TIGTA Recommends Steps for IRS to Reduce Fraudulent Refunds From Identity Theft

In a report released on Aug. 2, the Treasury Inspector General for Tax Administration (TIGTA) suggested that the IRS had missed 1.5 million tax returns with potentially identity-theft-related fraudulent tax refunds in excess of $5.2 billion for the 2011 filing season (TIGTA Rep’t No. 2012-42-080). The IRS itself reported that it detected 938,664 returns with fraudulent tax refunds of $6.5 billion in the same period.

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TIGTA recommended that the IRS make the following changes to its procedures to reduce the problem going forward:

1. Develop processes to use the National Directory of New Hires (NDNH), a database containing information on all newly hired employees, to verify wage and other information. (Currently, the IRS is not permitted to access this information for this purpose.) The IRS should also use prior-year third-party income and withholding information to identify fraudulent returns. The IRS agreed with this recommendation.

2. Develop processes to analyze characteristics of fraudulent tax returns resulting from identity theft and to refine the IRS’s existing tax processing filters. TIGTA used as an example its discovery that a large number of fraudulent tax returns came from the same address, noting that this was one method to flag suspicious returns. The IRS also agreed with this recommendation and noted that its processes are subject to continuous review.

3. Work on obtaining legislation authorizing the IRS to obtain information from the NDNH at frequent and regular intervals. The IRS agreed with this recommendation.

4. Develop a process to detect false Social Security benefit income and withholding claims at the time tax returns are processed using Form SSA-1099 information received from the Social Security Administration. That information is received in December, and the IRS should be using information from those forms earlier in the year, before it issues refunds. The IRS agreed and said that it had used the information in January this year while processing 2011 tax returns.

5. Coordinate with responsible federal agencies and banks to develop a process to ensure that tax refunds issued by direct deposit are made only to an account in the taxpayer’s name. The IRS said it will discuss with the government’s Financial Management Service whether such restrictions can be implemented.

6. Limit the number of refunds that can be deposited to the same account. Direct deposit makes it easier to get a refund without having to negotiate a paper refund check. The IRS has resisted having only one refund permitted per account because it is concerned about situations in which an account is in the name of multiple individuals. TIGTA countered by presenting evidence that some accounts had incredibly large numbers of deposits that the IRS had not detected. The IRS agreed to work with the Financial Management Service to determine whether these limits are feasible.

7. Work with Treasury to ensure financial institutions and debit card administration companies authenticate the identity of individuals purchasing a debit card and prevent the direct deposit of tax refunds to debit cards issued or administered by financial institutions and debit card administration companies that do not take reasonable steps to authenticate individuals’ identities. The IRS agreed to work with Treasury’s Financial Crimes Enforcement Network (FinCEN) to develop procedures to ensure individuals’ identities are authenticated.

There was one other recommendation, but it was completely redacted from the report.

Some other issues raised in the report included the IRS’s efforts to reduce the number of fraudulent returns filed using deceased taxpayers’ Social Security numbers by placing a lock on these taxpayers’ accounts. As of March 31, 2012, the IRS placed a deceased lock on more than 164,000 tax accounts and prevented approximately $1.8 million in fraudulent tax refunds claimed using deceased individuals’ identities.

The IRS issues an identity protection personal identification number (PIN) to protect victims of identity theft from further losses and make sure their refunds are not needlessly delayed. TIGTA had found that the process was not working well and many victims were having their refunds delayed. The IRS fixed the problem before the start of the 2012 filing season. The IRS issued an identity protection PIN to 251,568 individuals for this filing season, up from 53,799 last year.