The processes used by the Internal
Revenue Service to verify taxpayers’ income and withholding status are
inadvertently resulting in the issuance of potentially fraudulent tax refunds,
according to a new report.
The report, from the Treasury
Inspector General for Tax Administration, noted that a common characteristic of
fraudulent tax returns is that the income and withholding reported on the tax
return are false. The Electronic Fraud Detection System, or EFDS, is the IRS’s
main tool for identifying potentially fraudulent tax returns at the time they
are processed. As of April 3, 2013, the IRS reported that it prevented the
issuance this year of nearly $1.2 billion in fraudulent tax refunds through its
income and withholding verification processes. Yet those same processes are
nevertheless leading to the issuance of many potentially fraudulent tax
refunds.
TIGTA had earlier reported and
testified before Congress that access to current-year third-party income and
withholding information at the same time that tax returns are processed is the
single most important tool needed by the IRS to identify and prevent tax refund
fraud. However, most current-year third party information is not available
until well after tax-filing season begins and tax returns are processed, TIGTA
pointed out.
In July 2012, TIGTA reported on an
analysis of tax year 2010 tax returns in which it identified nearly 1.5 million
tax returns that were not detected by the IRS as potentially fraudulent, even
though they had the same characteristics as the fraudulent tax returns that the
IRS had confirmed as instances of identity theft. Analysis of the 1.5 million
undetected tax returns found that only 120,197 (or about 8 percent) received a
fraud score high enough to be sent for verification under the IRS’s
then-existing processes.
For its latest report, TIGTA
reviewed a random sample of 272 of the 120,197 tax returns and found that the
IRS’s income and withholding verification process is not always effective in
stopping the issuance of fraudulent tax refunds. In the report, TIGTA
recommended that the IRS ensure that it take action to prevent the issuance of
potentially fraudulent refunds when tax returns are not screened and verified
on a timely basis and ensure that the actions it takes in such cases are
sufficiently documented. In addition, TIGTA suggested that the IRS should change
its procedures to ensure that when tax returns are identified as potentially
fraudulent and are assigned to another IRS function for further scrutiny, the
tax refunds should be held until the tax returns are screened and verified.
In response to the report, IRS
officials agreed with TIGTA’s recommendations and said they have taken action
to extend tax account freezes to prevent the release of potentially fraudulent
tax refunds. The IRS also plans to re-emphasize the documentation requirements
of case actions and revise its instructions for IRS tax examiners to require
positive verification that an issue triggering an error code or referral has
been addressed.
“The report accurately describes the
challenges the IRS faces in processing returns prior to the availability of
third-party data,” wrote Peggy Bogadi, commissioner of the IRS’s Wage and
Investment Division, in response to the report. “The report is based on tax
year 2010 returns that were received and processed during calendar year
2011. In the two years since those returns were received and processed,
the IRS has identified and changed processes where controls needed to be
improved and new approaches taken to more effectively address the threats posed
by unscrupulous individuals filing fraudulent claims for refund.”
She pointed out that in the first
five months of 2013, the IRS has stopped over 1 million fraudulent tax refunds
valued at more than $6 billion.
Circular 230 Disclosure
Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication
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