Tax Scam: IRS Pays Out Billions in Fraudulent Refunds

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The IRS is paying out billions of dollars in fraudulent tax refunds to identity thieves; a problem that the tax service’s inspector general told CNBC is a “growing problem” involving numbers that are increasing “exponentially.”

In a new report to be issued Thursday, the inspector general for the IRS says that tax thieves are stealing the identities of taxpayers and then filing bogus returns on their behalf and collecting fraudulent refunds as a result.

The inspector general estimates that the IRS could issue as much as $21 billion in fraudulent tax refunds over the next five years.

The scam is so rampant that thieves are apparently sending in false returns in bulk without even bothering to change the mailing address on the returns. The inspector general said it found one residential address in Lansing, Michigan that was the source of an astonishing 2,137 tax returns, and to which the IRS directed more than $3.3 million in potentially fraudulent refunds.

In another case, a single residential address in Chicago was the source of 765 tax returns, generating more than $900,000 in potentially fraudulent refunds, the report said.

“Once the money is out the door, it is almost impossible to get it back,” IRS inspector general J. Russell George told CNBC. “The bad guys know that the IRS is unable, given the limited number of its staff it has, to address every single allegation of tax fraud it has.”

The report said the identity theft scam is most prevalent in Florida, with two cities, Tampa and Miami, topping the list of potentially fraudulent claims. Tampa saw 88,724 potentially fraudulent returns filed, generating refunds of more than $468 million. And Miami saw 74,496 potentially fraudulent returns generating more than $280 million in possibly bogus returns.

"Once the money is out the door, it is almost impossible to get it back." -Inspector General, IRS, J. Russell George

The inspector general concluded that the IRS is simply not doing enough to stop identity theft fraud. “Unfortunately, the IRS is not using information that it currently has, nor information that could be available to them,” George said.

In its analysis, the inspector general’s office said it identified approximately 1.5 million tax returns with potentially fraudulent tax refunds that the IRS had missed during tax year 2010. The potential fraud for that one year totaled in excess of $5.2 billion. That led the report’s authors to estimate that the “IRS could issue approximately $21 billion in fraudulent tax refunds resulting from identity theft over the next five years.”

Among the report’s other findings, was that the “use of direct deposits, including debit cards, to claim fraudulent tax refunds increases the risk that the IRS will not detect identity theft. The IRS continues to allow multiple direct deposits to the same bank account.”

The inspector general recommended that the IRS make certain changes in the way it operates internally, and that it push for new legislation on Capitol Hill that would give it access to the National Directory of New Hires database to help weed out identity theft.

In a response to the critical report, IRS wage and investment division commissioner Peggy Bogadi wrote, “We are devoting significant resources to combat tax refund fraud using stolen identities and have already taken action with respect to issues identified in the report.” And because of actions the IRS has already put in place, she wrote, “we believe that the report’s projection of undetected fraudulent refunds over the next five years is significantly overstated.”