Tax Fraud and Noncompliance: IRS Can Strengthen Pre-refund Verification and Explore More Uses
Released: 2018-01-30T00:00:00


Highlights: section_title: Why GAO Did This Study
paragraphs: IRS continues to confront the ongoing problems of identity theft (IDT) refund fraud. The agency estimates that at least $1.68 billion was paid in IDT refund fraud in 2016. To help address this issue, consistent with GAO's prior reporting, the Protecting Americans from Tax Hikes Act of 2015 advanced the deadline for employers to file W-2s to SSA to January 31 (about 1 to 2 months earlier than in prior years). This change allows IRS more time to match wage information to tax returns through systemic verification, and identify any discrepancies before issuing refunds.

GAO was asked to assess how well IRS implemented systemic verification. GAO assessed IRS's performance using systemic verification and the extent to which IRS analyzed the effectiveness of the refund hold on this process. GAO analyzed IRS and SSA data and documents, observed SSA's paper W-2 process, and interviewed IRS and SSA officials. GAO compared IRS actions to laws; IRS policies; and standards for internal control, fraud risk management, and program evaluation.

section_title: What GAO Found
paragraphs: Beginning in 2017, as required by law, the Internal Revenue Service (IRS) held all refunds for taxpayers claiming the Earned Income Tax Credit (EITC) or Additional Child Tax Credit (ACTC) until February 15. IRS also took actions to verify wage and other information reported on tax returns before issuing refunds, referred to as systemic verification, but several factors limited its success. IRS received over twice as many (over 214 million) Forms W-2, Wage and Tax Statement (W-2) by February 15 compared to the same time in 2016, and reported that W-2 data were responsible for improving fraud detection and reducing taxpayer burden. However, IRS was unable to verify over half of the returns it held until February 15 before issuing the refunds. For example, IRS received W-2s daily but its information technology systems processed them weekly. In response to GAO's review, IRS reported it is planning to assess options for processing W-2s daily. Also, some employers submit W-2s late, but IRS did not track the extent to which late W-2s are associated with fraud or noncompliance. Further, IRS has not assessed options for enforcing late W-2 penalties earlier. Additionally, about 9 percent (about 23 million) of W-2s were filed on paper, which IRS does not begin to receive from the Social Security Administration (SSA) until March. By law, employers who file 250 or more W-2s are required to file W-2s electronically, while those who file fewer than 250 W-2s may opt to file on paper or electronically. In August 2014, GAO suggested that Congress provide the Secretary of the Treasury with the authority to lower the electronic filing requirement from 250 W-2s to 5 to 10. This action could also have the benefit of reducing SSA's W-2 paper processing costs by $9.7 to $11.3 million per year. These issues reduce IRS's access to timely W-2 data, limiting its ability to prevent fraud and reduce noncompliance before issuing refunds.

IRS's preliminary and final analyses of the February 15 refund hold both showed that IRS could have detected significantly more in potential fraud and noncompliance if it held all refunds until late February, when it had more W-2 data available. There are differences between these analyses. For example, the final analysis included more returns and estimated total revenue IRS could protect by extending the refund hold and expanding it to all taxpayers. In that analysis, IRS estimated that it could have protected $100 million in fraud and noncompliance had it held all taxpayer refunds until February 15—$35 million more than it protected by holding refunds with EITC or ACTC. IRS further estimated that moving the refund hold to March 1 for all taxpayers could protect $895 million compared to $533 million if it only held refunds with EITC or ACTC until that date. However, GAO found limitations to IRS's analyses. For example, while IRS has plans to further explore holding refunds longer, it does not have an evaluation plan to assess the effectiveness of the refund hold on systemic verification. Also, IRS did not fully assess the benefits and costs, including taxpayer burden, of the refund hold, nor how its analysis informs its broader fraud risk management or compliance efforts. As a result, IRS does not have sufficient information to inform a decision on potential changes to the refund hold date and those subjected to it. Finally, IRS has not assessed the benefits and costs of expanding systemic verification to use for pre-refund compliance checks in other areas such as income underreporting and employment fraud. Therefore, IRS may be missing opportunities to maximize use of early W-2 data.

