What Can the IRS Do to Limit Fraudulent Tax Refunds Due to Identify Theft


By Jim Gilboy

The U.S. Government Accountability Office conducted a study of the Internal Revenue Service procedures related to the issue of tax refunds and fraudulent identity theft. Based on preliminary analysis, the IRS estimates it paid $5.2 billion in fraudulent identity theft refunds in filing season 2013, while preventing $24.2 billion.

Identity refund fraud takes advantage of the IRS's “look-back” compliance model. Under this model, rather than holding refunds until completing all compliance checks, the IRS issues refunds after conducting selected reviews. While there are no simple solutions, one option is earlier matching of employer-reported wage information to taxpayers' returns before issuing refunds. The IRS currently cannot do such matching because employers' wage data (from Form W-2s) are not available until months after the IRS issues most refunds. The filing deadline for electronic W-2s is April 1 each year. Consequently, the IRS begins matching employer-reported W-2 data to tax returns in July, following the tax season. If the IRS had access to W-2 data earlier—through accelerated W-2 deadlines and increased electronic filing of W-2s—it could conduct pre-refund matching and identify discrepancies to prevent the issuance of billions in fraudulent refunds.

The GAO made the following recommendations:

Accelerated W-2 deadlines. In 2014, the Department of the Treasury (Treasury) proposed that Congress accelerate W-2 deadlines to January 31. However, the IRS has not fully assessed the impacts of this proposal. Without this assessment, Congress does not have the information needed to deliberate the merits of such a significant change to W-2 deadlines or the use of pre-refund W-2 matching. Such an assessment is consistent with the IRS's strategic plan that calls for analytics-based decisions, and would help the IRS ensure effective use of resources.

Increased e-filing of W-2s. The Treasury has requested authority to reduce the 250-return threshold for electronically filing (e-filing) information returns. The Social Security Administration (SSA) estimated that to meaningfully increase W-2 e-filing, the threshold would have to be lowered to include those filing 5 to 10 W-2s. In addition, SSA estimated an administrative cost savings of about $0.50 per e-filed W-2. Based on these cost savings and the ancillary benefits they provide in supporting IRS's efforts to conduct more pre-refund matching, a change in the e-filing threshold appears warranted. Without this change, some employers' paper W-2s could not be available for IRS matching until much later in the year, due to the additional time needed to process paper forms.

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