Why Stolen Identity Refund Fraud is the IRS's Biggest Problem, and What Can Be Done About It

[Originally Published in the California Journal of Tax Litigation (November 2014)]

Part 1 of 3

By Daniel W. Layton

The IRS’s tax return-related identity theft problem has officially crossed from an item of interest to law enforcement and tax professionals to a disturbing problem worthy of the national primetime news. On September 21, 2014, tax return-related identity theft (also known as “stolen identity refund fraud”) was the focus of a 15-minute segment on CBS’s 60 Minutes, Biggest IRS Scam Around: Identity Tax Refund Fraud.8 Among those interviewed in the segment were IRS Commissioner John Koskinen, Deputy IRS Commissioner Steve Miller, Southern Florida United States Attorney Wilfredo Ferrer, and Miami Field Office FBI Special Agent In Charge George Piro.

The seriousness of the matter certainly came through to anyone watching, with United States Attorney Ferrer using a geographically-appropriate water analogy to describe the situation as “a tsunami of fraud.” Florida has been the hardest hit by these fraud schemes, and Ferrer was also refreshingly blunt on several key points: that the scheme is surprisingly simple and requires no more than a computer, a social security number, and a date of birth; that the IRS was not ready to deal with the large number of fraudulent returns; and that clearing up a victim’s identity theft refund claim with the IRS can be “a nightmarish process.”

A Digital-Age Crime

Stolen identity refund fraud has grown in large part due to the IRS’s, and then criminals’ move into the digital age. Unfortunately for the IRS and many victims of stolen identity refund fraud, the IRS’s acceptance and use of technology has apparently been balanced too far on the side of taxpayer convenience, making it easy for criminals and honest taxpayers alike to receive a refund.

The IRS’s move to online return filing as we know it began in 2002, when the IRS allowed signing of e-file returns using a PIN, making the process entirely paperless. By 2005, more than half of all returns were e-filed.9 The e-filing is only part of the paper-free process, which is completed by the ability to have a refund wired from the Treasury to a bank or even a pre-paid cash card. Those accounts, too, can be opened online using essentially the same personally identifying information (“PII”) appearing on a tax return – a social security number, a name, and a date of birth. One element does typically require a physical presence and access to a mail box, however: a prepaid cash card or a bank account still requires real-world interaction to receive the card and withdraw cash from an ATM. The IRS’s online refund tracking system,10 has also allowed taxpayers and criminals alike to monitor their anticipated payments.

A Tsunami of Fraud

Like a tsunami, the stolen identity fraud has swollen to epic proportions in a very short time. Information from the Federal Trade Commission shows that complaints of tax or wage-related fraud11 grew from 15.6% in 2010 to 24.3% in 2011, 43.4% in 2012, and 30% in 2013.12 Stolen identity refund fraud now sits at the top of the IRS’s “Dirty Dozen” tax scams.13

According to a Government Accountability Office report released on September 23, 2014, the IRS estimates that $29.4 billion in tax return-related identity theft was attempted in the 2013 filing season (which presumably includes mainly 2012 tax year returns).14 Of this amount, the IRS estimates it paid $5.2 billion, just less than 18%.15 This is particularly disappointing news given the headway the IRS appeared to be making in battling this type of refund fraud. According to reports by the Treasury Inspector General’s Office (“TIGTA”), for tax year 2010 the IRS issued potentially fraudulent refunds of $5.2 billion as well, but that number diminished to $3.6 billion for the 2011 tax year returns (processed in 2012).16

Perhaps more troubling is that the IRS is doing a better job, at least percentage-wise. TIGTA reported that the IRS prevented approximately $12.1 billion in fraudulent refunds for the 2012 processing year, allowing approximately 23% of the attempted fraudulent refunds (out of a total of $15.7 billion attempted).17 The current increase in fraudulent refunds issued is despite a 5% improvement in detection and prevention by the IRS.18 Assuming the statistics are reasonably accurate from year-to-year, the take-away is that the incidences of stolen identity refund fraud has almost doubled over a single year, completely mitigating any positive effects of the IRS’s improved detection.