section_title: What GAO Recommends
paragraphs: GAO recommends IRS collect data to track late W-2 filing penalties and assess options for earlier enforcement; assess the benefits and costs of using existing authority to hold refunds longer, hold all refunds, or both, and expanding systemic verification to other areas; and take actions based on the assessments. IRS listed steps to respond to 5 of 6 recommendations, but said it could not enforce penalties earlier. GAO recognizes the challenges but clarified that assessing other options would provide benefits, as discussed in the report.

section_title: Letter
paragraphs: In recent years, the Internal Revenue Service (IRS) has faced ongoing  problems with fraud and noncompliance. This includes identity theft (IDT)  refund fraud, which occurs when a fraudster obtains an individual’s Social  Security number, date of birth, or other personally identifiable information  (PII), and uses it to file a fraudulent tax return seeking a refund. IRS  estimates that at least $12.24 billion in IDT tax refund fraud was  attempted in calendar year 2016—of which it prevented at least $10.56  billion (86 percent)—but at least $1.68 billion (14 percent) was paid. This  represents an improvement compared to prior years. Improper payments  have been another costly problem, which includes both fraudulent activity  and noncompliance. IRS estimates also show that the Earned Income  Tax Credit (EITC) has consistently had a high improper payment rate.  For fiscal year 2017, IRS reported that total EITC payments were $68  billion, of which $16.2 billion were estimated to be improper.

To help address these issues, IRS implemented a process to verify wage  and related information on all tax returns with refunds for the 2016 filing  season, referred to as systemic verification. We previously reported that the information that employers report on Form W-2, Wage and Tax  Statement (W-2), had not been available to IRS until after it issued most  refunds. With earlier access to W-2 data, IRS could use this information  to verify taxpayers’ returns and identify any discrepancies before  potentially issuing billions of dollars in fraudulent refunds. Such  verification could also prevent some EITC improper payments. Consistent  with our prior reporting, Congress enacted the Protecting Americans from  Tax Hikes Act of 2015 (the Act) in 2015, which required employers to  submit W-2s to the Social Security Administration (SSA) by January 31,  effective beginning in 2017.

Compared to prior years, the new deadline is 1 month earlier if filing on  paper or 2 months earlier if filing electronically. SSA then provides W-2  data to IRS for verifying employee wage and withholding data on tax  returns. The Act also required IRS to hold refunds for all taxpayers  claiming EITC or Additional Child Tax Credit (ACTC) until February 15.  In April 2017, we testified based on our initial review that this process  holds promise for combatting IDT refund fraud and reducing improper  payments, but IRS faced some implementation challenges.

You asked us to review the 2017 filing season to determine how well IRS  implemented systemic verification. We assessed (1) IRS’s performance in  detecting fraud and noncompliance using systemic verification, and SSA’s  performance providing timely W-2 data to IRS; and (2) the extent to which  IRS analyzed the effectiveness of the refund hold on systemic verification  as well as opportunities for IRS to apply systemic verification to other  efforts to detect fraud and noncompliance.

To assess IRS’s performance detecting fraud and noncompliance using  systemic verification, we reviewed preliminary 2017 filing season data  and analyses of systemic verification results. We also reviewed applicable  laws, IRS documentation, and policies, and we interviewed IRS officials.  We compared IRS’s actions to IRS’s Strategic Plan, which includes  objectives to strengthen refund fraud prevention by using third-party data  and analytics for timely, informed decision making, and to innovate  technology systems to support IRS’s business needs. We also  compared IRS’s actions to the Standards for Internal Control in the  Federal Government, which call for management to design and  implement internal controls within programs based on the related benefits  and costs. To assess SSA’s performance providing timely data to IRS,  we compared IRS and SSA data to SSA’s goals. We also observed paper  W-2 processing and interviewed staff and managers at SSA’s paper W-2  processing facility in Wilkes-Barre, Pennsylvania.

