Identity Theft: Additional Actions Could Help IRS Combat the Large, Evolving Threat of Refund Fraud
Released: 2014-09-22T00:00:00


Highlights: section_title: Why GAO Did This Study
paragraphs: Identity theft tax refund fraud is a persistent, evolving threat to honest taxpayers and tax administration. It occurs when an identity thief files a fraudulent tax return using a legitimate taxpayer's identifying information and claims a refund.

GAO was asked to review IRS's efforts to combat IDT refund fraud. This report, the first of a series, examines (1) what IRS knows about the extent of IDT refund fraud and (2) additional actions IRS can take to combat IDT refund fraud using third-party information from, for example, employers and financial institutions.

To understand what is known about the extent of IDT refund fraud, GAO reviewed IRS documentation, including the Identity Theft Taxonomy . To identify additional actions IRS can take, GAO assessed IRS and SSA data on the timing of W-2s; and interviewed SSA officials and selected associations representing software companies, return preparers, payroll companies, and others.

section_title: What GAO Found
paragraphs: Based on preliminary analysis, the Internal Revenue Service (IRS) estimates it paid $5.2 billion in fraudulent identity theft (IDT) refunds in filing season 2013, while preventing $24.2 billion (based on what it could detect). The full extent is unknown because of the challenges inherent in detecting IDT refund fraud.

IDT refund fraud takes advantage of IRS's “look-back” compliance model. Under this model, rather than holding refunds until completing all compliance checks, IRS issues refunds after conducting selected reviews. While there are no simple solutions, one option is earlier matching of employer-reported wage information to taxpayers' returns before issuing refunds. IRS currently cannot do such matching because employers' wage data (from Form W-2s) are not available until months after IRS issues most refunds. Consequently, IRS begins matching employer-reported W-2 data to tax returns in July, following the tax season. If IRS had access to W-2 data earlier—through accelerated W-2 deadlines and increased electronic filing of W-2s—it could conduct pre-refund matching and identify discrepancies to prevent the issuance of billions in fraudulent refunds.

Accelerated W-2 deadlines. In 2014, the Department of the Treasury (Treasury) proposed that Congress accelerate W-2 deadlines to January 31. However, IRS has not fully assessed the impacts of this proposal. Without this assessment, Congress does not have the information needed to deliberate the merits of such a significant change to W-2 deadlines or the use of pre-refund W-2 matching. Such an assessment is consistent with IRS's strategic plan that calls for analytics-based decisions, and would help IRS ensure effective use of resources.

Increased e-filing of W-2s. Treasury has requested authority to reduce the 250-return threshold for electronically filing (e-filing) information returns. The Social Security Administration (SSA) estimated that to meaningfully increase W-2 e-filing, the threshold would have to be lowered to include those filing 5 to 10 W-2s. In addition, SSA estimated an administrative cost savings of about $0.50 per e-filed W-2. Based on these cost savings and the ancillary benefits they provide in supporting IRS's efforts to conduct more pre-refund matching, a change in the e-filing threshold is warranted. Without this change, some employers' paper W-2s could not be available for IRS matching until much later in the year, due to the additional time needed to process paper forms.

section_title: What GAO Recommends
paragraphs: GAO recommends that Congress should consider providing Treasury with authority to lower the annual threshold for e-filing W-2s. In addition, IRS should fully assess the costs and benefits of shifting W-2 deadlines, and provide this information to Congress. IRS neither agreed nor disagreed with GAO's recommendations, and it stated it is determining how these potential corrective actions align with available resources and IRS priorities.

section_title: Letter
paragraphs: Tax refund fraud associated with identity theft (IDT) continues to be an  evolving threat, one that imposes a serious financial and emotional toll on  honest taxpayers and threatens the integrity of the tax administration  system. Within the tax system, IDT refund fraud occurs when a refund- seeking identity thief files a fraudulent tax return using a legitimate  taxpayer’s identifying information. The Internal Revenue Service (IRS)  estimates that millions of IDT refund fraud attempts claiming tens of  billions of dollars in fraudulent refunds occurred in 2013. IDT refund fraud  also creates administrative costs: In 2014, IRS has approximately 3,000  people working on cases of IDT victims—more than twice the number of  people working on these cases in 2011. In light of this, IRS recognized  refund fraud and IDT as a major challenge affecting the agency in its  recently issued strategic plan.

To craft a response to IDT refund fraud, IRS must understand the extent  and nature of the fraud. In 2012, we reported that IRS managers did not  have a complete picture.IDT refund fraud, nor did IRS systematically track the characteristics of  known identity theft tax returns. While complete knowledge about  identities stolen and perpetrators responsible will likely never be attained,  the more thoroughly IRS understands the problem, the more effectively  IRS and policymakers can respond.

For example, IRS did not know the full extent of  IRS has taken a number of steps to address this threat, including  developing an estimate of the extent of IDT refund fraud and using third- party information (such as leads about suspicious refunds) to help in its  IDT efforts. However, available information suggests that the problem is  persistent and evolving.

Within this context, you asked us to examine IRS’s efforts to combat IDT  refund fraud, which we will review in a series of reports. This report  answers the following questions:  1.  What does IRS know about the extent of IDT refund fraud?  2.  What additional actions can IRS take to combat IDT refund fraud  using third-party information (for example, from employers and  financial institutions)?

A report to be issued later in 2014 will address a broader set of actions  that IRS could take to combat IDT refund fraud.

To understand what IRS knows about the extent of IDT refund fraud, we  reviewed IRS’s Identity Theft Taxonomy (Taxonomy)—a matrix of IDT  refund fraud categories—which estimates the amount of IDT refund fraud  that IRS is, and is not, preventing. We conducted manual data testing for  obvious errors and compared underlying data to IRS’s Refund Fraud &  Identity Theft Global Report. We confirmed Taxonomy components where  we had data available to cross check. We also interviewed IRS officials to  better understand the methodology used to create the estimates. For a  summary of Taxonomy limitations, see appendix I.

To identify opportunities to improve IRS’s IDT refund fraud efforts, we  reviewed Internal Revenue Manual sections detailing IRS’s Identity  Protection Program and IRS documentation for its External Leads  Program (where third parties, often financial institutions, report suspicious  refunds to IRS), Opt-In Program (where financial institutions can flag and  reject suspicious refunds sent via direct deposit), and other third-party  efforts. We interviewed officials from the Social Security Administration  (SSA) and from associations representing software companies, return  preparers, financial institutions, and payroll companies. To help ensure  our analysis covered a variety of viewpoints, we selected a nonprobability  sample of 22 associations and stakeholders with differing positions and  characteristics, based on IRS documentation and suggestions, prior GAO  work, and other information. Because we used a nonprobability sample,  the views of these associations are not generalizable to all potential third  parties. We then communicated with IRS offices, including (1) Privacy,  Government Liaison, and Disclosure; and (2) Return Integrity and  Correspondence Services, to determine the feasibility of various options  and the challenges of pursuing them. See appendix II for details on our  scope and methodology.

We conducted this performance audit from May 2014 to August 2014 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: IRS has reported a substantial increase in IDT refund fraud; however, it is  unclear whether this reported increase is due to an overall increase in IDT  refund fraud, to an improvement in IRS’s ability to detect IDT refund  fraud, or to a combination of the two. For example, IRS instituted IDT  filters in 2012, which helped IRS find additional IDT incidents, but it is not  known how much of the reported increase can be attributed to filters or to  an increase in IDT refund fraud.

