Tax-related identity theft is a complex and evolving threat—and one that costs taxpayers billions of dollars annually. It is, without question, one of the most pressing challenges that we face in the world of tax administration. And while the government has taken some steps forward over the past several years in the effort to stop tax-related identity theft, it has also suffered some major setbacks. The current data indicates that the threat is growing, not shrinking, and without a more effective deterrence model, that trend is likely to continue in the wrong direction.
The recent cyber-attack on IRS computer systems that compromised the identifying information of more than 100,000 U.S. taxpayers was an unprecedented event. It was a grim reminder that our systems remain vulnerable and that our safeguards are not foolproof. While the data breach underscores the IRS’s technological challenges, even more fundamentally, it reinforces the need to prioritize and fund efforts to safeguard sensitive taxpayer data. But that, of course, is not a particularly new insight. Indeed, TIGTA warned just last year that protecting taxpayer data is currently the Service’s number one challenge. And for an agency facing many, many serious challenges, that is, well, saying a lot.
For their part, the Service and the administration have dedicated significant resources to combat identity theft. They have implemented technological tools and procedures that are significantly improving the ability to detect and prevent known forms of identity theft. They have initiated programs to centralize the analysis of identity theft leads, coordinate investigations, and facilitate information sharing with other law enforcement agencies. And their efforts have been recognized by TIGTA in its 2015 report, lauding the Service’s “significant improvements” in the prevention of identity theft fraud.
But a below-the-surface look at the data reveals that the government’s recent successes—and, to be sure, there have been some—have met head on with the dual reality that (1) the threat is only increasing, and (2) the IRS still has a long, long way to go to keep up. While the Service is thwarting more and more fraudulent identity theft refund claims, there are increasingly more and more fraudulent claims to prevent, and it is paying out more than ever to identity thieves.
Current Trends and the Scope of the Problem
Attempted identity theft refund fraud is rampant. During the 2013 filing season, identity thieves attempted to defraud the government out of an estimated $30 billion in refunds. The Service prevented approximately $24.2 billion of that, detecting over 832,000 fraudulent tax returns in the process.
How do these most recent figures compare with prior years? Favorably in at least one respect: Each year the IRS is detecting and preventing payment on more and more fraudulent refund claims. During the 2011 filing season, the IRS detected and prevented approximately $14 billion in fraudulent tax refunds. And during the 2012 filing season, $21.6 billion. These numbers, standing alone, imply a trend in the right direction.
But the other side of the equation tells a competing, and much less optimistic, story. While the Service prevented approximately $24.2 billion from being paid out in 2013, it still paid out about $5.8 billion on fraudulent identity theft refund claims. That represents a roughly 60 percent increase over the amount paid out on fraudulent claims in 2012. And that implies a step back in the wrong direction—a reversal of the positive headway that the Service had made in this respect over the two years leading up to the most recent data.
In other words, while the Service is indeed preventing more fraudulent refunds, there are increasingly more fraudulent refunds to prevent, and it is struggling to keep pace with the growing threat. And make no mistake, the threat is growing. The number of identity theft “incidents” impacting tax administration reported by the IRS has ballooned in recent years. In calendar year 2010, the IRS reported that the total number of incidents was 440,581. In calendar year 2011, the total number of incidents jumped to 1,125,634. The number continued to grow (in almost exponential fashion), reaching 1,785,866 in 2012, then skyrocketing to 2,919,484 in 2013.
From a policy perspective, this particular trend implies that current efforts are not having a significant enough deterrent effect on would-be identity thieves. More and more identity thieves are lining up to engage in activity that, from their perspective, appears to have a relatively low risk and relatively high potential payoff. Unless we can more effectively deter the growing number of would-be identity thieves, the practical reality seems to be that the threat is likely to continue to grow.
Unfortunately, however, current investigation and prosecution trends do not show signs that the problem is likely to improve any time soon—and these metrics are the key to deterrence. Although the Service and the Department of Justice (DOJ) made significant improvements from 2011 to 2013 in terms of increasing the number of identity theft-related criminal investigations, prosecution recommendations, and actual prosecutions, that progress fell off sharply in the past year. In fiscal year 2014, the Service initiated roughly 30 percent fewer identity theft investigations than it did in 2013. The number of recommended prosecutions and actual prosecutions decreased significantly as well. All this, despite the enormous growth in IRS reported identity theft “incidents” mentioned above. Again, these trends evidence a step (or two) backwards, and bode poorly for any hoped-for deterrent effect.
Although the IRS is detecting and preventing more fraudulent identity theft refunds than ever before, there are increasingly more fraudulent refunds to prevent. And despite some significant progress in the effort, the Service is still paying out more than ever to identity thieves. That cost, of course, falls on taxpayers—and it is in the billions. As this complex threat continues to evolve, we must face the unsettling reality that we have a long, long way to go to stem tax-related identity theft.
Visit the Identity Theft Information and Tools webpage for additional guidance, resources, and tools to help combat this problem for your clients. New resources that are exclusive for Tax Section members were added this week!
1Annual Assessment of the Internal Revenue Service Information Technology Program, Treasury Inspector General for Tax Administration, Ref. No. 2014-20-095, Sept. 30, 2014, p. 6.
2Efforts Are Resulting in the Improved Identification of Fraudulent Tax Returns Involving Identity Theft, Treasury Inspector General for Tax Administration, Ref. No. 2015-40-026, April 24, 2015, p. 3. 3Identity Theft and Tax Fraud: Enhanced Authentication Could Combat Refund Fraud, but IRS Lacks an Estimate of Costs, Benefits and Risks, Government Accountability Office, GAO-15-119, Jan. 2015, p. 10.
4Id. at 1.
5Efforts Are Resulting in the Improved Identification of Fraudulent Tax Returns Involving Identity Theft, Treasury Inspector General for Tax Administration, Ref. No. 2015-40-026, April 24, 2015, p. 3.
6Identity Theft and Tax Fraud: Enhanced Authentication Could Combat Refund Fraud, but IRS Lacks an Estimate of Costs, Benefits and Risks, Government Accountability Office, GAO-15-119, Jan. 2015, p. 1.
7See There are Billions of Dollars in Undetected Tax Refund Fraud Resulting From Identity Theft, Treasury Inspector General for Tax Administration, Ref. No. 2012-42-080, July 19, 2012, p. 1; Detection Has Improved; However, Identity Theft Continues to Result in Billions of Dollars in Potentially Fraudulent Tax Refunds, Ref. No. 2013-40-122, Sept. 20, 2013, p. 1.
8There are Billions of Dollars in Undetected Tax Refund Fraud Resulting From Identity Theft, Treasury Inspector General for Tax Administration, Ref. No. 2012-42-080, July 19, 2012, p. 1.
10Victims of Identity Theft Continue to Experience Delays and Errors in Receiving Refunds, Treasury Inspector General for Tax Administration, Ref. No. 2015-40-024, Mar. 20, 2015, p. 2.
11Statistical Data - Identity Theft Investigations, IRS, available at http://www.irs.gov/uac/Statistical-Data-Identity-Theft-Investigations
Jason Freeman is an attorney at Meadows, Collier, Reed, Cousins, Crouch & Ungerman, LLP in Dallas, Texas and an adjunct professor at Southern Methodist University’s Dedman School of Law. He also serves as a valued member of the AICPA Tax Practice and Procedures Committee. For more information about this article, contact Jason at firstname.lastname@example.org.