It's been no secret that the IRS has been underfunded - not to mention under-staffed…
I thought it would be a good idea to discuss an issue that affects many taxpayer returns, namely the IRS processes for identifying and stopping refund fraud. Attempted refund fraud has become a significant problem in our tax system. According to the most recent figures available, in the calendar year (CY) 2016, identity theft (IDT), refund fraud alone, cost the government roughly $1.7 billion.
Everyone fully supports the IRS’s efforts to reduce refund fraud and protect revenue. However, there are expressed concern over several years that the refund fraud false positive rate (FPR) is too high and that the IRS takes far too long to process legitimate taxpayers’ returns once it has determined that they have been inaccurately selected. For some taxpayers who rely on their tax refund to pay for necessary living expenses, their anxiety increases every day that their refund is delayed.
The main problem behind these issues is the timing between when the IRS selects returns to be analyzed for possible refund fraud, and when it receives payor information that would either verify or disprove this possibility. But before we get into specific concerns surrounding the IRS’s fraud detection program, here is a little background on how the systems that select possible fraudulent returns work.
The IRS’s Return Integrity Operations office (RIO), which is housed in the Wage and Investment Division (W&I), is tasked with detecting and preventing both IDT and non-IDT refund fraud. RIO oversees both the Taxpayer Protection Program (TPP) and the pre-refund wage verification program. TPP is the program responsible for detecting and preventing IDT fraud, and the pre-refund wage verification program is responsible for detecting and preventing non-IDT refund fraud, such as creating fake or altering W-2s with inflated wages or withholding to receive larger credits or refunds.
When RIO selects a taxpayer’s return into the TPP, the return will be suspended until the taxpayer contacts the IRS and authenticates his or her identity. When a taxpayer’s return is selected into the pre-refund wage verification program, the income and withheld tax reported on the return will be matched against third-party data provided by employers and other payors (e.g., Forms W-2 and 1099-MISC-Nonemployee Compensation). Form W-2 information must be submitted to the Social Security Administration (SSA) by January 31, and the SSA then forwards the information on to the IRS. 1099-MISC-Nonemployee Compensation forms must be submitted directly to the IRS by January 31.
The IRS uses two systems for the detection of refund fraud: the Dependent Database (DDb), which is used to detect only IDT, and the Return Review Program (RRP), which is used to detect both IDT and non-IDT refund fraud. The DDb contains filters which are comprised of rules and are binary in nature (i.e., if the rule is broken, the return will be selected for further analysis; if the rule is not broken, the return will continue through normal processing). RRP’s filters are comprised of both rules and models. In the most recent filing season (2018), significantly more taxpayers were selected into the IRS’s pre-refund wage verification program as a result of the IRS adding two filters to the RRP system for non-IDT refund fraud. Specifically, non-IDT refund fraud filters selected in excess of one million returns from January 1 through October 17, 2018, a roughly 400 percent increase when compared to the same time period last year.
The addition of these filters is partially responsible for the high false positive rate (FPR) for non-IDT refund fraud in particular. For January 2018 through October 17, 2018, non-IDT refund fraud had an FPR of about 81 percent, while IDT refund fraud had an FPR of about 63 percent.
Just as concerning is the delay that taxpayers who filed legitimate returns experience in receiving their refunds. The IRS determined that sixty-three percent of returns selected into the non-IDT refund fraud program in 2018 were legitimate even though more than two weeks elapsed from the time of selection until the IRS released the refund – this is in addition to a two-week screening time prior to selection. The IRS refers to this 63 percent figure as the “operational performance rate” (OPR). Unfortunately, a similar measure for IDT refund fraud is currently not tracked. This is because the IRS relies on taxpayers taking action to authenticate their identity (i.e., calling the IRS and authenticating over the phone or authenticating in person at a Taxpayer Assistance Center [TAC]), whereas the non-IDT refund fraud program is entirely reliant on the IRS taking action in order for the refund to be released (i.e., the IRS must verify the income reported by the taxpayer with the income reported by the employer/payor).
Dealing with a refund delayed beyond normal processing times may cause great anxiety for taxpayers, especially low-income taxpayers who often rely on their refunds for emergencies such as paying medical expenses, or to pay other day-to-day bills. For those taxpayers selected into the non-IDT refund fraud program, this anxiety is magnified by the fact that IRS customer service representatives (CSRs) do not have access to the non-IDT refund fraud case management system, leaving them in the dark as to what is delaying their return, and when they can expect their refund.
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