Why Stolen Identity Refund Fraud is the IRS's Biggest Problem, and What Can Be Done About It (Part 2 of 3)

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

Part 2 of 3

By Daniel W. Layton

The Government’s Response

The government’s response comes from three angles: (1) law enforcement response, designed to effectively prosecute identity thieves; (2) taxpayer-victim response; and (3) preventative measures.

Law Enforcement Response

Perhaps the biggest tool the IRS has used to detect identity theft schemes is the Scheme Development Center. By at least 2013, the IRS developed filtering tools that detect commonalities in returns, like the repeated use of the same address or bank accounts. In February of 2014, the first month of the filing season, the IRS identified and confirmed 28,076 fraudulent tax returns involving ID theft.21 However, because this method of detection involves recognition of patterns, it will only allow the IRS to respond to the scheme after several returns have already been processed.

Federal prosecutors now have more tools at their disposal as well. In 2004, Congress enacted 18 U.S.C. § 1028A, which prohibits the knowing use, without authorization, of another’s PII in connection with certain predicate offenses, many of which are now routinely charged in stolen identity refund fraud cases, like mail, wire and bank fraud. Although a similar statute with a wider range of predicate offenses, 18 U.S.C. § 1028(a)(7), had already been in the books in since 1998, the “big A” statute has become the prosecutor’s preferred charge in order to deter would-be identity thieves due to the mandatory minimum 2-year sentence consecutive to the sentence for the underlying offense.

To expedite investigation and prosecution of these cases, Department of Justice Tax Division Directives 144 and 145 were enacted in 2012 and 2014, respectively. These directives allow United States Attorney’s Offices to open stolen identity refund fraud grand jury investigations, to bring charges, and to obtain seizure warrants for forfeiture of criminally derived proceeds arising from such crimes, all without prior authorization from the Tax Division – so long as the United States Attorney’s Office has a designated in-house point of contact who reviews the cases and sends notice to the Tax Division.

In addition to IRS and federal law enforcement, local law enforcement is beginning to prosecute these cases more often. Because these are not particularly sophisticated crimes, many of them are committed by street-level criminals, gangs, or others with histories with local, rather than federal, law enforcement. The stolen identity refund fraud is often discovered as part of a larger criminal investigation or as part of a routine traffic or DUI stop. To allow local law enforcement to keep their momentum and use their resources to prosecute these cases, the IRS has begun a pilot program to enable local law enforcement, with the taxpayer-victim’s consent, to access the tax records necessary to prove the criminal conduct.22

Response to Taxpayer-Victims of Identity Theft Refund Fraud

The IRS’s Identity Protection Program is outlined in section 10.5.3 of the Internal Revenue Manual. Because, as tax practitioners know, talking to the right person and finding the right form are often half the battle, the two most important parts of that program are arguably the use of the Identity Theft Affidavit, IRS Form 14039, and the IRS Identity Protection Specialized Unit, which may be called at (800) 908-4490 for any ID theft related inquiries. Although there have been some instances in the past where identity theft victims have had to wait as much as 18 months to have their tax accounts cleared, the IRS now touts an average processing time of 6 months.23

The IRS divides identity theft issues into two categories: identity theft that is affecting tax administration, and identity theft theft at risk of (but not yet) affecting tax administration.24 Elsewhere in the Internal Revenue Manual this is referred to as “tax-related” or “non-tax-related” identity theft. The Form 14039 reflects this division, having different boxes to check depending on whether the taxpayer has reason to believe the identity theft has affected his or her return or has no reason to believe his or her returns have been affected yet.25 If the IRS has initiated and made a determination that the taxpayer was a victim of tax-related identity theft, it will systemically issue a notice CP 01A, We Have Assigned You an Identity Protection Personal Identification Number.26

To prove tax-related identity theft alleged by a taxpayer, the IRS will request supporting documentation, including:27

Authentication of Identity – a copy of a valid U.S. federal or state government issued form of identification (examples include a driver’s license, state identification card, social security card, or passport); and Evidence of Identity Theft – a copy of a police report or Form 14039, IRS Identity Theft Affidavit. Fortunately, supporting documentation can be accepted from someone who has power of attorney for the taxpayer (e.g., Form 2848, Power of Attorney and Declaration of Representative). Form 14039 requires a signature of the taxpayer or representative of the taxpayer.

Once a positive identity theft determination is made, the IRS will correct their records based on information submitted and cause issuance of a refund.28 In addition, the IRS will also issue the taxpayer an IRS Identity Protection PIN. The IRS Identity Protection PIN (IP PIN) is a unique six digit number that is assigned annually to victims of identity theft for use when filing their federal tax return that shows that a particular taxpayer is the rightful filer of the return. This is in addition to the e-filing PIN. The IP PIN will allow these individuals to avoid further delays in filing returns and receiving refunds.

Preventative Measures

The IRS has stated that it will continue to expand the filters it uses to recognize schemes prior to processing and issuing refunds.29 In addition, although IP PINs are not ordinarily issued without a tax-related identity theft determination, the IRS began a pilot plan in 2014 to issue IP PINs preemptively to some taxpayers in Florida, Georgia, and Washington DC, in addition to those who received a CP01A. 30

Click Here to Read Part 1 of 3 (A Digital Age Crime and A Tsunami of Fraud)

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

Footnotes:

21 Semiannual Report to Congress – October 1, 2013-March31,2014, TIGTA, available at http://www.treasury.gov/tigta/semiannual/semiannual_mar2014.pdf.
22 http://www.irs.gov/uac/Law-Enforcement-Assistance-Pilot-Program-on-Identity-Theft-Activity-Involving-the-IRS Back
23 IRS Combats Identity Theft and Refund Fraud on Many Fronts, FS-2014-1 (January 2014), http://www.irs.gov/uac/Newsroom/IRS-Combats-Identity-Theft-and-Refund-Fraud-on-Many-Fronts-2014; I.R.M. § 21.9.2.2.1 (05-29-2013), Identity Theft Time Frame.
24 I.R.M. § 21.9.2.1 (10-01-2013).
25 The process for non-tax related identity theft victims is not discussed here, but more information can be found in I.R.M. § 21.9.2.
26 An example can be found at http://www.irs.gov/pub/notices/cp01a_english.pdf.
27 I.R.M. § 10.5.3.2.5.3 (01-16-2014), Identity Theft Case Building.
28 I.R.M. § 10.5.3.2.8 (01-16-2014), Closing Identity Theft Issues.
29 IRS Combats Identity Theft and Refund Fraud on Many Fronts, FS-2014-1 (January 2014), http://www.irs.gov/uac/Newsroom/IRS-Combats-Identity-Theft-and-Refund-Fraud-on-Many-Fronts-2014.
30 2014 Identity Protection PIN (IP PIN) Pilot, IRS (January 2014), http://www.irs.gov/uac/Newsroom/2014-Identity-Protection-PIN-(IP-PIN)-Pilot.