There are two types of tax-related IDT fraud: (1) refund fraud and (2)  employment fraud. IDT refund fraud occurs when a refund-seeking  identity thief files a fraudulent tax return using the legitimate taxpayer’s  identifying information. Employment fraud occurs when an identity thief  uses a taxpayer’s name and Social Security number (SSN) to obtain a  job. This report’s discussion focuses on IDT refund fraud and not  employment fraud.

IDT refund fraud takes advantage of the typical process of filing a tax  return. Taxpayers receive information returns from third parties, such as  the Form W-2, Wage and Tax Statement (W-2), and use this information  to complete their tax returns. As shown in figure 1, taxpayers with wage  income typically receive a Form W-2 from their employer by late January.  Taxpayers copy the information from the W-2 to prepare their returns.  Taxpayers filing paper returns are required to attach a copy of the W-2 to  the return. Taxpayers filing electronically (e-file), as most do, are not  required to send W-2s to the IRS. Most taxpayers entitled to a refund,  along with many identity thieves attempting refund fraud, file early in the  filing season—many in February. During return processing, IRS performs  some compliance checks and issues refunds, but at this time it cannot  verify the W-2 information for all returns (paper W-2s can be forged and  fictitious wage information can be entered on a tax return). By the end of  March, employers are also required to send a copy of the W-2 to SSA,  which performs verification checks before sending the information to  IRS. However, IRS only begins matching W-2 information from  employers to tax returns in July. This gap between when IRS issues  refunds and when IRS matches W-2s to tax returns creates the  opportunity for fraudsters to file returns using a stolen identity and to  receive a tax refund.

Issuing refunds before fully verifying the information on tax returns is an  example of what IRS officials refer to as a “look-back” compliance model:  rather than holding refunds until all compliance checks can be completed,  IRS issues refunds after doing some selected, automated reviews of the  information the taxpayer submits to verify identity (e.g., name and SSN  matching); filtering out returns with indicators of fraud such as a  mismatched name and SSN; and correcting obvious errors, such as  calculation mistakes and claims for credits and deductions exceeding  statutory limits. IRS’s intent is to issue refunds quickly.

After refunds are issued, IRS does further checks. Two of these checks  enable IRS to detect significant amounts of IDT refund fraud after the fact.  One, shown at the top of figure 2, is checking for duplicate returns. If an  identity thief and a legitimate taxpayer file returns using the same name  and SSN, IRS will have duplicate returns. The other is matching tax  returns to third-party information provided to IRS by employers, financial  institutions, and others (bottom of figure 2). Matching tax returns to W-2s  is an example of these checks. As we have reported, these post-refund  compliance checks can take a year or more to complete.
subsections: section_title: IRS Tools to Combat Identity Theft Refund Fraud
paragraphs: Recognizing the limitations of the look-back compliance model, IRS’s  efforts to combat IDT refund fraud occur at three different stages of the  refund process: (1) before accepting a tax return, (2) during tax return  processing, and (3) after issuing tax refunds. At each stage of the  process, IRS uses specific tools to detect IDT refund fraud (see figure 3  for examples of IRS tools at each stage).

Identity Protection Personal Identification Number (IP PIN). IP PINs  are single-use identification numbers sent to IDT victims who have  validated their identities with IRS. Tax returns with IP PINs pass through  IRS’s IDT fraud filters, avoiding false positives—where a legitimate  taxpayer is identified as an identity thief—and a delayed tax refund.  Taxpayers who were issued an IP PIN but e-filed without using it or  entered it incorrectly are prompted to enter the IP PIN on their tax return  or to file on paper, according to IRS officials. Paper returns filed with the  SSN of these taxpayers and without an IP PIN are subject to additional  checks. (In January 2014, IRS offered a limited IP PIN pilot program to  eligible taxpayers in Florida, Georgia, and the District of Columbia.)

Duplicate return rejects. Once IRS receives an e-filed return for a given  SSN, it automatically rejects subsequent returns filed using that SSN and  sends a notice of duplicate filing, as shown at the top of figure 2.
subsections: section_title: During Tax Return Processing
paragraphs: IDT and other fraud filters. IDT filters screen returns, using  characteristics that IRS has identified in previous IDT refund fraud  schemes. characteristics, such as the same bank account or address, which could  indicate potential fraud. If an IDT filter flags a return, IRS stops  processing the return and sends a letter asking the taxpayer to validate  his or her identity.

The filters also search for clusters of returns with similar  IDT indicators. Indicators—account flags that are visible to all IRS  personnel with account access—are a key tool IRS uses to resolve and  detect IDT. IRS uses different indicators (e.g., to denote whether the  incident was identified by the IRS or a taxpayer), depending on the  circumstances in which IRS learns of an identity theft-related problem.

section_title: After Issuing Refunds (Post-Refund)
paragraphs: Third-party leads. IRS receives third-party leads regarding suspected  IDT refund fraud and other types of refund fraud through efforts including  the External Leads Program and the Opt-In Program. The External Leads  Program involves third parties providing lead information to IRS. If a  questionable refund is confirmed as fraudulent, IRS requests that the  financial institution return the refund. The Opt-In Program allows financial  institutions to electronically reject suspicious refunds and return them to  IRS, indicating why the institution is rejecting the refunds.

Two of the tax-administration systems employing filters are the Dependent Database  (DDb) and Electronic Fraud Detection System (EFDS). DDb incorporates IRS, Health &  Human Services, and Social Security Administration data to identify compliance issues  involving IDT, refundable credits, and prisoners. EFDS is a legacy system built in the mid- 1990s. To replace EFDS, IRS is developing the Return Review Program.

IRS has income and/or payment information that does not match the  information reported by the taxpayer on his return.

section_title: Performance Management Information and Controls Help Agencies Assure Results and Best Use of Federal Resources
paragraphs: A key practice in results-oriented management of federal agencies is the  establishment of agency-wide, long-term strategic goals. IRS’s strategic  plan for fiscal years 2014-2017 identifies two strategic goals: (1) deliver  high quality and timely service to reduce taxpayer burden and encourage  voluntary compliance and (2) effectively enforce the law to ensure  compliance with tax responsibilities and combat fraud. The strategic plan  also outlines several objectives relevant to its efforts to combat identity  theft, including  strengthening refund fraud prevention by balancing the speed of  refund delivery with the assurance of taxpayer identity, using analysis  of third-party and historical taxpayer data, and educating taxpayers  and tax professionals on fraud risk factors and fraud prevention  methods;  implementing enterprise-wide analytics and research capabilities to  make timely, informed decisions; and  implementing and maintaining a robust enterprise risk management  program, which includes establishing routine reporting procedures to  external stakeholders on operational risks.

As a complement to the potential benefits of strategic planning, internal  control is a major part of managing an organization.comprises the plans, methods, and procedures used to meet missions,  goals, and objectives: this supports performance-based management.  Internal control helps agency program managers achieve desired results  and provides reasonable assurance that program objectives are being  achieved through—among other things—effective and efficient use of  agency resources. Managers are to design internal controls based on  related costs and benefits. In addition, internal control standards in the  federal government call for agencies to record and communicate relevant,  reliable, and timely information on internal and external events to agency  managers and others who need it.

section_title: In Filing Season 2013, IRS Estimates Paying $5.2 Billion in Fraudulent IDT Refunds While Preventing $24.2 Billion; However, the Full Extent of IDT Refund Fraud Is Unknown
paragraphs: Based on IRS’s preliminary Identity Theft Taxonomy (Taxonomy), the  agency estimated that $29.4 billion in IDT refund fraud was attempted in  filing season 2013. IRS estimated it prevented or recovered about $24.2  billion (82 percent) of the estimated attempted refund fraud. However,  IRS estimated it paid $5.2 billion (18 percent) in IDT refunds during the  same timeframe (see figure 4). IRS officials noted that they are updating  their analysis and anticipate revising the Taxonomy’s estimate of IDT  refunds paid. The officials said the revised estimates could be somewhat  higher (perhaps by $0.6 billion) but the analysis was not completed in  time for us to include it in figure 4.

