Identity theft and tax simplification are high priorities for members of Congress, the IRS, and all taxpayers. All people are concerned about identity theft and how it affects them. According to a CNN Money report, 40 million people had their credit/debit card information stolen during the 2013 Christmas shopping season through a security breach at Target (see Wallace, "Target Credit Card Hack: The Latest," CNN Money (Dec. 27, 2013), available at money.cnn.com). In addition, people are aware of the complexity of the Code, and the majority of the population seeks assistance from tax preparers to file their returns. Though most people think the issues are unrelated, one potential way to decrease identity theft and preparer fraud is tax simplification.
Tax return identity theft and return preparation fraud are as rampant as ever and take various forms:
- An identity thief steals a taxpayer's Social Security number (SSN) and files a false return with it before the taxpayer files. The identity thief receives the refund unquestioned, since the thief's return is the first one filed with that SSN.
- An identity thief steals a deceased taxpayer's SSN and files a false return claiming a refund. Often, this can go on for years since no other person is filing a tax return under that SSN.
- A deceitful tax preparer promises large, attractive refunds where his or her commission is based on the refund. The taxpayer does not understand that the preparer is claiming false deductions such as, for example, extraordinary job expenses or that the taxpayer has five children instead of two. The taxpayer pays the return preparation fees and receives the large refund. Eventually, the IRS sends a notice requesting a return of the incorrect refund amount.
- An unscrupulous tax preparer alters a taxpayer's return, requesting a larger refund, after the taxpayer has signed the return. The preparer pockets the inflated portion of the refund, while the unsuspecting taxpayer receives the correct refund. Eventually, the IRS sends a notice requesting repayment for the misstatements on the tax return.
In response to a tax reform draft proposal by former Sen. Max Baucus, the former chairman of the Senate Finance Committee, the AICPA provided a comment letter on tax simplification measures that can help reduce identity theft. (Baucus's proposal is available at www.finance.senate.gov. The AICPA's comments are available at www.aicpa.org.) The proposal would provide much-needed reform for information returns (e.g., W-2, Wage and Tax Statement; Form 1099-INT, Interest Income; Form 1099-B, Proceeds From Broker and Barter Exchange Transactions; and Form 1099-DIV, Dividends and Distributions). The AICPA generally supports accelerated filing of forms such as W-2s with the IRS along with a request to immediately transfer information from the Social Security Administration (SSA) to the IRS. This would provide the IRS with a first line of defense by allowing it to properly match the reported information with amounts reported on tax returns. This would reduce the risk of identity theft, particularly using stolen SSNs. Since the thief, in most cases, has no other supporting taxpayer documentation, the false return would not be approved due to an inability to match to reported information.
Furthermore, accelerating due dates of third-party information returns would allow taxpayers to file more timely. Currently, many taxpayers are forced to extend their returns, since some information returns might not be provided to them until September. Earlier filing of this information, along with expanded electronic filing, would decrease the window of opportunity for filing false returns.
The AICPA also supports measures to close the tax gap by making the Code simpler. For example, the AICPA supports a proposal to expand information reported on Form 1098, Mortgage Interest Statement. The Institute thinks additional information, such as the unpaid mortgage balance and the address of the property, would assist taxpayers in complying with the mortgage interest limitations. The AICPA also supports simplifying higher education tax incentives to make it easier for students to determine which educational incentives they are eligible for, as well as simplifying reporting requirements for educational institutions.
Both simplification measures would decrease the opportunity for dishonest tax return preparers to take advantage of confused taxpayers as to which credits or deductions they can legally take. If taxpayers understood the higher education tax incentives or the mortgage interest limitations, a deceitful preparer would not be able to hoodwink them into receiving thousands more in refunds by wrongfully claiming the lifetime learning credit, an increased mortgage interest deduction, or other inflated deductions.
It has often been noted that prevention is much cheaper than correcting wrongs already committed. In 2012, the IRS estimated it prevented paying out $12 billion in fraudulent refunds by screening returns for potential identity theft (see Treasury Inspector General for Tax Administration Rep't No. 2013-40-122). Unfortunately, many fraudulent refunds were still paid. The costs of identity theft affect everyone, particularly in a time when budget constraints are felt by individuals, businesses, and government. As Chi Chi Wu, a staff attorney for the National Consumer Law Center, testified before the Senate Finance Committee on April 8:
Given the widespread level of incompetence and fraud, bringing enforcement actions on a one-by-one basis is simply inadequate as a response. For example, the lawsuit by U.S. Department of Justice (DOJ) against Instant Tax Service involved a multiyear investigation that revealed an "astonishing array of repeated fraudulent and deceptive conduct" [see ITS Financial, LLC, No. 3:12-cv-95 (S.D. Ohio 11/6/13)]. While it might be ultimately considered a success because it shut down that chain, the case probably cost the government tens and even hundreds of thousands of dollars in staff time by IRS personnel and DOJ lawyers-and there are allegations that the principals of Instant Tax might be continuing to operate under a new structure [see Rust, "Instant Tax to Dodge DOJ Order," Bank Talk blog (Nov. 20, 2013), at banktalk.org]. There are simply not enough resources to go after all of the bad actors. While it would get rid of a few of them, relying on enforcement alone is akin to treating just a skin lesion when the related disease has invaded a patient's entire body. [A complete transcript is available at www.finance.senate.gov.]
These immoral people perceive taxpayers' lack of understanding and prey on the opportunity it creates. By the time an unsuspecting taxpayer is alerted to a problem, the unscrupulous preparers or identity thieves are long gone. The resources spent on finding identity thieves could be spent instead on tax simplification. For example, it is hoped that a simple measure such as truncating SSNs will go into effect sooner rather than later. Though it seems simple, there are costs associated with truncating SSNs on various tax forms. IRS systems would need to be updated to correctly identify taxpayers from limited information. Brokers would need to update their systems to appropriately truncate SSNs and keep track of information.
Fortunately, some proposals have taken effect. For example, President Barack Obama signed into law restricted access to the Death Master File (DMF) (Bipartisan Budget Act of 2013, P.L. 113-67, §203). Limiting access to the DMF will help prevent identity thieves from taking on the identity of a deceased taxpayer.
Regardless of how tax return identity theft occurs, it is a crime of opportunity—an opportunity that a complex tax Code has created for devious criminals. The AICPA supports efforts to deter these behaviors since they create an administrative burden for unsuspecting taxpayers, are costly to the government, and result in a loss of public trust in the government and in the respectable tax practitioner community.
|Melanie Lauridsen is a tax technical manager with the AICPA. For more information about this column, contact her at email@example.com.