Does the IRS really know who you are?
Connecting state and local government leaders
Identity theft could be costing the government billions of dollars a year in fraudulent tax refunds, and it is hard to say whether the shift to electronic tax filing is a boon or a bane.
The IRS touts electronic filing as the safest way to file tax returns, but it is impossible to say just how safe it is.
There are hints in a recent report from the Treasury Department’s Inspector General for Tax Administration that online filing might be making things safer, but the title of the report highlights the broader problem: “There are Billions of Dollars in Undetected Tax Refunds Resulting from Identity Theft.”
According to the report, auditors turned up 1.5 million potentially fraudulent returns claiming refunds of $5.2 billion. Extrapolating this figure, while taking into account improvements the agency is making in spotting phony claims, the auditors projected that this could cost (honest) taxpayers $21 billion over the next five years.
Auditors turned up some interesting figures on fraudulent returns that should have been tip-offs to tax collectors. For example, there were 4,864 tax returns filed from just five addresses in Michigan, Illinois and Florida, for which $8.1 million in refunds had been issued. By far the busiest address was in Lansing, Mich., sending in 2,137 returns for $3.3 million in refunds.
The IRS cannot say for sure whether the shift to e-filing is making things safer or more dangerous. In recent testimony prepared for a House Oversight and Government Reform subcommittee, the Government Accountability Office reported that the total number and cost of fraudulent returns is unknown, and the agency does not track the characteristics of known frauds, including whether returns are more likely to be filed electronically or on paper.
IRS policy is to encourage — if not require — online filing. It is offering a Free File option for electronic filing in conjunction with a number of companies and it promotes its e-file service that can be used with commercial tax preparation software. As of last year, any tax preparer filing more than 10 individual returns must use e-file.
There are signs that electronic filing lets the IRS do a better job of spotting fraudulent tax returns. In calendar year 2009 the IRS identified 456,453 cases of ID theft, and just 440,581 in 2010. Each year taxpayers discovered about a quarter of these cases and the IRS found the rest. In 2011 the number of identified cases shot up to 1.1 million, with IRS identifying about 90 percent of them. In that year the number of online filings also increased sharply to 109 million from about 97 million in 2010. Maybe it is easier to spot those phony returns electronically.
Identity theft is not strictly an online problem, of course. But the nature of the Internet makes it easy for criminals to anonymously reach out to steal and manipulate, and the potential certainly exists for fraud on a scale that is not practical with ink and paper.
However the fraud is being committed, the IRS needs to take steps to ensure that electronic filing can be relied upon by both the taxpayers and the tax collectors. There is a burden on the third parties who are intermediaries for taxpayers and the IRS to ensure that data and identities are valid, but there also is a responsibility on the part of the IRS to adequately monitor that data as it arrives, flagging what is suspicious and improving its filtering over time.