Although the dreaded tax day deadline has passed, for a number of taxpayers the difficulty may just have begun. Millions of Americans, who have waited the better part of a year to receive tax refunds, are in for a big shock when they learn that their refunds were sent to someone else as a result of tax-related identity theft. The legitimate refund will now take considerable time to be received by the taxpayer.
Currently, the Internal Revenue Service (IRS) has more than 3,000 employees assigned to identify theft cases. As of 2012, tax fraud identity theft made up 43 percent of all identification fraud in the United States. The IRS reports that it has identified 14.6 million false returns and stopped $50 billion in fraudulent refunds since 2012. Often taxpayers do not even know they are victims until they file their tax returns only to find a fraudulent return claiming refunds was previously filed and the false refund was issued by the IRS.
While the IRS has discovered many such incidents, identity thieves have nevertheless increased their efforts. Prisoners in jails throughout the United States have filed thousands of false tax returns through Internet-based tax-filing software. Foreign criminals have filed fraudulent tax returns and received refund payments via U.S. Treasury-issued debit cards. And thieves have even stolen Social Security numbers of children and deceased individuals to obtain fraudulent tax refunds.
To combat the epidemic, the IRS has implemented a multipronged approach. First, the IRS instituted new processes for the handling of filed tax returns and new compliance filters to detect fraud. Second, the IRS has begun mailing notification letters to taxpayers who may be victim and not know it. These letters advise taxpayers to check with their credit rating companies for possible fraudulent activity. Third, the IRS requests that identity theft victims, or those who believe to be targets of such schemes, file Form 14039, Identity Theft Affidavit, to obtain an IRS issued Identification Protection personal identification number (IP PIN). This IP PIN is a unique six digit number assigned annually to victims of identity theft for use in addition to their Social Security numbers when filing their federal tax return or other tax correspondence. In 2013, more than 770,000 IP PINs were issued. Finally, in conjunction with the IRS, U.S. Attorneys’ Offices have prioritized the investigation and prosecution of individuals who engage in stolen identity refund fraud. In the last year alone, more than 880 defendants involved in stolen identity refund fraud were charged.
While the IRS’s increased attention and resources has prevented the issuance of some 87 percent of all fraudulent refunds it identified, all of this raises a fundamental question. Why does the IRS persist in the practice that enables such schemes by issuing refunds before being certain the money is going to the legitimate taxpayer? Unfortunately under its current system, the IRS cannot always be certain that a return is filed by the person whose name and Social Security number is on it, but it often pays the refund anyway.
One simple way to stop most of the fraudulent refunds is to prevent any refund payments from being sent until after the April 15th filing deadline has passed. This would enable the IRS to recognize that more than one person is using the same Social Security number for a tax return, and prompt the agency to investigate which one is legitimate. But the IRS follows a congressional mandate to pay refunds as soon as possible after a return is received, often within days. While that has been promoted as efficient service, it also has prompted criminals to file false returns as soon as tax filing season begins, hoping to get a refund before the real taxpayer even thinks about filing.
Another way to cut the identity theft is for Congress to approve a recommendation from the National Taxpayer Advocate to create a “real time” system in which tax returns are matched up front with third-party financial information, such as Form W-2s and 1099s. Currently, the IRS often receives the electronic versions of that information weeks or months after it has issued a refund. This, however, would likely take several years to fully implement and would require increased IRS funding at a time when Congress has been cutting the agency’s budget.
If you have any questions regarding identity theft fraud, please contact Manager of Tax Controversy and State and Local Tax Alan Goldenberg, at firstname.lastname@example.org or 212-897-6421, or contact your Friedman LLP tax professional.