Ineffective income and withholding verification hinder IRS in detecting fraudulent returns

BY SALLY P. SCHREIBER, J.D.

On Monday, the Treasury Inspector General for Tax Administration (TIGTA) released the results of its review of the IRS’s fraudulent tax return detection system, the Electronic Fraud Detection System (EFDS), concluding that inadequate income and withholding verification resulted in the IRS’s missing many fraudulent returns (TIGTA, Income and Withholding Verification Processes Are Resulting in the Issuance of Potentially Fraudulent Tax Refunds, Rep’t No. 2013-40-083 (8/7/13)).

The IRS claimed to prevent $1.2 billion of fraudulent tax refunds in 2013, but TIGTA found in an analysis of 2010 tax year returns that the IRS’s EFDS did not screen 92% of the 1.5 million returns that TIGTA identified as potentially fraudulent. Although income and withholding verification is the most efficient method to detect fraud, the IRS is stymied in using that system because most of the information necessary to do this verification is received after many taxpayers have filed their income tax returns. (A new system, the Return Review Program, is expected to replace EFDS beginning in 2015.) 

TIGTA specifically reviewed a random sample of 272 of the 120,197 potentially fraudulent 2010 tax returns for which tax refunds were issued and that received a high enough EFDS score to be sent for income and withholding verification. TIGTA found that IRS examiners confirmed that 96 of these tax returns had false income and withholding, but the IRS did not take timely actions to prevent the issuance of the fraudulent refunds. Another eight tax returns were not screened within the required time period to prevent the issuance of a refund. A number of returns that had been identified as fraudulent did not have sufficient information in the file for TIGTA to determine what had happened.

TIGTA made two recommendations in its report, both of which the IRS agreed with:

  • Ensure that the IRS takes actions to prevent issuing potentially fraudulent refunds when tax returns are not timely screened and verified and that case notes are sufficient to support the actions tax examiners took to verify income and release the tax refunds.
  • Revise procedures to ensure that when tax returns identified as potentially fraudulent are assigned to another IRS function to address processing issues, the tax refunds are held until the tax return is screened and verified by a tax examiner in the Integrity and Verification Operations unit.

Sally P. Schreiber ( sschreiber@aicpa.org ) is a JofA senior editor.

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