The reason for the increase is fairly obvious. Succinctly put by Corey Williams, a convicted perpetrator of stolen identity refund fraud who was interviewed as part of the 60 Minutes piece: “Anybody who knew about it, you’d be a fool to not try to get involved with making some money. I could just wake up in the comfort of my own home, and just get on a laptop, do about 15 returns a day. Fifteen time $3,000 a return, that’s $45,000 a day.”19 In other words, it became popular among criminals (or opportunists-cum-criminals) because it is easy and it works extremely well.

Williams was not exaggerating about how profitable the scheme can be for a criminal. According to TIGTA, 355 undetected fraudulent 2011 tax returns were filed using a single address in Colorado as part of such a scheme, and the IRS issued more than $1 million in refunds to that address before it was detected.20

The $3,000 per return figure was also not randomly picked by Williams. A common component to these schemes is that they rely on small refunds and filing high volumes of returns. To obtain those small refunds, the false returns are accompanied by a fabricated Form W-2 or 1099 showing a small amount of withholding and a small amount of income. The income is typically zeroed-out using the standard deduction, schedule A or dependents, and the return claims the modest refund of the false withholdings. Although the IRS has matching programs that most tax practitioners are familiar with, the matching programs don’t operate in real-time. During filing season, the IRS gives taxpayers the benefit of the doubt, assuming the information returns from the employers weren’t filed or processed yet. Because the amount of the refunds claimed is small, the returns aren’t given much scrutiny before refunds are issued.

Click Here to Read Part 2 of 3 (The Government’s Response)

Click Here to Read Part 3 of 3 (Potential IRS and Legislative Fixes)

Footnotes:

8 Currently available at www.cbsnews.com/news/irs-scam-identity-tax-refund-fraud-60-minutes.
9 IRS E-File: A History, available at http://www.irs.gov/uac/IRS-E-File:-A-History.
10 Where Is My Refund?, available at http://www.irs.gov/Refunds.
11 Where an undocumented worker uses false identity documents to obtain work, identity theft can result in a taxpayer having a Form 1099 or W-2 showing income they didn’t earn filed with the IRS.
12 Consumer Sentinel Network Data Book for January-December 2011, Federal Trade Commission, available at http://www.ftc.gov/sites/default/files/documents/reports/consumer-sentinel-network-data-book-january-december-2011/sentinel-cy2011.pdf; Consumer Sentinel Network Data Book for January-December 2013, Federal Trade Commission, http://www.ftc.gov/system/files/documents/reports/consumer-sentinel-network-data-book-january-december-2013/sentinel-cy2013.pdf.
13 IRS Releases the “Dirty Dozen” Tax Scams for 2014; Identity Theft, Phone Scams Lead List, IR-2014-16 (February 19, 2014), http://www.irs.gov/uac/Newsroom/IRS-Releases-the-%E2%80%9CDirty-Dozen%E2%80%9D-Tax-Scams-for-2014;-Identity-Theft,-Phone-Scams-Lead-List.
14 Identity Theft – Additional Actions Could Help IRS Combat the Large, Evolving Threat of Refund Fraud, GAO-14-633, p. 10 (released September 22, 2014), available at http://www.gao.gov/assets/670/665368.pdf.
15 Id.
16 Detection Has Improved, However Identity Theft Continues to Result in Billions of Dollars in Potentially Fraudulent Tax Refunds, TIGTA Report 2013-40-122 (September 20, 2013), available at http://www.treasury.gov/tigta/auditreports/2013reports/201340122fr.pdf.
17 Id.
18 Of course, another explanation for the differences in the data could be different methods of identifying the potentially fraudulent returns, e.g., the higher 2012 figures could be the result of better detection and, thus, more accurate inclusion in the data pool.
19 Biggest IRS Scam Around: Identity Tax Refund Fraud, 60 Minutes, CBS (September 21, 2014).
20 Detection Has Improved, However Identity Theft Continues to Result in Billions of Dollars in Potentially Fraudulent Tax Refunds., TIGTA Report 2013-40-122 (September 20, 2013).