To assess the extent to which IRS conducted analyses on the  effectiveness of the refund hold and opportunities to improve systemic  verification and apply it to other efforts to detect fraud and  noncompliance, we assessed IRS data for 2017 and analyses of  verification outcomes under different scenarios against overarching  concepts and leading practices provided in our Fraud Risk and  Management Framework and Program Evaluation guidance. We also  determined whether IRS conducted a complete economic analysis of the  effects on taxpayer burden based on interviews with IRS and Department  of the Treasury (Treasury) officials, and three economic experts. We  identified key elements experts reported that IRS should consider. We  selected these three economists based on their expertise in the field of  tax policy and refundable tax credits, and to ensure variation in  perspectives on tax issues. The views of these experts are not  generalizable. In addition, we interviewed IRS officials on the benefits and  costs of systemic verification.

To assess the reliability of the data we used for this report, we reviewed  IRS and SSA reports on W-2 data, and IRS reports on systemic  verification and its results. We also reviewed IRS reports on the  performance of its fraud filters. We examined systemic verification data to  identify obvious errors or outliers or potential data limitations that would  affect how we use the data, and we found no such problems. We also  interviewed IRS officials about their data quality procedures and the data  and their limitations. We determined that the data presented in this report  are sufficiently reliable for the purposes of our reporting objectives. More  information on our scope and methodology can be found in appendix I.

We conducted this performance audit from March 2017 to January 2018  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
subsections: section_title: IDT Refund Fraud
paragraphs: Viewed broadly, IDT refund fraud is composed of two crimes: (1) the theft  or compromise of PII, and (2) the use of stolen (or otherwise  compromised) PII to file a fraudulent tax return and collect a fraudulent  refund. Figure 1 presents an example of how fraudsters may use stolen  PII and other information, real or fictitious (e.g., sources and amounts of  income), to complete and file a fraudulent tax return and successfully  receive a refund. In this example, a taxpayer may alert IRS of IDT refund  fraud. Alternatively, IRS can detect IDT refund fraud through its  automated filters that search for specific characteristics as well as through  other reviews of taxpayer returns. IRS reported that, through September  2017, the number of taxpayers reporting that they were a victim of IDT  refund fraud had decreased by about 40 percent compared to the same  period in 2016 (from 348,650 to 208,503). IRS officials attribute this  decline to improved fraud filters.

section_title: Pre-refund Compliance Checks
paragraphs: We have long highlighted the importance of pre-refund compliance  checks as a means to improve compliance while minimizing taxpayer  burden. As we testified in 2011, pre-refund compliance checks help IRS  to confirm taxpayers’ identity, quickly and efficiently correct some errors  with virtual certainty, and identify and audit some returns before refunds  are issued. They also have the potential to deter billions of dollars in  erroneous refunds, especially for refundable tax credits. These credits  have complex eligibility requirements and are often overclaimed. IRS’s  ability to match tax returns to information provided by third parties,  including from financial institutions, can help enforce compliance with the  tax laws. Pre-refund checks benefit taxpayers directly when IRS identifies  underclaimed benefits.

Pre-refund compliance checks can reduce the tax gap created when  taxpayers file returns that, for example, underreport their tax liability. In  2016, IRS estimated that the average annual gross tax gap was $458  billion for tax years 2008 to 2010. IRS estimated that through late  payments and enforcement actions, it would collect an additional $52  billion annually for those tax years, resulting in an average net tax gap of  $406 billion. Because of the importance of improving voluntary  compliance and addressing the tax gap, we continued to include  Enforcement of Tax Laws as a high-risk area in our 2017 High-Risk  Report.