IRS’s Taxonomy demonstrates a significant effort on the part of IRS and  is an important first step in estimating how much identified IDT refund  fraud IRS is stopping or failing to stop. IRS has made substantial  progress in its efforts to estimate IDT refund fraud. For example, IRS  developed an estimate of IDT refund fraud by identifying characteristics of  fraudulent returns, matching and analyzing information returns and tax  returns based on these characteristics, and researching other sources.

However, the estimates will continue to evolve as IRS updates its  methodology to better reflect new IDT refund fraud schemes and to  improve the accuracy of its estimates, according to IRS officials.

IRS’s Taxonomy is a valuable tool to help inventory, characterize, and  analyze available IDT refund fraud data and to assess the performance of  IRS’s IDT refund fraud defenses. For example, the Taxonomy may help  IRS

Monitor progress. Given the evolving, persistent nature of IDT  refund fraud, IRS will constantly need to monitor and adapt its IDT  defenses to protect against new and emerging schemes. The  Taxonomy provides IRS with a methodology for monitoring IDT refund  fraud and the progress of IRS defenses over time. However, IRS will  continue to face challenges in evaluating its defenses. For example, it  is difficult to differentiate whether an increase in returns detected by  the IDT filters is due to improved filter performance or to an increase  in the overall number of IDT refund fraud attempts. In addition, future  methodology updates which reflect evolving schemes and improve  accuracy could make comparisons between filing seasons difficult.

Identify schemes. The Taxonomy may help IRS develop a better  understanding of taxpayer characteristics related to current,  successful IDT refund fraud, including filing status, the size of the  refund, filing method, and filing history. This could help IRS identify  IDT refund fraud scheme trends and assist it in further developing and  modifying its defenses.

Communicate the extent of the problem to stakeholders. While  the Taxonomy has limitations, it may help improve IRS managers’  understanding of the problem, allowing them to better communicate  with policymakers about schemes and resource needs. It may also  improve the ability of Congress (and other decision makers) to  oversee IRS’s efforts. In addition, the data collected could be of use to  IRS partners, including tax preparers and financial institutions.

Although IRS’s Taxonomy estimates are valuable in helping estimate IDT  refund fraud, they are, by their nature, incomplete. This is in part because  IRS’s estimate of IDT refunds paid (the $5.2 billion shown in figure 4) is  based on duplicate returns, information return mismatches, and criminal  investigations identified after the refunds are paid. However, for cases  where there are no duplicate returns, information returns, or criminal  investigations associated with a tax return, IRS has been unable to  estimate the amount of IDT refund fraud (the unidentified IDT refund fraud  shown in figure 4). Also, certain Taxonomy estimates are based on  assumptions using the characteristics of past IDT refund fraud. While the  assumptions are based on IRS’s research from known cases and appear  reasonable, we could not verify the accuracy and comprehensiveness of  these assumptions. This is because the accuracy of the Taxonomy  estimates is largely based on whether the estimate includes all true IDT  refund fraud returns and excludes all legitimate returns. IRS officials  acknowledged their estimates for returns flagged during information  return matching could include legitimate returns that are not actual IDT  refund fraud.   that we identified in the Taxonomy include the

The Taxonomy underestimates the number of IDT refund fraud  returns and refund amounts for some IDT categories and  overestimates others. The Taxonomy underestimates IDT refund  fraud because, as previously discussed, IRS has been unable to  estimate the amount of IDT refund fraud for cases where there are no  criminal investigations, duplicate returns, or information returns—such  as a W-2—associated with a tax return (the unidentified IDT refund  fraud shown in figure 4). An example of an overestimated category is  that of “refunds recovered,” which includes refunds returned to IRS as  a result of external leads. However, IRS data on external leads do not  distinguish whether the type of fraud was IDT refund fraud or some  other type of fraud. Our analysis of the Taxonomy found that IRS did  not adjust its estimate to account for other types of refund fraud.

While IRS provided Taxonomy estimates for filing seasons 2012  and 2013, methodology changes make it difficult to compare  these estimates over time. For example, the filing season 2013  estimate uses a different data source to estimate the number of IDT  refunds paid and eventually detected after the filing season (when IRS  matches tax returns to information return data, such as W-2s). In  addition, it is unclear whether changes in the number of IDT refund  fraud returns are due to overall changes in fraud patterns, such as an  increase or decrease in fraud attempts; to improvements in IRS IDT  defenses; or to identity thieves’ ability to file returns using schemes  IRS has not yet learned to detect.

section_title: Stronger Pre-refund and Post-refund Strategies Can Help Combat IDT Refund Fraud
paragraphs: IRS has responded to the problem of IDT refund fraud with new ways to  combat fraud. However, according to IRS officials, identity thieves are  “adaptive adversaries” who are constantly learning and changing their  tactics as IRS develops new IDT strategies. Therefore, IDT refund fraud  remains a persistent, evolving threat that requires stronger pre-refund and  post-refund strategies to combat.

A robust pre-refund strategy is important because preventing fraudulent  refunds is easier and more cost-effective than trying to recover them after  they have been issued. We have previously reported that implementing  strong preventive controls can help defend against invalid payments,  increasing public confidence and avoiding the difficult “pay and chase”  aspects of recovering invalid refunds. According to IRS, the agency’s  Return Review Program (RRP) is one way that IRS is trying to improve its  pre-refund detection efforts. As IRS processes tax returns, other  strategies can assist in identifying and stopping suspicious refunds.  Moreover, improving post-refund programs may help IRS work with  financial institutions to stop refunds that earlier controls have missed.  However, recapturing a fraudulent refund after it is issued can be  challenging—if not impossible—because identity thieves often spend or  transfer the funds immediately, making them very difficult to trace.

Agency officials and third-party stakeholders we spoke to identified the  following potential pre- and post-refund strategies that may help IRS  combat IDT refund fraud:

Pre-refund. Improve W-2 matching by (1) adjusting W-2 deadlines,  (2) lowering the threshold for e-filed W-2s,(4) delaying the filing season. (3) delaying refunds, and

Post-refund. Improve external leads programs by providing timely,  accurate, and actionable feedback to third parties.
subsections: section_title: Earlier, Pre-refund W-2 Matching May Prevent Billions of Dollars in Estimated IDT Refund Fraud but Would Involve Costs
paragraphs: Characteristics of the current tax processing system hamper IRS’s ability  to effectively verify taxpayer information prior to issuing refunds. As part  of a broader proposal, the Department of the Treasury (Treasury) has  proposed accelerating W-2 deadlines. This proposal will help ensure that  IRS has accurate, timely W-2 data to conduct pre-refund matching. IRS  has also requested funding to support timelier processing of W-2s.

