Wray Rives

Identity theft and fraudulent tax returns

How it impacts your clients and what the IRS is doing about it.

June 11, 2012
By Wray Rives, CPA, CGMA

If your firm prepares tax returns, you may have noticed that the IRS took a little longer to get refunds processed this year, especially if you had clients who filed early in the reporting season. This is because of the new steps that the IRS took to weed out fraudulent refund claims, many of which were processed very early, when electronic filing first opened up in January.

Tax refund theft has become a billion-dollar business. For the 2010 tax year/2011 filing season, the IRS identified 2.2 million fraudulent returns, including 940,000 involving identity theft, on which $6.5 billion in fraudulent refunds were claimed. The Treasury Inspector General for Tax Administration estimates that the IRS missed another 1.5 million bogus returns with fraudulent refunds potentially exceeding $5.2 billion. The IRS has been developing new processes and filters for returns, especially early filed returns, in an attempt to identify questionable refund claims.

The schemes

The IRS has become very aggressive in combating identity theft and helping legitimate taxpayers avoid being the victims of lost identities. Fraudulent tax returns typically involve someone filing a tax return using a stolen name and the Social Security number of a legitimate taxpayer or using the name and Social Security number of a child or elderly dependent and then claiming that person as a dependent on the thief’s return. The thieves typically file fraudulent returns early in the tax-filing season before the IRS has even received W-2 or 1099 information. When the legitimate taxpayers file their returns later in the tax season, they are notified that they are attempting to file a duplicate return. This is one good reason to use e-filing, as you receive such notifications almost immediately.

While the duplicate filing issue can be resolved fairly easily by filing an originally signed paper copy with the IRS, there have been delays of as long as four months in legitimate taxpayers receiving their refunds. Some preparers’ clients may even be asked to participate in an IRS initiative for previous victims of ID theft that will require supplementary verification processes for any transactions or return filings with the IRS. For the 2012 filing season the IRS has issued 250,000 Identity Protection Personal Identification Numbers (IP PINs) to taxpayers whose identities are known to have been stolen. The IRS also requires tracking of the IP (Internet protocol) address, date, time, and time zone of any computer that submits an electronic tax return.

Another common ID theft issue involving the IRS occurs when someone uses another taxpayer’s Social Security number when he or she is hired for a job. There is a lucrative black market for legitimate Social Security numbers that illegal alien workers frequently use. There may even be a realistic-looking copy of a Social Security card being sold at a flea market somewhere right now. Typically the name the employee uses does not match the Social Security number, but it can take a year or more for the IRS to contact employers to notify them of the inaccuracy. By the time the IRS notifies the employer, the employee may be long gone.

Even if the employee is still working, businesses tend to be very trusting of their employees and will almost always assume it is just a legitimate clerical error in entering the number, giving the worker plenty of time to use another number or simply move on to another job and not be heard from again. The legitimate owner of the Social Security number will not even know about the problem until he or she receives a matchup letter from the IRS inquiring why the taxpayer did not report all earnings from a prior year. This type of ID theft can actually be much more difficult for clients to resolve with the IRS than a fraudulent tax return, because there is almost always a presumption that information on a W-2 or 1099 is correct, even if a name and address do not match up.

What the IRS is doing about it

The IRS is taking steps to address where it believes there are weaknesses in the tax-reporting process that crooks can exploit. IRS Notice 2011-38 allows anyone filing a W-2 or 1099 to truncate Social Security numbers on information returns. The IRS has stopped placing full Social Security numbers on some of the notices it mails and is testing a barcoding system to identify taxpayers in IRS correspondences.


Unfortunately, there are still many clients who fall for email phishing scams and bogus websites, which attempt to steal their information. CPAs can use the publications and information from the IRS website to help educate clients about avoiding and dealing with ID theft.

As for the folks behind a number of fraudulent returns from the 2011 tax season, in the week of Jan. 23, 2012, IRS criminal enforcement along with the Justice Department issued 69 indictments against almost 100 individuals in 23 states in connection with filing false tax returns. As of March 9, 2012, the IRS had stopped 215,000 questionable returns that represented more than $1.15 billion in claimed refunds that are believed to be bogus.

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Wray Rives, CPA, CGMA, helps startup and small business owners compete and succeed in their local or global market as founder and manager of NeedaCFO.com and through his public accounting firm Wray Rives CPA.