section_title: Systemic Verification
paragraphs: As noted previously, beginning in 2017 the Protecting Americans from  Tax Hikes Act of 2015 requires employers to submit W-2s to SSA by  January 31 (about 1 to 2 months earlier than in prior years, depending on  the method of filing). It also requires IRS to hold refunds for all taxpayers  claiming EITC or ACTC until February 15. In October 2017, IRS reported  that, among the 13.4 million refunds subjected to this hold, it had  completed processing 10.3 million refunds totaling $51.2 billion. Although  IRS has authority to hold additional refunds until it receives more W-2  data, IRS, in consultation with Treasury, decided not to exercise this  authority in 2017. IRS officials explained that they did not do more than  required by the law because it would be a major shift in refund issuance  causing a strain on the economy, industry partners, taxpayers, and IRS  telephone and other operations. Officials said that they expect to learn  from their experience during the 2017 filing season and will continue to  consider changes for future filing seasons as they have for 2018.  However, all returns—with EITC or ACTC and without EITC or ACTC— were subject to systemic verification as well as other fraud filters.

Systemic verification is one element of IRS’s Return Review Program  (RRP), its primary system to detect fraud and noncompliance. RRP is a  platform that runs individual tax returns through a comprehensive set of  rules and models to detect potential taxpayer fraud and other  noncompliance, then selects returns for various treatment options.  Systemic verification categorized taxpayer returns in one of three  outcomes to detect potentially fraudulent or noncompliant returns (see  figure 2):  1.  Wage information verified: Income and withholding on the return  matches W-2 data within the allowed threshold.  2.  False or incorrect income: Information on the return is not valid  when compared to W-2 data. This mismatch can include income,  withholding, employer identification number, or other characteristics.  3.  Unable to verify: Unable to verify income or withholding on the return  because W-2 data are unavailable or the taxpayer did not report wage  income but had other types of income such as Social Security or self- employment. IRS reprocessed (looped) all returns that reported wage  income through RRP when new third-party data became available.  For EITC or ACTC returns that IRS was required to hold until  February 15, IRS had additional time to reprocess these returns  before releasing the refund.

After systemic verification is completed, IRS either continues processing  the refunds for release or holds the refunds for additional review. For  returns where IRS either verified or was unable to verify the wage  information, the refunds were processed (beginning February 15 for  returns with EITC or ACTC) unless selected by the fraud filters for  review. However, IRS does not have the authority to correct a  taxpayer’s return based on W-2 data, so it must initiate a correspondence  audit which, as we have reported, is more costly to IRS, more  burdensome on the taxpayer, and more time consuming for both.  Therefore, for returns with false or incorrect income, IRS froze the refund  and directed it to various units for review depending on the results of  systemic verification and fraud filters. For example, if IRS suspected that  the return was IDT refund fraud, it directed it to the Taxpayer Protection  Program to verify the taxpayer. For returns where IRS suspected potential  noncompliance, it directed the return to the Integrity and Verification  Operations group.

section_title: Systemic Verification Shows Promise but Legacy Information Technology and Issues with Employer W-2 Filing Limit Its Success
subsections: section_title: Early W-2 Data and the Refund Hold Helped IRS Prevent Fraud and Noncompliance for a Limited Number of Tax Returns
paragraphs: By mid-February 2017, 2 weeks following the new W-2 filing deadline and  about when the refund hold expired, IRS had received more than twice as  many (over 214 million) W-2s than SSA provided at a similar time in 2016  (see figure 3). Nevertheless, IRS did not have all W-2 data in time to  conduct pre-refund checks of wages, withholding, and other information  before issuing refunds, especially early in the filing season.

Despite not having all W-2 data, IRS was able to identify and prevent  some fraud and noncompliance before issuing refunds. IRS received and  initially processed through systemic verification a total of about 35.1  million individual tax returns through February 14, representing nearly  $200 billion in refunds.