IRS issues most refunds before it has access to employers’ W-2  data. IRS issues most refunds months before receiving and matching  information returns, such as W-2s. For 2012, IRS received more than  148.3 million tax returns and issued more than $309.6 billion in refunds to  110.5 million taxpayers. By March 1, 2012 IRS had issued about 50  percent of all 2012 refunds, but did not have access to most of the 2012  W-2 data verified by the Social Security Administration (SSA) (see figure   As previously noted, IRS’s look-back compliance model does not  5).allow it to match tax returns to information returns until early summer.

IRS is under pressure to issue refunds promptly. IRS is required by  law to pay interest if it takes longer than 45 days after the due date of the  return to issue a refund.refunds generally within 21 days after filing and actively tries to meet this  target. For tax year 2013, IRS reported that for tax returns filed through   IRS informs taxpayers to anticipate their  early March, taxpayers received refunds an average of 9.6 days after  filing.
subsections: section_title: Treasury’s Proposal for Accelerated W-2 Deadlines is Intended to Benefit IRS and Taxpayers
paragraphs: To facilitate the use of W-2 information in detection of noncompliance  (which includes IDT refund fraud) earlier in the filing season, Treasury  recently proposed to Congress that the W-2 deadlines be moved to  January 31 (for both paper and e-filing). processing W-2s more quickly as part of its fiscal year 2015 budget  request. The IRS Commissioner has also advocated for earlier  deadlines, testifying that challenges with IDT refund fraud have led IRS to  propose an accelerated W-2 filing deadline. Further, the National  Taxpayer Advocate has repeatedly written about the need to develop an  accelerated information reporting system to enable IRS to match third- party reports to return data before issuing refunds.

Treasury, General Explanations of the Administration’s Fiscal Year 2015 Revenue  Proposals, (Washington, D.C.: Mar. 2014). Each February, Treasury releases this  publication in conjunction with the President’s budget. As part of its proposal to stagger  tax return filing dates, Treasury proposed implementing an accelerated deadline for filing  information returns and eliminating the extended due date for e-filed returns. Under the  proposal, paper and e-filed W-2s would be due to SSA by January 31, the same date W- 2s are due to employees. of dollars of IDT refund fraud. Returns flagged during IRS’s  information return matching make up a substantial portion of the $5.2  billion in IDT refunds that IRS estimated it paid in filing season 2013,  according to IRS’s Taxonomy. With earlier access to W-2 data, IRS  could validate information reported on a tax return (e.g., wages and  compensation) with information reported by employers before issuing  refunds. Even without automatic matching, IRS officials said that  earlier W-2 data would speed up manual reviews of high-risk  returns—such such as those flagged by the IDT filters—because the  information they rely on to perform those checks would be readily  available.

Benefiting taxpayers and employers. In addition to protecting  revenue, accelerated W-2 reporting and pre-refund matching could  improve taxpayer service and reduce burden. IRS officials said that  having W-2 data at the beginning of the filing season would reduce  taxpayer burden by allowing IRS to verify income immediately and to  release legitimate tax returns caught by the IDT filters (false  positives). Earlier W-2 data could also help IRS reduce employer  burden, as IRS would no longer have to contact employers of  taxpayers whose returns are flagged by IDT and other fraud filters.

Providing other benefits. Earlier W-2 matching could reduce IRS’s  workload of collection cases and help taxpayers avoid penalties and  interest on under-paid taxes, according to IRS officials.

section_title: Accelerated W-2 Deadlines Could Create Other Challenges that Would Need to be Addressed
paragraphs: Implementing accelerated W-2 deadlines could result in an increased  number of corrected W-2s filed as well as other technical and logistical  challenges. SSA officials and all three payroll and information reporting  associations we interviewed told us that accelerating the W-2 deadline   (These are W-2s that  would increase the number of corrected W-2s.employers correct after sending the first incorrect version to SSA.)  Corrected W-2s represent less than 1 percent of the 213.5 million W-2s  IRS received from SSA in tax year 2011, according to IRS data. The  correction rate is currently low because the deadlines for filing with SSA  are well after the January 31 deadline for sending W-2s to employees,  giving employers a window of time to make corrections before they file  with SSA. Based on data tracking payroll submissions and subsequent  adjustments, the National Payroll Reporting Consortium estimated that  should the deadline be accelerated to before January 31, corrections may   To  increase from 1 percent of filed W-2s to greater than 6 percent.mitigate potential corrections, SSA officials and all three payroll and  information reporting associations we interviewed recommended allowing  a corrections window of time (e.g., 1 to 2 weeks) between submission to  employees and to SSA.

Employers must submit W-2 forms to employees by January 31 and to SSA by February  29 (if filing on paper) and March 31 (if e-filing). during that timeframe; however, the computer experts are available to  implement an accelerated W-2 filing date of February 29.

section_title: The Costs and Benefits of Accelerated W-2 Deadlines and Pre-refund Matching Have Not Been Assessed Fully
paragraphs: While Treasury and IRS officials have proposed moving up W-2  deadlines, the costs and benefits have not been identified, estimated, or  documented. How IRS decides to implement pre-refund matching using  W-2 data would affect the costs and benefits for itself and other  stakeholders. Some of the stakeholder issues that we identified and that  remain unaddressed include the following:  IRS. IRS has not identified cost-effective options for updating the  information technology systems or work processes (such as the  process for correcting refund amounts if mismatches are detected)  needed to implement pre-refund matching using W-2 data. IRS  officials said that a lack of budgetary resources is the primary reason  IRS has not conducted planning and analysis of the costs and  benefits related to accelerating W-2 deadlines. The full costs will not  be known until IRS analyzes details regarding how the agency would  implement this change (e.g., the thresholds IRS uses to match W-2s  will influence the number of W-2 mismatches due to IDT refund fraud  or false positives, where legitimate returns are flagged during  matching). Similarly, IRS does not have a well-developed estimate of  the magnitude of the benefits of pre-refund W-2 matching. Treasury  developed revenue projections for moving all information reporting  deadlines, but did not develop projections specific to the W-2  deadline. While IRS has a basis for estimating the revenue protected  from pre-refund matching (from its Taxonomy), other benefits—such  as employer savings from fewer queries from IRS—may be harder to  estimate.

SSA. Moving the deadline to January 31 would create logistical and  technical challenges for SSA. As previously discussed, SSA officials  told us that moving the deadline to January 31 or earlier would require  shifting its software development cycle because SSA’s computer  experts are working on another system during that timeframe;  however, the computer experts are available to implement an  accelerated W-2 filing date of February 29. If concurrent changes in  the e-file threshold are not made, SSA may also incur administrative  costs, should the number of W-2 corrections increase or a processing  backlog occur (see next section for details).

Third parties. The costs and benefits to employers and payroll  providers have not been quantified. SSA officials stated that moving  any W-2 deadline (other than the current e-file deadline of March 31)  involves a degree of risk that cannot be quantified at present. They  recommended surveying employers and payroll providers to better  understand the impact of shortening or eliminating the time gap  between when W-2s must be provided to employees and when they  must be provided to SSA.

Estimating the costs and benefits of options to accelerate W-2 deadlines  and to conduct earlier W-2 matching is consistent with IRS’s strategic  plan, which includes objectives to strengthen refund fraud prevention  through the use of third-party data and to use analytics for timely,  informed decision making. It is also consistent with Standards for  Internal Control in the Federal Government, which calls for IRS  management to design and implement internal controls within its  programs based on the related costs and benefits. However, without  better analysis of the costs and benefits of options for implementing  accelerated W-2 deadlines and pre-refund matching, Congress does not  have the information needed to consider Treasury’s proposal and  deliberate the merits of making such a significant change.

section_title: Other Policy Changes May Be Needed to Implement Earlier, Pre-refund W-2 Matching
paragraphs: Agency officials and third-party stakeholders we spoke to noted that other  policy changes may also be needed in concert with moving W-2  deadlines. This is because W-2 matching is part of a much larger tax- administration system that provides IRS with information needed to help  verify the identity, employment, and earnings of taxpayers. These  changes could include lowering the e-file threshold for employers,  delaying refunds, or delaying the start of the filing season. IRS has not yet  undertaken efforts to understand the full costs of implementing earlier,  pre-refund W-2 matching, and the costs associated with these other  changes.

