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Does the IRS need more options to fight identity theft?

With tax fraud on the rise, the IRS faces a number of challenges but could use some expanded battle options

By Layer 8 on Fri, 06/03/11 - 10:42am.

The number of tax-related identity theft incidents is exploding and nowhere is that more obvious than at the Internal Revenue Service which as seen reports rice from 51,702 in 2008 to 248,357 in 2010.

More on identity theft: IRS: Top 10 things every taxpayer should know about identity theft

While it has programs in place to fight the identity theft issue, it is also hamstrung in many other areas, according to a report out this week from the Government Accountability Office. For example, the GAO says the IRS' ability to address identity theft issues is constrained by:

privacy laws that limit IRS' ability to share identity theft information with other agencies;
the timing of fraud detection-more than a year may have passed since the original fraud occurred;
the resources necessary to pursue the large volume of potential criminal refund and employment fraud cases; and
the burden that stricter screening would likely cause taxpayers and employers since more legitimate returns would fail such screening.

On top of those issues, according to the GAO, IRS officials said the agency pursues criminal investigations of suspected identity thieves in only a small number of cases. IRS's Criminal Investigations (CI) Division's investigative priorities include tax crimes, such as underreporting income from legal sources; illegal source financial crimes; narcotics-related financial crimes; and counterterrorism financing. In fiscal year 2010, CI initiated 4,706 investigations of all types, a number far smaller than the total number of identity theft-related refund and employment fraud cases identified in that year, the GAO said.

"The decision to prosecute identity thieves does not rest with IRS. CI conducts investigations and refers cases to the Department of Justice, which is responsible for prosecuting cases in the federal courts. IRS officials said that the small number of tax-related identity theft cases that they investigate recognizes that DOJ has to conclude that the case is of sufficient severity that it should be pursued in the federal courts before it will be prosecuted. According to data from CI included in a prior GAO report, the median amount of suspected identity theft-related refunds identified in the 2009 filing season was around $3,400," the GAO stated.

The IRS sees two kinds of identity theft, refund and employment fraud, according to a report issued this week by the GAO. With refund fraud, an identity thief uses a taxpayer's name and Social Security Number to file for a tax refund, which IRS discovers after the legitimate taxpayer files. In employment fraud, an identity thief uses a taxpayer's name and SSN to obtain a job. When the thief's employer reports income to IRS, the taxpayer appears to have unreported income on his or her return, leading to enforcement action, the GAO stated.

"The hundreds of thousands of taxpayers with tax problems caused by identity theft represent a small percentage of the expected 140 million individual returns filed, but for those affected, the problems can be quite serious," the GAO stated.

According to the GAO, the IRS has a three-pronged strategy to battle employment and refund fraud:

Resolve-IRS marks taxpayer accounts to alert its personnel of a taxpayer's identity theft. The purpose is to expedite resolution of existing problems and alert personnel to potential future account problems. . Taxpayers benefit because they do not have to repeatedly explain their identity theft issues or prove their identity to multiple IRS units. Indicators also alert IRS personnel that a future account problem may be related to identity theft and help speed up the resolution of any such problems.
Detect-IRS screens tax returns filed in the names of known refund and employment fraud victims. As of May 12, 2011, 216,000 returns filed in 2011 failed the screens and were assigned for manual processing. Of these, IRS has completed processing 195,815 and found that 145,537 (74.3%) were fraudulent.
Prevent-IRS provides taxpayers with information to increase their awareness of identity theft, including tips for safeguarding personal information. IRS has also started providing identity theft victims with a personal identification number to help identify legitimate returns. Since our 2009 report, IRS began a pilot program providing some identity theft victims with a 6-digit Identity Protection Personal Identification Number (PIN) to place on their tax return. IRS officials told us they created the PIN based on their ongoing evaluation of their identity theft initiatives. When screening future years' returns for possible identity theft, IRS will exclude returns with a PIN, which will help avoid the possibility of a "false positive" and a delayed tax refund. IRS sent letters containing an identity theft PIN to 56,000 taxpayers in the 2011 filing season. IRS will provide taxpayers a new PIN each year for a period of 3 years following an identity theft.

From the GAO: Looking further forward, other long-term initiatives underway at IRS have at least some potential to help combat identity theft-related fraud. In April 2011, the Commissioner of Internal Revenue gave a speech about a long-term vision to increase up-front compliance activities during returns processing. One example is to match information returns with tax returns before refunds are issued. Before this could happen, IRS would have to make significant changes. Third-party information returns would have to be filed with IRS earlier in the filing season. The IRS would also have to improve its automated processing systems; IRS's current Customer Account Data Engine effort is one key step.

While these efforts are part of a broad compliance improvement vision, they could also detect some identity theft-related fraud. If, for example, IRS could match employer information to tax returns before refunds are issued, identity thieves could not use phony W-2s to claim fraudulent refunds.

Follow Michael Cooney on Twitter: nwwlayer8

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