As shown in table 1, nearly 13.4 million (38 percent) of those returns  claiming about $115 billion in refunds were filed by taxpayers who  claimed EITC, ACTC, or both, and were subject to the refund hold. Using  systemic verification, as of February 14, 2017, IRS determined that nearly  150,000 of these 13.4 million returns (1 percent) were potentially  fraudulent because they included false or incorrect income. The returns  represented approximately $800 million in refunds. IRS also verified wage  and other information for approximately 4.72 million (35 percent) of those  returns filed and processed through February 14, representing $73.5  billion in refunds. However, IRS was unable to verify 7.79 million (58  percent) of these returns before it released refunds because W-2 data  were unavailable, as described later in this report. Finally, table 1 also  notes that, as of October 2017, IRS reported that, among those returns  filed and processed through February 14, 10.3 million had completed  processing and $51.2 billion in refunds had been issued.

As the February 15 refund hold expiration approached, IRS continued to  reprocess (loop) returns through systemic verification as more W-2 data  became available. In doing so, IRS staff identified 12,000 more returns, in  addition to the 150,000 initially identified, that they suspected to be  fraudulent. This brought the total number of potentially fraudulent or  noncompliant returns to about 162,000 with nearly $863 million in  refunds. IRS manually held these refunds and referred the suspicious  returns for further screening to the Integrity and Verification Operations  group. IRS later cleared approximately 150,000 (93 percent) of these  returns and released about $797 million in refunds. IRS confirmed that  approximately 12,000 (7 percent) of the returns that it had not cleared  were fraudulent, eventually protecting $65 million, which included $51  million in EITC or ACTC claims.

To reduce false positives (when legitimate tax returns are erroneously  selected for review), an IRS working group made several changes to how  IRS’s fraud filters make selections based on W-2 data and other  information. For 2018, IRS plans to automatically select returns that it had  held manually in 2017. However, officials noted that while verifying wage  information is important, the complexity of determining EITC and ACTC  eligibility remains a challenge.

We reviewed IRS’s systemic verification results and found that IRS  improved its selections of potentially fraudulent returns with W-2 data  contributing to its fraud filters. As of February 15, returns selected for  review by systemic verification comprised 14,618 (6 percent) of all paper  and electronic returns selected as potential identity theft by the fraud  filters. By September 15, selections from systemic verification increased  to nearly 78,369 (about 10 percent) of all returns selected as potential  identity theft. Moreover, we found that if more W-2 data were available  earlier, IRS could have excluded more returns from review, thereby  reducing or eliminating work and reducing taxpayer burden by not  delaying legitimate taxpayers’ returns. For example, systemic verification  allowed IRS to exclude about 321,000 electronically-filed tax returns out  of more than 700,000 that had been selected for review by the fraud  filters.

section_title: IRS’s Ability to Process W-2s Was Limited by Its Information Technology Systems and Issues with Employer W-2 Filing
paragraphs: We found that IRS’s ability to verify information on tax returns early in the  filing season was limited because of its Information Technology (IT)  systems and issues with employers filing W-2s on paper or after the filing  deadline.

IT systems. IRS receives and maintains validated taxpayer data,  including W-2 and 1099-MISC forms, through the Information Return  Master File (IRMF) system. IRS received W-2 data from SSA daily but  only loads the data onto IRMF weekly due to the legacy design of this  system. This contributed to IRS’s inability to verify more than half (7.79  million or 58 percent) of tax returns with EITC or ACTC claiming $38.4  billion in refunds when the February 15 refund hold expired. IRS officials  stated that due to the system’s legacy design, adding new or updating  existing information return documents requires the agency to reload its  entire file, which contains billions of information returns.

Officials reported that this process can take up to 3 days or more to  complete, depending on the file size of the incoming and existing data,  and has prevented IRMF from processing and making the W-2 data  available for use, as it is received from SSA. Consequently, while IRS had  received a total of about 210.9 million W-2s by February 13, it received an  additional 3.9 million W-2s between February 13 and 20 that IRS was  unable to use in systemic verification before the February 15 refund hold  expired.