Lowering the E-File Threshold for Employers  Because of the additional time and resources associated with processing  paper W-2s submitted by employers, SSA officials told us that a change  in the e-file threshold would be needed to sufficiently increase the number  of e-filed W-2s. Reducing the e-file threshold would allow IRS to obtain  timely, accurate data from a significant number of employers and would  enhance the benefits IRS could obtain from the accelerated W-2 deadline  and pre-refund W-2 matching. Currently, employers who file 250 or more  W-2s annually must e-file those forms. Low-volume filers (filing fewer  than 250 information returns annually) can file on paper, and for tax year  2011 these employers sent about 27.6 million paper W-2s (13 percent of  all W-2s filed), according to IRS data. Because of the additional time SSA  needs to process paper W-2s before sending them to IRS, changes in the  e-file threshold would be necessary for earlier W-2 deadlines to have the  intended effect. Without a change in the e-file threshold, backlogs in  paper W-2s could result in IRS receiving W-2 data after the end of the  filing season. For example, SSA officials said they can have a large  backlog of paper W-2s and can process some paper W-2s as late as  August or September. Having more e-filed W-2s would speed processing  time for SSA (as compared to paper W-2 processing time) and would  enable IRS to receive a larger percentage of W-2 data earlier, according  to SSA officials.

More than 4.5 million establishments have fewer than 10 employees, and SSA officials estimated that the e-file threshold would need to be  reduced to 5 to 10 information returns for the change to result in a  meaningful increase in the number of e-filed W-2s. Many states have  already implemented lower e-file thresholds. According to the American  Payroll Association, 19 states, the District of Columbia, and Puerto Rico  have a W-2 e-file threshold that is lower than IRS’s information return  requirement.

According to 2011 U.S. Census Bureau data. implementing a gradual reduction in the threshold and/or allowing  employers to file for hardship waivers. Additionally, small employers can  e-file W-2s at no cost through SSA’s web application, Business Services  Online.

In addition to contributing to the IRS’s ability to verify employment  information on tax returns, lowering the e-file threshold could reduce  administrative costs for SSA. Based on fiscal year 2013 data, SSA  officials stated that an e-filed W-2 costs about $0.002 to process, while a  paper W-2 costs about $0.53 to transcribe and process. officials said it is more difficult to ensure data quality with paper W-2s, as  transcription errors can occur while processing paper W-2s.

Treasury recently requested that Congress expand legal authority to allow  a reduction of the 250-return e-filing threshold for a broad set of  information returns, including W-2s. According to Treasury, benefits  such as enhancing taxpayer compliance, improving IRS service to  taxpayers, and modernizing tax administration make this change  worthwhile. For example, expanding e-filing will help IRS focus its audit  activities, as IRS will receive information in a useable form, according to  Treasury. The cost savings described above, as well as compliance and  other benefits, could be realized before Congress decides on whether to  accelerate W-2 deadlines (as proposed by Treasury). The change would  support IRS’s strategic objectives to encourage compliance while  minimizing costs and taxpayer burden. In addition, increasing e-filing is  consistent with internal controls, which require that information be  recorded and communicated to management and others within the entity  who need it and in a form and within a timeframe that enables them to  carry out their internal control and other responsibilities. For an entity to  run and control its operations, it must have relevant, reliable, and timely  communications relating to internal as well as external events.

We did not verify SSA’s estimates.

Implementing a lower e-filing threshold would have the ancillary benefit  (described above) of supporting pre-refund matching.

Delaying Refunds and Delaying the Start of the Filing Season  In conjunction with other strategies such as earlier filing of W-2s, delaying  the filing season or delaying refunds would provide more time for IRS to  receive W-2s, conduct pre-refund matching, and identify IDT refund fraud,  according to IRS and third-party officials. IRS could delay the start of the  filing season—the date IRS begins to process tax returns—but changing  IRS’s obligation to issue refunds within 45 days of the due date of the  return would require a statutory amendment. Both changes would have  costs associated with educating taxpayers about the changes and  potential costs to taxpayers who receive refunds later (discussed below).  In our discussions with third parties about ways to prevent IDT refund  fraud, 10 of the 22 groups we interviewed—ranging from financial  institution associations to software companies to payroll associations— specifically suggested the option of delaying refunds or delaying the filing  season until IRS could match W-2 data to tax returns.

National Taxpayer Advocate, 2013 Annual Report to Congress, Vol. II. that interval may be increased by several months. This additional waiting  time in the first year could be burdensome for some taxpayers; however,  there should be no added burden in subsequent years (i.e. the interval  between refunds will be approximately 12 months in those later years).

section_title: Weaknesses in Third- Party Partnership Programs Limit Post- Refund Fraud Detection
paragraphs: Through its external leads programs, IRS collaborates with financial  institutions, software companies, prepaid card companies, and other third  parties. These partnerships provide valuable information about emerging  IDT trends and fraudulent returns that have passed through IRS’s  prevention and detection systems. External leads help IRS identify  fraudulent refunds and understand emerging trends in IDT refund fraud  and other refund fraud. According to IRS officials, the agency has used  third-party leads to improve detection of IDT refund fraud. Between  January 1, 2014 and May 31, 2014, IRS reported that more than 350  sources sent IRS successful leads for nearly 94,000 taxpayer accounts:  these leads were for all types of refund fraud including, but not limited to,  IDT refund fraud.million in fraudulent refunds during this period.

IRS reported that financial institutions returned $214.8  Communicating with third parties is consistent with IRS’s strategic plan  objective to implement a robust enterprise risk management program by  establishing routine reporting procedures to inform external stakeholders  about operational risks. Also, it is consistent with internal controls, which  require relevant, reliable, and timely communications relating to external  events. As such, management should ensure there are adequate  means of communicating with external stakeholders and of obtaining  information from them that could help IRS achieve its goal of reducing  IDT refund fraud.

Disclosure constraints limit what IRS can share. Section 6103 of the  Internal Revenue Code limits the types of information IRS can share with  external parties, even for fraudulent returns. However, section 6103  does not limit IRS’s ability to share general information about how to  manage IDT refund fraud or emerging fraud trends. Disclosure of  individual taxpayer information could be prevented by aggregating  information so that no individual taxpayers could be identified. IRS  officials told us that aggregated feedback to third parties may be possible,  as long as a sufficient number of leads are discussed.

IRS feedback to third parties is limited. While IRS’s feedback differs by  external leads program, third parties receive limited feedback across both  programs.associations/companies we interviewed said that IRS provides little to no  feedback in response to leads sent through the External Leads Program  or the Opt-In Program, or they told us they requested additional feedback  from IRS. Furthermore, IRS officials told us that the agency has received  millions of leads from software companies, but while IRS makes an effort  to examine and address the highest priority leads (e.g., high refund  dollars), IRS has not analyzed or provided feedback about many of these  leads because it does not have the resources to do so. Without accurate,  timely, and actionable feedback, external parties do not know if the leads  they provide to IRS are useful. Five of these eleven financial institution  associations and tax software associations/companies volunteered that   Eight of the eleven financial institution and tax software  they are not able to assess their success in identifying IDT refund fraud,  or to improve their own detection tools. Useful feedback may include  aggregated information about the share of each institution’s leads that  helped to identify suspicious returns and other information about IDT  refund fraud trends. This type of aggregated information would also  comply with section 6103 disclosure requirements.

