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Tax Identity Theft Awareness Week in the US begins January 25. This national awareness campaign encourages Americans to take action to prevent criminals defrauding the government and delaying legitimate tax refunds to honest taxpayers. The big shift towards electronic filing of income tax returns in America over the last 10 years has enabled tax identity theft to thrive, a relatively easy way for criminals to steal money from the government.
The most common type of tax identity fraud is possible because income tax is deducted from employee paychecks at an estimated rate. Although the percentage that is withheld can be adjusted by the wage earner, many Americans use a default rate which results in overpayment of taxes. Thus there is a need to claim a refund from the Internal Revenue Service (IRS) at the end of the tax year (for most workers this the calendar year, with the filing of returns and refund requests beginning at some point in the following year, January 19 for 2016).
As soon as employers issue a form called W-2 to employees, showing the income earned and amount of taxes withheld, the employee can file a return and claim a refund if they overpaid. Unfortunately, employers have until January 31 to give employees these forms, giving scammers a window of up to 12 days to file a bogus return using the identity of a person who has not yet had a chance to file. But the window for fraud is actually much longer than that because employers don’t have to file W-2 information with the IRS until the end of March. In essence, the IRS just takes the taxpayer’s word for the W-2 numbers. Refunds for over-payment of taxes are sent out before the W-2 data is verified.
Crooks can thus submit fake reports of taxes paid above and beyond taxes owed, resulting in a refund due (and sent to the address or account the crook specified). If a scammer files using your identity (basically your Social Security number) you may not find out until you file your return, only to have the IRS reject it. This rejection can be fairly quick if you are filing electronically. If you file by mail and there is already a fraudulent return on file, any refund you were expecting to receive will fail to appear. Eventually you will get a letter from the IRS telling you about the situation. Later in this article I discuss how to deal with these situations and hopefully prevent them, but first let’s look at the size and scope of the monster we’re dealing with here.
To say that tax identity fraud is rampant in America would be an understatement. In 2013, crooks took $5.3 billion from the US Treasury through tax ID fraud. The IRS publishes a dossier of tax ID fraud cases it prosecuted in 2015, listing details of the fraud committed. It makes for pretty depressing reading despite the fact that, on the bright side, many criminals were convicted. Sadly, convictions are not a strong enough deterrent for some people. While the main target has been the federal income tax refund, last year saw an increase in this type of crime targeting state tax authorities (many US states have their own income tax, in addition to the federal tax).“To say that tax identity fraud is rampant in America would be an understatement.”
You can get a good sense of the scale and nature of tax identity fraud from this 60 Minutes segment, available as a transcript (plus video in some regions of the planet). To get the perpetrator’s perspective, consider this statement from Corey Williams, who was a legitimate tax preparer until his boss turned him on to the scam (before he was arrested and sentenced to 40 months in prison, Mr. Williams had raked in millions of dollars in fraudulent refund payments):
“Anybody who knew about it, you’d be a fool to not try to get involved with making some money. I could wake up in the comfort of my own home, and just get on a laptop, do about 15 returns a day. Fifteen times $3,000 a return, that’s $45,000 a day.”
So it’s no surprise that tax identity fraud is a flourishing industry. The perpetrators even have online support groups (as described by Brian Krebs last year) in which to share tactics. On the plus side, the IRS is getting better at spotting the most flagrant abuses. A report on last year’s filing season found the IRS identified 163,087 tax returns with more than $908.3 million claimed in fraudulent refunds, blocking approximately $787 million (86.6 percent) in fraudulent refund payments.
Unfortunately, these anti-fraud efforts have led some scammers to adopt more aggressive tax-based cons, including threatening phone calls. Fortunately, America’s consumer watchdog, the Federal Trade Commission has taken a leading role in educating the public about tax identity theft and other IRS-related scams. The FTC website has lots of resources for Tax Identity Theft Awareness Week.
Unfortunately, there is a limit to what consumers and small businesses can do right now to prevent tax identity fraud. One thing all Americans can all do is lobby congress to clean up this mess. After all, the IRS did not choose to issue refunds before employer W-2 data was processed – no responsible accountant would voluntarily do such a thing – the current situation exists because of various congressional edicts.
In addition, here are a few defensive measures one can take:
While the “file early” strategy is the main line of defense against basic W-2 income tax refund fraud, a risk management approach to the problem suggests an alternative strategy: don’t give the government more money than you need to. That way you won’t risk waiting for a large refund if you are a tax ID theft victim. Taxpayers can use form W-4 to adjust withholding. You will have filled out one of these when you started your job. However, a surprising number of taxpayers don’t adjust their withholding when life changes occur – such as marriage, new dependents, and so on – that may reduce their annual tax bill, resulting in a large refund. If you have come to rely on this pattern, consider changing it. Although tax ID scammers don’t actually steal any of the refund money to which you are legally entitled, they can delay you getting it, which can be painful.
If you would prefer a more balanced approach which puts more money in your hands sooner, consider increasing your withholding allowance number so that it better matches the amount of taxes due, thus reducing the refund. You have a right to do this, but it comes with responsibilities and some risks of its own (see this article and also IRS Topic 306). Note that I am not a chartered accountant. Although I once worked as a tax auditor, nothing said here should be taken as financial planning advice and you should only use this strategy if you are prepared to monitor your status throughout the year and pay any shortfall promptly.
As for the ongoing effort to stamp out tax identity theft, I would like to end on a positive note. For several years I have written tax season articles that encouraged people to lobby their representatives for better IRS funding. Now we read that Congress has finally increased the IRS’s budget, by $290 million over last year’s level. The extra funding must be spent on improving customer service, cracking down on identity theft, and increasing cybersecurity. While this amount is less than half of the $700 million the agency had requested for those three programs for fiscal year 2016, it is a lot better than a cut!
Author Stephen Cobb, ESET