The Internal Revenue Service is facing not only a budget crunch this tax season, but also rampant identity theft.

IRS commissioner John Koskinen recently issued warnings about the impact of years of successive budget cuts on the agency’s ability to help taxpayers and tax preparers answer questions this tax season, while cautioning that tax returns filed on paper are likely to experience longer delays than usual this year (see IRS Commissioner Warns Tax Refunds Could Be Delayed by Budget Cuts).

“This is the lowest level of funding since 2008, and the lowest since 1998 when inflation is considered,” he said. Koskinen warned that the cuts would set back efforts to curb identity theft-related tax fraud. “This means that new taxpayer protections against identity theft will be delayed,” he said.

Unfortunately, even as the IRS attempts to improve its computer filters to prevent identity theft, with its limited budget, states increasingly become the front lines of the battle. Last Friday, Intuit temporarily suspended electronic filing of state tax returns by its consumer tax prep software, TurboTax, when officials in Minnesota, Louisiana and several other states discovered attempts to file fraudulent income tax returns through TurboTax (see Intuit Temporarily Halts State E-Filing Amid Fraud Concerns). On Sunday, Intuit resumed e-filing of state tax returns after beefing up its security measures (see Intuit Resumes State E-Filing, Remains Vigilant).

Identity thieves are not only stealing Social Security Numbers these days, they are reportedly also stealing and selling login credentials for popular tax software.

Jay Weill, a partner at the law firm Sideman & Bancroft and former chief of the Tax Division of the U.S. Attorney's Office in San Francisco, thinks the IRS budget cuts at the hands of Congress are a big mistake.

“I do a lot of criminal tax work and the IRS Criminal Investigation agents predict that within a year, after attrition and retirements, there will only be about 1,600 IRS special agents, and of those special agents 300 or 400 of them are reviewers and supervisors,” he said in an interview last week. “So maybe there will be 1,100 or 1,200 people whose sole job is to investigate criminal tax cases throughout the United States. They’re going to have to do a lot more with a lot less.”

Tax professionals are concerned about how the IRS will cope with sharply limited resources. “They just don’t have the agent manpower to work on all the matters that come up,” said Weill.

He pointed out that the IRS is increasingly relying on automated cross-checking of W-2 and 1099 information forms by computer as a way to ensure compliance, but the IRS systems—many of which Koskinen recently told Congress date back to the Kennedy administration—often don’t catch more sophisticated forms of tax fraud or simple misreporting.

“They always are arguing there will be more audits of high-end individuals,” said Weill. “I don't know how they do that. Those audits are usually difficult and time consuming, because those individuals have the ability to hire professionals and there are just fewer agents.”

Identity theft-related tax fraud has become increasingly prevalent, with even prison inmates able to practice it from behind bars.

“For most of these guys in prison doing it, there’s not much deterrence,” said Weill. “What do they care? If they’re in prison sending out false tax returns, what are you going to do to them? Put them in jail? They’re already in jail.”

The IRS is making some headway working with both federal and prison authorities to deter this type of activity, but a report last November by the Treasury Inspector General for Tax Administration found that it could be doing more (see IRS Not Doing Enough to Curb Prisoner Tax Refund Fraud).

But with budget cuts nipping at the IRS’s heels and the probability of employee furloughs after tax season, the agency will be hard pressed to contend with all the many demands it has been tasked with, including implementation and enforcement of the Affordable Care Act and the Foreign Account Tax Compliance Act. The IRS has cut back on its help desk for both taxpayers and tax preparers, and is advising taxpayers to turn first to its Web site, IRS.gov, before calling its overloaded phone lines. Even the so-called Practitioners Priority Line is subject to long delays now.

“When I call the practitioner hotline it will tell me I’m going to be on the phone for three hours,” said Weill. “So you can just imagine, if a taxpayer calls, they're just going to say you’re going to get a callback. In that case, it can be four days later. To sit on the phone for three hours, just listening to music, no.”

Without a fresh infusion of funding from Congress, which does not hold the IRS in high esteem these days after a series of embarrassing scandals, the federal tax system is in danger of running off the rails.

Do you think the IRS is doing a good job so far this tax season?