IRS’s general and aggregated feedback is limited to particular  groups. IRS shares general information about high-level schemes and  IDT refund fraud trends during meetings with BITS, the technology policy  division of the Financial Services Roundtable. institutions that are not part of that organization may not have the  opportunity to learn from these discussions.said they provide aggregated data about leads received to tax software  companies that request the information, but companies that do not  request the information may not receive this feedback.

According to a BITS official, the Financial Services Roundtable represents the largest  integrated financial services companies providing banking, insurance payment and  investment products and services to the American consumer. BITS addresses emerging  technology and operational opportunities for the financial services industry, helping  members manage risk, particularly in cybersecurity, fraud reduction, vendor management,  and critical infrastructure protection. BITS is not an acronym. At one time, BITS stood for  “Banking Industry Technology Secretariat.” However, with financial modernization and the  emergence of integrated financial services companies, that term is no longer used. that submitted them. In addition, IRS officials said while IRS provides  some overall data for the Opt-In Program, it does not track this  information by financial institution. Because IRS does not track external  leads by institution, it cannot use this information to improve IDT refund  fraud programs or to provide feedback to third parties about the  effectiveness of their leads.

Strengthening IRS’s partnerships with third parties would require IRS to  expend resources analyzing leads and providing feedback to third parties.  These costs could vary, depending on the systems involved and the level  of feedback IRS provides. IRS has some of the information needed to  track leads in this way. For example, spreadsheets submitted through the  External Leads Program contain the institutions’ names, so entirely new  data collection systems may not be needed. Our past work has shown  that developing metrics to track external leads by submitting party is  consistent with practices that enhance the use of performance  information, such as communicating that information frequently and  effectively. In addition, tracking external leads would support IRS’s  strategic goal of supporting effective tax administration by providing timely  information to external partners in the tax community.allow IRS to communicate information to specific third parties, who could  then adapt their own IDT detection tools. Given the millions of dollars in  refund fraud returned by financial institutions in the first five months of  2014, even a modest increase in IDT refunds returned due to institution- specific feedback may be worth the investment of tracking external leads.

section_title: Conclusions
paragraphs: IDT refund fraud is a large problem: IRS estimates it issued at least $5.2  billion in fraudulent IDT refunds in filing season 2013. Given the size and  scope of IDT refund fraud, additional bold and innovative steps are  needed from Congress and IRS. For IRS to successfully combat IDT  refund fraud, it will need to develop heightened awareness in its  understanding of emerging trends, and in its ability to leverage both  internal and external resources. While there is no “silver bullet” available  to resolve the problem, developing strategies that focus on both  preventing IDT refund fraud and resolving it can help IRS respond to this  evolving threat. These strategies are likely to include constantly adapting  and strengthening present defenses while also developing new strategies  for both electronic and paper returns that stop IDT refund fraud at all  stages of return processing.

Given the billions in dollars of successful IDT refund fraud, IRS must  strive to stay one or more steps ahead of identity thieves, or the risk of  issuing fraudulent IDT refunds could grow. Staying ahead of identity  thieves will require a significant resource investment from IRS as it  strengthens and develops new tools. Accelerating the W-2 deadline to  January 31—as proposed by Treasury—would provide a powerful tool for  IRS to detect and prevent IDT refund fraud. At the same time, the full  costs and benefits are not known because IRS has not considered how it  would implement pre-refund matching using W-2 data. The burden this  would impose on employers, the costs to IRS for systems changes, and  the likely need for other changes (such as increased e-filing) means this  step should not be taken without an informed discussion among all  stakeholders, including Congress. Further, taxpayers’ expectations about  the filing season and when they can anticipate receiving refunds may  need to shift. Also, IRS has not fully leveraged third parties, having  provided only limited feedback on the IDT refund leads third parties are  submitting and offering limited general information on IDT refund fraud  trends. However, to provide this information, IRS will need metrics to  track external leads by the third party that submitted them, which it  currently does not have. While the cost of providing third-party feedback  could vary depending on the level of feedback IRS provides, third-party  leads returned hundreds of millions of dollars in all refund fraud to the IRS  in 2014, and are a valuable information resource about fraudulent returns  that have bypassed IRS’s prevention and detection systems.

section_title: Matters for Congressional Consideration
paragraphs: Congress should consider providing the Secretary of the Treasury with  the regulatory authority to lower the threshold for electronic filing of W-2s  from 250 returns annually to between 5 to 10 returns, as appropriate.

section_title: Recommendations for Executive Action
paragraphs: We recommend the Commissioner of Internal Revenue fully assess the  costs and benefits of accelerating W-2 deadlines and provide information  to Congress on  the IRS systems and work processes that will need to be adjusted to  accommodate earlier, pre-refund matching of W-2s and then identify  timeframes for when these changes could be made; potential impacts on taxpayers, IRS, SSA, and third parties; and what other changes will be needed (such as delaying the start of the  filing season or delaying refunds) to ensure IRS can match tax returns  to W-2 data before issuing refunds.

We recommend that the Commissioner of Internal Revenue take the  following two actions to provide timely, accurate, and actionable feedback  to all relevant lead-generating third parties: provide aggregated information on (1) the success of external party  leads in identifying suspicious returns and (2) emerging trends  (pursuant to section 6103 restrictions); and develop a set of metrics to track external leads by the submitting third  party.

section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this product to IRS and SSA for review and  comment. In its written comments, reproduced in appendix III, IRS neither  agreed nor disagreed with our recommendations. IRS stated that it is  determining how potential corrective actions align with available  resources and IRS priorities before deciding whether to implement the  recommendations. With regard to our first set of recommendations, IRS  acknowledged that accelerating W-2 deadlines or delaying the tax filing  season represents a significant change to tax administration. IRS stated  that in order to determine the best course of action, Congress needs an  understanding of the costs and benefits for IRS and other stakeholders.  With regard to our second set of recommendations, IRS stated that  information sharing, as permitted under the law—such as providing  feedback to third parties—fosters good working relationships and  promotes ongoing program improvements. IRS provided technical  comments that we incorporated, as appropriate.

We recognize the need for IRS to assess its priorities given the fiscal  constraints it faces. We previously reported that since fiscal year 2010,  IRS has absorbed approximately $900 million in budget cuts while facing  increasing workloads as a result of legislative mandates and priority  programs, such as work related to the Patient Protection and Affordable  Care Act. Even with these constraints and other potentially competing  priorities, we believe the size of the IDT problem warrants additional  action now. Pre-refund matching of W-2 data is one option that IRS  agrees has the potential to prevent a substantial portion of the estimated  $5.2 billion in IDT refunds paid in filing season 2013. However, such a  change may require a significant resource investment by IRS as well as  impact taxpayers and employers. Without better information about the  benefits and costs of such a significant change, Congress cannot make  an informed decision about implementing it. With respect to our  recommendations regarding the External Leads Program, IRS highlighted  the fact that the program has generated more than $2.3 billion in refunds  returned to the U.S. Treasury from 2010 to 2014. Given that IRS already  has some of the information needed to better track external lead results,  IRS should be able to control the costs of implementing our  recommendations.

