IRS prevents payment of $1.2 billion for fraudulent tax returns

The IRS was able to prevent $1.2 billion in payments from going to fraudulent tax returns in the first four months of 2013 alone, but the tax agency remains vulnerable to a lack of information from the private sector that could allow billions of dollars to be wasted, an investigative report has found.

The agency relies on third-party information from companies to confirm that what individuals report as their income and withholdings is accurate. It’s an easy way to check if taxpayers are telling the truth and is “the single most important tool that the IRS needs to identify and prevent tax refund fraud,” said a report by the IRS internal watchdog, the Treasury Inspector General for Tax Administration.

But often tax officials are being left with little information to go on when trying to track down frauds, making it more difficult to catch the billions that could be paid out.

“Most current year third-party information is not available until well after the tax return filing season begins and tax returns are processed,” the IG said.

It would take an act of Congress to change the dates of the tax filing season so fraud-detection agents could get the data they need, the IG said.

The report, made public Monday, was completed in August, but was heavily redacted so as not to give potential fraudsters a glimpse into how the IRS is tracking down bogus tax returns.

It follows an investigation from July 2012 that concluded the IRS missed 1.5 million fake tax returns in 2010 and paid out a potential $5.2 billion in false refunds.

The agency’s Electronic Fraud Detection System is supposed to red-flag tax returns that are believed to be falsified. It started in 1994, but the nation’s tax collection agency believes the process is becoming outdated and will begin using a new system in January 2015.

IRS officials said they are working to improve their fraud-detection capabilities.

“In the two years since those returns were received and processed, the IRS has identified and changed processes where controls needed to be improved and new approaches taken to more effectively address the threats posed by unscrupulous individuals filing fraudulent claims for refund,” a response from the agency said.

The most common falsehoods on tax forms are people misstating their income or withholding. Most are likely results of identity theft, with criminals filing false claims, the IG said.

Investigators did say that the IRS has improved its fraud-identification techniques since the massive amount of fakes that surfaced in 2010, and there could be a drastic reduction in money paid for false claims in 2011 to 2013. The IG’s office is beginning a similar investigation to look into the tax process for those years.

The agency’s verification did identify roughly 250,000 false tax returns in 2010, the watchdog said, stopping $1.45 billion from being paid out incorrectly.

In 2012, the IRS was able to stop $4.6 billion from going to fake tax returns, but it’s unknown at the moment whether that was because enforcement was better or there were more fraudulent forms filled.