Submitted: The Two Sides Team January 17, 2013

Identity-theft cases rocketed to 1.1 million in 2011 from 51,700 in 2008. The IRS has a backlog of 650,000.
January 13 2013

by Jay Starkman, via Wall Street Journal

Now that Americans finally know the tax rate they’ll be paying, it’s
time to start thinking about the annual drudgery of filing their
returns. It’s also the season when identity thieves begin ripping off
those returns and stealing billions in false or misdirected refunds. Tax
fraud, amazingly, is now the third-largest theft of federal funds after
Medicare/Medicaid and unemployment-insurance fraud.

Tax-identity theft exploded to more than 1.1 million cases in 2011
from 51,700 in 2008. The Treasury Inspector General for Tax
Administration last summer reported discovering an additional 1.5
million potentially fraudulent 2011 tax refunds totaling in excess of
$5.2 billion.

Why has identity theft rocketed through the Internal Revenue Service?
Because American taxpayers, urged on by the IRS, have taken to filing
their income-tax returns electronically and arranging for refunds to be
directly deposited into bank accounts. E-filing is appealing because it
provides an electronic postmark confirmation that the return was filed
on time. When it is combined with direct deposit, a refund can arrive in
as little as seven days. In 2012, 80% of individual returns were
e-filed, fulfilling an initial goal Congress set in 1998. The result is
an automated system in which the labor burden is transferred to the
taxpayer.

E-filing contributes to tax complexity as the IRS demands ever more
data for reporting of wage, interest and brokerage income with more tax
forms. A discrepancy may result in a rejection code, a letter from the
IRS Automated Underreporting Unit, or a computerized audit out of a
centralized IRS office in Ogden, Utah. There’s no cost to the IRS for
requesting extra information when it’s received electronically.

Targeting taxpayers for audit is a major factor behind the IRS’s push
for e-filing. E-filed returns are available for audit several months
sooner than paper returns, allowing more time before the three-year
statute of limitations expires. The IRS has even boasted that its e-file
database is “a rich and fertile field” for selecting audits and has
estimated that if its “screeners could be reallocated to performing
audits, they could bring an additional $175 million annually.”

Fraudulent tax returns can come in the form of tax-identity theft,
refund fraud, or return-preparer fraud and are difficult to prosecute.
With e-filing, evidence of fraud is difficult to find. There are no
signed tax forms, envelopes or fingerprints, and e-filing promises quick
refunds.

It’s easy for criminals to e-file using a real name and Social
Security number combined with a phony Form W-2 (wages) or fabricated
Schedule C (business income). The refund can be posted to an anonymous
“Green Dot” prepaid Visa or MasterCard
MA -1.43%
purchased at a drugstore. Such cards have a routing and account number
suitable for direct deposit. The IRS may even correct a fraudulent
return to refund the estimated taxes that the real taxpayer already
remitted, as happened to one of my victimized clients.

Another
form of fraud is when an unscrupulous return preparer modifies the
bank-routing information on a return so the direct-deposit refund will
wind up in his own bank account. He might increase the deductions so a
return will show a larger refund due, with only the increase routed to
his bank account. The victim will know nothing unless the IRS sends an
audit notice.

Other preparers have abused the return information of former clients
to file false refund returns in subsequent years. Criminals have
established physical offices and websites displaying names of major
tax-preparation franchises in order to gain genuine return documents and
signatures from unsuspecting victims.

The IRS will replace a lost or stolen refund check. However, a stolen
refund using an altered or erroneous routing number on a tax return
will generally not be refunded until the bank returns the funds to the
IRS. Otherwise, the taxpayer’s sole recourse is a lawsuit against the
return preparer.

Millions of Americans now pay the IRS via an Electronic Federal Tax
Payment System debit. Unlike ordinary creditors paid electronically, the
IRS is in the business of sending refunds but it doesn’t compare names
on bank records against its own files. So, with just the routing
information from a personal check, a skilled criminal can use the
electronic tax-payment system to transfer funds from a victim’s bank
account as an estimated-tax payment to another stolen name and Social
Security number, then file a refund claim transferring the stolen funds
to his own account. (This can be prevented by having your bank place an
“ACH debit block” on your account.)

Fraud is a major problem for states, too. Using TurboTax, a
25-year-old woman e-filed a fraudulent 2011 Oregon return reporting
wages of $3 million and claiming a $2.1 million refund—and the Oregon
Department of Revenue sent her the refund. In October, a hacker stole
3.8 million unencrypted tax records from the South Carolina Department
of Revenue. Georgia reports that 4% of its returns are fraudulent.

If you become a tax-identity theft victim, immediately seek a
referral to the IRS Identity Protection Specialized Unit or the Taxpayer
Advocate Service using Form 911. Keep in mind that it can take over a
year to resolve. The IRS has a backlog of 650,000 cases.

The national taxpayer advocate has
recommended that taxpayers be allowed to tell the IRS to accept their
return only when filed on paper, thus preventing e-file tax-identity
theft. So far the IRS has failed to allow this. Less effective methods
are to request an “electronic filing PIN,” available at www.irs.gov, and
file Form 14039, “Identity Theft Affidavit,” so that the IRS might
apply additional return-screening procedures. Sadly, conventional
credit-monitoring services are useless against income-tax identity
theft.

In sum, e-filing helps the IRS with
audit selection, costs the Treasury billions through fraud, and
transfers many costs of tax administration to you.

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