In its written comments, reproduced in appendix IV, SSA stated that its  implementation of a redesigned Annual Wage Reporting system for  processing W-2s in January 2015 and W-2cs in January 2016 will position  the agency to support an accelerated W-2 deadline as well as support  lowering the threshold for e-filing W-2s. SSA also said that it transmits  wage data to IRS immediately upon receiving electronic W-2s. Paper W- 2s require manual handling and therefore have a significantly longer  processing time. SSA also recommended that IRS consider the impact of  Form 1099 reporting in making decisions to accelerate the W-2 reporting  and change IRS business processes. SSA also provided technical  comments that we incorporated, as appropriate.

As agreed with your offices, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date. At that time, we will send copies to the Commissioner of  Internal Revenue. In addition, the report will be available at no charge on  the GAO website at http://www.gao.gov.

If you or your staff have any questions about this report, please contact  me at (202) 512-9910 or whitej@gao.gov. Contact points for our Offices  of Congressional Relations and Public Affairs may be found on the last  page of this report. GAO staff who made key contributions to this report  are listed in appendix V.

section_title: Appendix I: IRS Identity Theft Taxonomy Limitations
paragraphs: IRS developed the Identity Theft Taxonomy (Taxonomy) to monitor the  volume of identity theft (IDT) refund fraud attempts and assess the impact  of its IDT defenses over time, among other reasons. The Taxonomy is a  matrix of IDT refund fraud categories that estimate the amount of  identified IDT refund fraud IRS prevented or recovered, as well as the  identified IDT refund fraud IRS paid. The estimates are based on IRS’s  administrative records of known IDT refund fraud (e.g., data on the  number of duplicate returns or returns detected by identity theft filters).  The Taxonomy also estimates likely identity theft by identifying returns  with the characteristics of IDT refund fraud, which are found when IRS  matches returns to W-2 and other information return data after the tax  filing season. The Taxonomy is a valuable step toward inventorying  available IDT refund fraud data and assessing the performance of IRS’s  IDT refund fraud defenses. However, we identified limitations in the  Taxonomy, specifically

Taxonomy estimates are preliminary. After we provided a draft for  comment, IRS officials stated that the Taxonomy estimates are  preliminary, as they are updating their analysis using information  return matching to identify likely returns where IRS paid IDT refunds.  They anticipate their estimates for IDT refunds paid will increase  somewhat (perhaps by $0.6 billion), but an updated Taxonomy  estimate was not completed in time for us to include in this report.

Using administrative records could result in imprecise estimates.

Taxonomy estimates could be imprecise because the returns  identified may not accurately represent the true universe of IDT refund  fraud. If only certain kinds of criminals (or fraudsters) are more likely  to be detected by IRS defenses, IRS records on detected IDT refund  fraud may not accurately represent all individuals attempting to  commit IDT refund fraud.

Certain Taxonomy estimates are based on assumptions using  the characteristics of past IDT refund fraud. While the assumptions  are based on IRS’s research from known cases and appear  reasonable, we could not verify the accuracy and comprehensiveness  of these assumptions. This is because the accuracy of the Taxonomy  estimates is largely based on whether the estimate includes all true  IDT refund fraud returns and excludes all legitimate returns. IRS  officials acknowledged their estimates for returns flagged during  information return matching could include legitimate returns that are  not actual IDT refund fraud. For example, the estimate could include  returns flagged due to taxpayer or employer error or other non-IDT  fraud by taxpayers (e.g., the taxpayer deliberately enters false  information on his tax return to obtain a larger refund). Changes in  these assumptions can substantially affect the estimates, but this  uncertainty is not reflected in IRS’s Taxonomy estimates for filing  season 2013 (e.g., IRS does not present a range of estimates based  on differing assumptions).

IRS’s Taxonomy underestimates the number of IDT refund fraud  returns and refund amounts for some IDT categories. IRS’s  estimate of IDT refunds paid is based on duplicate returns,  information return mismatches, and criminal investigations identified  after the refunds are paid. However, for cases where there are no  duplicate returns, information returns, or criminal investigations  associated with a tax return, IRS has been unable to estimate the  amount of IDT refund fraud. IRS officials have considered using  surveys to estimate unidentified IDT refund fraud, but have not been  able to come up with a survey method that would avoid significant  taxpayer burden.

IRS’s Taxonomy overestimates the number of IDT refund fraud  returns and refund amounts for some IDT categories. For  example, IRS’s estimates for “refunds protected” include refunds  returned to IRS as a result of external leads. However, IRS data on  external leads do not distinguish whether the type of fraud was IDT  refund fraud or some other type of fraud. Our analysis of the  Taxonomy found that IRS did not adjust its estimate to account for  other types of refund fraud.

Methodology changes and other factors prevent comparisons  between filing seasons 2012 and 2013 estimates. For filing season  2012, IRS estimates it prevented or recovered about $21.6 billion (71  percent) of the estimated IDT refunds and paid $8.9 billion (29  percent). Comparing filing season 2012 and 2013 estimates is  problematic because it is unclear whether the changes are due to  methodological changes, such as using different data sources or  changing the criteria for querying data. IRS officials said they update  their methodology to better reflect evolving IDT refund fraud schemes  and improve the accuracy of Taxonomy estimates, although they  attempt to use consistent definitions to promote comparability of  estimates across years. In addition, it is unclear whether changes are  due to overall changes in fraud patterns, such as an increase or  decrease in fraud attempts; improvements in IRS IDT defenses; or  identity thieves’ ability to file returns using schemes IRS has not yet  learned to detect.

It is likely that IRS’s estimates of the IDT refund fraud for filing seasons  2012 and 2013 will continue to evolve as IRS improves the Taxonomy  methodology. For example, during the course of our audit, we found that  IRS’s methodology for counting returns did not include two categories of  duplicate returns that should have been included in the estimates. IRS  officials estimated that including these returns would increase IRS’s  original 2013 estimates of refunds paid out by $0.47 billion, from $4.75  billion to $5.22 billion in filing season 2013.

section_title: Appendix II: Objectives, Scope, and Methodology
paragraphs: This report examines (1) what the Internal Revenue Service (IRS) knows  about the extent of identity theft (IDT) refund fraud and (2) what additional  actions IRS can take to combat IDT refund fraud using third-party  information (for example, from employers and financial institutions). As  described earlier, the report discusses IDT refund fraud and not  employment fraud, unless otherwise noted.

To understand what IRS knows about the extent of IDT refund fraud, we  reviewed IRS’s Identity Theft Taxonomy (Taxonomy), which estimates the  amount of IDT refund fraud that IRS is, and is not, preventing. We  conducted manual data testing for obvious errors and compared  underlying data to IRS’s Refund Fraud & Identity Theft Global Report. We  confirmed Taxonomy components where we had data available to cross  check. We also interviewed IRS officials to better understand the  methodology used to create the estimates and the changes in  methodology, data sources, and assumptions across the years of data  available. For details on our findings about the Taxonomy components we  evaluated, see appendix I.

