municipal governments now receiving tax return information, it is only a matter of time before one or more local officials—who unlike IRS employees do not receive regular training about the importance of protecting this information—use tax return information carelessly or inappropriately. I have raised this concern with the IRS, and its position seems to be that there is no problem because it only releases tax return information if a taxpayer executes a consent form. While it is true that the IRS is releasing return information only when taxpayers sign consent forms, my position is that most taxpayers are not experts on confidentiality waivers and may assume that state and local law enforcement authorities have the same legal obligations as IRS employees to keep their tax information confidential. It is critical that safeguards be put in place immediately to prohibit law enforcement authorities who receive tax return information for a specified purpose from using or re-disclosing that information for any other purpose without additional taxpayer consent.”

Re-imposing Tax Preparer Regulation

Olson also recommended that Congress re-impose tax preparer regulation, even though courts had ruled that the IRS had exceeded its statutory authority in imposing the regulatory regime. “Since 2002, I have recommended that tax return preparers be required to register with the IRS, pass a basic competency test, and take continuing education courses in order to improve industry standards and protect taxpayers from preparer errors. In 2010, the IRS began to implement such a program, but a U.S. District Court recently held that the IRS lacks the legal authority to do so,” said Olson. “The Justice Department has appealed the case to the U.S. Court of Appeals for the District of Columbia, and there is a reasonable chance the D.C. Circuit will reverse the lower court decision. If it does not, however, I recommend that Congress move quickly to grant the IRS the authority to reinstate the program. This committee has twice approved legislation along these lines–once under Chairman Baucus and before that under former Chairman Grassley. The program enjoys broad support from most preparer organizations and consumer groups, and should be relatively non-controversial.”

Baucus also called for reinstating the tax preparer regulation regime that was invalidated by the courts. “We also know that too often it can be the tax return preparers themselves who are the identity thieves,” he said. “Proper oversight by the IRS can help prevent this. But we still face obstacles. The IRS was handed a major setback recently when a federal court ruled against their authority to regulate tax return preparers. The case, Loving v. IRS, is ongoing, and I am hopeful that the IRS will succeed on appeal.” He said Congress would need to consider whether additional legislation is necessary to protect taxpayers from fraudulent preparers.

Baucus noted that his committee had outlined several ideas recently to re-impose tax preparer regulations (see Senators Lay out Tax Reform Options and Consider Re-imposing Tax Preparer Regulation).

Accessing Taxpayer Email
During the hearing, Sen. Chuck Grassley, R-Iowa, pressed IRS Acting Commissioner Miller to account for recent media reports stating that agency internal documents say agents have the ability to access taxpayer emails without warrants, despite a court opinion to the contrary (see IRS Reads Taxpayer Emails Without a Warrant). “The IRS has a very high burden to treat taxpayers within legal bounds and without abusive intrusion of privacy,” said Grassley. “The agency’s written materials suggest agents have the ability to access taxpayer emails without warrants.”

Miller said it isn’t the agency’s position that it has the right to access taxpayer emails without a search warrant. “If it’s not agency policy or practice, the IRS needs to clarify the true policy in writing, agency-wide,” said Grassley. “That’s critical, but it’s not enough. The IRS also needs to explain its aggressive stance in internal documents about accessing electronic communications and whether it in fact accessed electronic communications without search warrants and, if so, when and why. The IRS has to take this issue seriously, and a casual explanation is inadequate.”

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