In my last blog I talked about the scandal of the Internal Revenue Service paying out billions to over the last few years to scammers who file phony returns seeking refunds using stolen identities or Social Security numbers stolen from children.
In a July 2012 report, J. Russell George, the Treasury Department's Inspector General, predicted that the IRS was on pace to pay out $21 billion in fraudulent refunds to scammers.
When I talk with people about this they are, of course, incredulous, I know I was when I first starting looking at this problem some time ago. We tend to think of the IRS as big brother looking over our shoulders just waiting for us to overstate a deduction or make some other error. But how these crooks get away with stealing billions in unearned refunds has to do with technology and with politics.
The scam is mainly based on timing. Each year your employer sends you a W-2 form on which is recorded how much you made in the previous calendar year and how much was withheld from your pay for federal, state and local taxes and other deductions like Social Security tax, etc.
Employers are required to get us our copies of these forms no later than the end of January, but — and this is one of the key facts in this entire scam — they are not required to transmit this data to the IRS until the end of March. It's this 60-day lag that is at the center of the whole fraudulent process.
Now here's where the new technology comes in. In 2011, 111.1 million returns (77.6%) were filed electronically. If you file what has become the old fashioned way — a paper return — you are required to attach a copy of your W-2. But if you file electronically you can't physically attach a copy of the W-2, you just must list the information contained on it.
Now here's where politics come into play. First, businesses and their lobbyists complained that they should not be expected to file their copies of employee wage and benefit statements at the same time they send them out to the employees. So they have until the end of March to file their statements.
This interval between the time an employee receives the W-2 and the time that the IRS gets the information is the golden period for scammers. They have gotten the name and Social Security number of a taxpayer, or they simply make up a name (or amazingly use their own) coupled with a clean Social Security number stolen from a child and file a return with made-up data showing more federal tax withheld than owed and requiring a refund. They then file in late January or early February, well before the IRS has employer data.
Now here's where politics plays an even bigger role. Taxpayers who are owed money by the IRS want their money back quickly. "It's my money and I want it now," is a common refrain. They don't want to hear that the IRS is withholding that refund until the data on the return can be confirmed — think six months or so. Thus the IRS is under tremendous pressure from Congress to get those refunds on their way and they do so well before they even have the data to confirm the accuracy of the return.
The IRS disputes the Inspector General's prediction of $21 billion in fraudulent refunds to scammers in the next five years. It says it is getting better at identifying possibly fraudulent returns and delaying refund payments until they can be verified. This year (2011 tax year) the IRS says it identified 938,664 fraudulent returns and prevented $6.5 billion from going out the door to scammers. But the numbers of fraudulent returns is skyrocketing (some tax fraud rings may file as many as 10,000 false returns) and undoubtedly millions got through.