To identify opportunities to improve IRS’s IDT refund fraud efforts, we  reviewed Internal Revenue Manual sections detailing IRS’s Identity  Protection Program and IRS documentation for its External Leads  Program, the Opt-In Program, and other third-party efforts. We also  reviewed Treasury’s legislative proposals and Congressional testimony of  IRS officials. We interviewed officials and reviewed documentation from  the Social Security Administration (SSA) and several of the third parties  shown in table 1 below, where applicable. We selected a nonprobability  sample of 22 associations and stakeholders with differing positions and  characteristics to help ensure our analysis covered a variety of  viewpoints, based on IRS documentation and suggestions, our prior work,  and other information. For example, to select associations representing  financial institutions, we considered, among other factors, the size and  type of institutions they represented (e.g., large or small banks, credit  unions, and prepaid debit card companies). Because we used a  nonprobability sample, the views of these associations are not  generalizable to all potential third parties.

When possible, we used a standard set of questions in interviewing these  associations and summarized the results of the semistructured interviews.  However, as needed, we also sought perspectives on additional  questions tailored to these associations’ expertise and sought their  opinions on key issues. We then discussed these options with officials  from IRS offices, including (1) Privacy, Government Liaison, and  Disclosure and (2) Return Integrity and Correspondence Services to  determine the feasibility of various options and the challenges of pursuing  them.

To describe the timing of refunds issued compared to W-2 submissions,  we analyzed SSA data for filing season 2013 and IRS data for filing  season 2012. SSA provided data on the cumulative number of W-2s it  received for filing season 2013. We assessed the reliability of SSA data  by performing electronic tests to identify obvious errors and discussing  the data with SSA officials. We found the data were sufficiently reliable for  the purposes of providing contextual information on when SSA receives  W-2s.

For IRS data, we used analysis developed for  of W-2s and tax returns. This analysis obtained data from IRS’s  Compliance Data Warehouse (CDW) database, which provides a variety  of tax return, enforcement, compliance, and other data.when tax returns were received by IRS, we used the cycle posting date  (when IRS posts tax return data to the master file), as it represents when  the tax return data are available for matching. Officials noted that IRS  must refine the data prior to posting to IRS systems. This may include  identifying and correcting incomplete or inaccurate data before posting  the data to IRS systems. We assessed the reliability of CDW data by (1)  performing electronic or manual testing of required data elements to  identify obvious errors, (2) reviewing existing information about the data  and the system that produced them, and (3) interviewing agency officials  knowledgeable about the data. We determined that the data were  sufficiently reliable for the purposes of this report.

We conducted this performance audit from May 2014 to August 2014 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.

section_title: Appendix III: Comments from the Internal Revenue Service

section_title: Appendix IV: Comments from the Social Security Administration

section_title: Appendix V: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
paragraphs: James R. White, (202) 512-9110 or whitej@gao.gov.

section_title: Staff Acknowledgments
paragraphs: In addition to the individual named above, Neil Pinney, Assistant Director;  Shannon Finnegan, Analyst-in-Charge; Amy Bowser; Deirdre Duffy;  Michele Fejfar; Timothy Guinane; Katharine Kairys; Donna Miller; Dae  Park; and Ellen Rominger made key contributions to this report. Gary  Bianchi, Nina Crocker, Mary Evans, Ron Jones, David Lewis, Paul  Middleton, Susan E. Murphy, Sabine Paul, Sara Pelton, Julie Spetz, Jim  Wozny, and John Zombro also provided assistance.

section_title: Related GAO Products
paragraphs: GAO. Financial Audit: IRS’s Fiscal Years 2013 and 2012 Financial  Statements. GAO-14-169. Washington, D.C.: December 12, 2013.

GAO. Internal Revenue Service: 2013 Tax Filing Season Performance to  Date and Budget Data. GAO-13-541R. Washington, D.C.: April 15, 2013.

GAO. Identity Theft: Total Extent of Refund Fraud Using Stolen Identities  is Unknown. GAO-13-132T. Washington, D.C.: November 29, 2012.

GAO. Financial Audit: IRS’s Fiscal Years 2012 and 2011 Financial  Statements. GAO-13-120. Washington, D.C.: November 9, 2012.

GAO. Taxes and Identity Theft: Status of IRS Initiatives to Help Victimized  Taxpayers. GAO-11-721T. Washington, D.C.: June 2, 2011.

GAO. Taxes and Identity Theft: Status of IRS Initiatives to Help Victimized  Taxpayers. GAO-11-674T. Washington, D.C.: May 25, 2011.

GAO. Tax Administration: IRS Has Implemented Initiatives to Prevent,  Detect, and Resolve Identity Theft-Related Problems, but Needs to  Assess Their Effectiveness. GAO-09-882. Washington, D.C.: September  8, 2009.


Question-summary annotations: questions: question: How does IDT refund fraud work?
answer: IDT refund fraud takes advantage of IRS's “look-back” compliance model. Under this model, rather than holding refunds until completing all compliance checks, IRS issues refunds after conducting selected reviews.
child_questions: question: How can the model be changed to prevent IDT refund fraud?
answer: While there are no simple solutions, one option is earlier matching of employer-reported wage information to taxpayers' returns before issuing refunds.
child_questions: question: Why can't the IRS currently do such matching?
answer: IRS currently cannot do such matching because employers' wage data (from Form W-2s) are not available until months after IRS issues most refunds.

question: What changes would allow the IRS to conduct such matching?
answer: If IRS had access to W-2 data earlier—through accelerated W-2 deadlines and increased electronic filing of W-2s—it could conduct pre-refund matching and identify discrepancies to prevent the issuance of billions in fraudulent refunds.

questions: question: What has Treasury proposed regarding W-2 deadlines?
answer: In 2014, the Department of the Treasury (Treasury) proposed that Congress accelerate W-2 deadlines to January 31.
child_questions: question: To what extent has IRS examined the effects of this proposal?
answer: However, IRS has not fully assessed the impacts of this proposal.
child_questions: question: Why is this assessment important for a Congressional decision?
answer: Without this assessment, Congress does not have the information needed to deliberate the merits of such a significant change to W-2 deadlines or the use of pre-refund W-2 matching.

question: How does this assessment compare with the IRS's strategic plan?
answer: Such an assessment is consistent with IRS's strategic plan that calls for analytics-based decisions, and would help IRS ensure effective use of resources.

questions: question: How has Treasury proposed changing the return threshold for e-filing?
answer: Treasury has requested authority to reduce the 250-return threshold for electronically filing (e-filing) information returns.
child_questions: question: To what extent would the threshold need to change to increase e-filing?
answer: The Social Security Administration (SSA) estimated that to meaningfully increase W-2 e-filing, the threshold would have to be lowered to include those filing 5 to 10 W-2s.

question: How do e-filed W-2 forms affect administrative costs?
answer: In addition, SSA estimated an administrative cost savings of about $0.50 per e-filed W-2.

question: Why is a change in the e-filing threshold warranted?
answer: Based on these cost savings and the ancillary benefits they provide in supporting IRS's efforts to conduct more pre-refund matching, a change in the e-filing threshold is warranted.
child_questions: question: How would these changes affect IRS matching?
answer: Without this change, some employers' paper W-2s could not be available for IRS matching until much later in the year, due to the additional time needed to process paper forms.

questions: question: What does GAO recommend regarding the W-2 deadline?
answer: GAO recommends that Congress should consider providing Treasury with authority to lower the annual threshold for e-filing W-2s.
child_questions: question: What does GAO recommend regarding IRS's role?
answer: In addition, IRS should fully assess the costs and benefits of shifting W-2 deadlines, and provide this information to Congress.

question: To what extent did IRS agree with GAO's recommendations?
answer: IRS neither agreed nor disagreed with GAO's recommendations, and it stated it is determining how these potential corrective actions align with available resources and IRS priorities.