How Does Tax Fraud Happen?

An audit of the Internal Revenue service regarding fraudulent tax returns was requested by U.S. Senator Bill Nelson, a Democrat from Florida. The investigation was conducted by the Treasury Department’s Inspector General, J. Russell George. According to this investigation, more than $5 billion in refund checks were delivered to identify thieves who filed fraudulent 2011 tax returns.  The Treasury Department estimated that $21 billion could be delivered to identity thieves in the next five years.

The Internal Revenue Service detected approximately 940,000 fraudulent tax returns for 2011, totaling $6.5 billion in refunds.  There were 1.5 million cases that weren’t detected; these thieves assumed the identity of a dead person, child, or someone who won’t normally file a return. Most of the cases (80 percent) used direct deposits, including pre-loaded debit cards. This payment is preferred by thieves because there is no address or photo identification needed to use the card.

The key reason fraud is undetected is that the Internal Revenue Service issues refunds before the employers and financial institutions have submitted the withholding and income documents to the Internal Revenue Service. Therefore, there is no verifying information on which to give the refund. According to the Internal Revenue Service, identity theft fraud is their biggest challenge.

Fraud Cases

One fraud case involved 2,137 separate tax returns filed from the same address in Michigan, with more than $3.3 million in refunds sent to this one address. Another one included three addresses in Florida that filed more than 500 returns totaling more than $1 million in returns per address.  In another case, 590 refunds totaling more than $900,000 were deposited into one bank account.

Legislation

The House has approved legislation to increase the criminal penalties against identity thieves who steal taxpayer information to file fraudulent returns which is a called The Stopping Tax Offenders and Prosecuting Identity Theft Act, H.R. 4362. This bill strengthens criminal penalties for tax identity theft and increases the sentence length. It would add tax fraud to the identity theft charges, which would be subject to two- to five-year mandatory sentencing.

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Credit Reporting Expert, John Ulzheimer, is the President of Consumer Education at SmartCredit.com, the credit blogger for Mint.com, and a Contributor for the National Foundation for Credit Counseling.  He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry.  Follow him on Twitter here.