By now almost all of us have had this happen—a client calls to say they’ve received a 5747c letter from the IRS. They are being told to appear in person at a main IRS office (not necessarily one of the smaller community offices) along with two years of “everything they have” to verify their identity. They’ve called the IRS to make an appointment and been told there are no available appointment times within a 100 mile radius in the next 60 days.
And yes, this delay happens in large cities like Los Angeles too. The issue here is the IRS is being ever more vigilant in trying to confirm taxpayers’ identities and stop fraudulent returns. They are of course targeting people who are receiving a refund or had an overpayment applied to next year. However, the IRS’ filters aren’t working too well. I’ve seen letters for:
• A minor (the child of a large client) with a $10 refund who is filing their first return.
• A couple rolling $50 over as a prepayment to next year.
• An 85-year-old senior in an assisted living facility receiving a small refund.
While anybody could be the victim of identity theft, the three returns above fail the materiality test. And thieves don’t often roll over refunds as a pre-payment on next year’s return!
The one thing that these returns all have in common is they were professionally prepared.
A CIO friend of mine has said that IT security is like an onion—it consists of layers of protection. Identity theft prevention, particularly for the IRS, is similar. While the IRS’ current program needs to be refined, there is more that can and should be done to help them. This is where Positive File come in.
Back in the 1990s (and possibly earlier) banks and software publishers got together and established a system whereby check issuers could send a file to their banks detailing checks they had issued. As checks were presented for payment, the bank compared the check against the list of issued checks and if it didn’t match, payment was held until the validity of the check could be confirmed. The system is still in use today.
Similarly, Positive File adds another layer of security to IRS return processing. Here are the basics of what I’m suggesting:
• Paid preparers who already have an EFIN would be issued a software “key” by the IRS. The IRS might determine they need to further verify the preparer in order to issue a key.
• Periodically (such as at the end of the day), the preparer would create a file identifying the returns that contained refunds or applied overpayments, and were e-filed with the IRS since the last time a similar file was prepared.
• The file would be an XML file that would contain information on each return e-filed, including the
o EFIN number
o Preparer PTIN number
o Taxpayer SSN(s)
o AGI as shown on the return
o Refund Due/Overpayment Applied
o Whatever additional data the IRS determines they need.
• The file would be encrypted with the above-mentioned key. The file name would contain the EFIN number of the preparer sending the document so the IRS would know what key to use to decrypt the file.
• As with the Positive Pay system referenced above, the Positive File system’s data would be matched against electronically filed returns, and those that matched would go forward with their processing. Those that didn’t would be subject to further selection and possibly additional verification.
Benefits and Limitations
• The files would be encrypted in transmission, thus protecting their contents.
• Since only the IRS and the preparers have the preparer’s software “key,” it wouldn’t be easy for bad actors to insert data into the process.
• XML data file requirements could be easily changed from year-to-year. And the program could be expanded to include all returns if necessary.
• No, this won’t benefit self-prepared returns, and yes that is where the majority of fraudulent returns come from.
While this isn’t the solution for all cases, it would go a long way toward simplifying the IRS’ identity verification processes and could become a part of a comprehensive system that the IRS uses to reduce fraudulent returns. And this is simple enough that, with cooperation between the tax preparation software publishers and the IRS, it should be available by next tax season. A win for the IRS, the preparers and our clients.