In October 2017, IRS officials told us several reasons why they were not  addressing IT limitations. At that time, they said they had discussed  various options to make W-2 data available faster, but they had not  assessed whether IRMF processing could occur more than once weekly.  Further, these officials said IRS developed a plan to modernize IRMF,  which would allow for faster processing, but officials told us that this effort  is on hold because of competing priorities and funding shortages. These  officials also said they had not considered the potential financial benefits  of either modifying existing procedures or continuing to pursue  modernizing IRMF to process W-2 data more frequently for use in  systemic verification.

However, in response to our discussions, in November 2017, IRS officials  reported they had started to assess the possibility of processing W-2 data  on IRMF daily. Specifically, IRS is planning to assess daily processing for  the months of January and February during the 2019 filing season when  the number of information returns is lower and the file is less time  consuming to load. They noted they would not have time to assess their  options and make necessary changes to process W-2s daily for the 2018  filing season.

As we reported in October 2017, IRS faces challenges with managing its  aging legacy systems, and with establishing a process for prioritizing its  modernization efforts. IRS’s planned action is consistent with its  strategic plan, which includes objectives to strengthen refund fraud  prevention by using third-party data and analytics for timely, informed  decision making, and to innovate technology systems to support IRS’s  business needs. It is also consistent with Standards for Internal Control  in the Federal Government, which calls for management to design and  implement internal controls within programs based on the related benefits  and costs. By taking its planned action to assess processing W-2 data  more frequently, IRS would be in a better position to make informed  decisions about the future of IRMF and its modernization efforts.

Paper W-2 processing. Of the 253 million W-2s that SSA received by  December 1, 2017, about 23 million (9 percent) were paper. SSA  receives and processes paper W-2s at the Wilkes-Barre Direct  Operations Center (WBDOC) in Wilkes-Barre, Pennsylvania. Beginning in  October or November of each year, WBDOC programs and tests its  systems for transmitting transcribed paper W-2 data. The majority of W- 2s that WBDOC receives are in optical character recognition (OCR)  format, which SSA can scan into its systems instead of manually entering  the data. Officials stated that W-2s that are not in OCR format require  more time and effort to process. This process of developing, testing,  scanning, or entering data manually occurs between October and March  before WBDOC begins transmitting the paper W-2 data to SSA’s  Baltimore facility. Beginning in March, SSA continually transmits all paper  and electronic W-2 data to IRS.

By law, employers who file 250 or more W-2s are required to file W-2s  electronically, while those who file fewer than 250 W-2s may opt to file on  paper or electronically. This requirement has not changed since 1989  when employers filed electronically using magnetic media or other  machine-readable forms. Since then, technological advancements allow  employers to file for free using SSA’s website or other software packages.  Consequently, even though not required, by July 28, 2017, SSA had  received approximately 69 million electronically filed W-2s from about 4.4  million employers who filed fewer than 250 W-2s.

In August 2014, we reported that lowering the electronic W-2 filing  requirement would not only contribute to IRS’s ability to verify  employment information on tax returns, but it could reduce administrative  costs for SSA. According to SSA estimates, the cost to transcribe and  process a total of 24.2 million paper W-2s in 2016 was about $13.3  million, or $0.55 per paper W-2. In addition to the cost savings from  lowering the electronic filing requirement, as we reported in August 2014,  there would be fewer transcription errors and fewer W-2s subject to the  longer paper W-2 processing time. In that report, we suggested that  Congress should consider providing the Secretary of Treasury with the  regulatory authority to lower the requirement for electronic filing of W-2s from 250 returns annually to between 5 to 10 returns, as appropriate. In  August 2017, SSA officials estimated that SSA can save between $9.7  and $11.3 million per year if the W-2 paper filing requirement is lowered  to 10 or fewer W-2s. These officials reported that this estimate is based  on a projected increase of 17.6 million to 20.6 million in electronically filed  W-2s and a decrease of paper W-2s by more than two-thirds.

Late W-2 filing. IRS began publicizing the change in the W-2 deadline in  June 2016. Nevertheless, about 260,000 employers missed the January  31 filing deadline, accounting for late filing of about 7.9 million W-2s in  2017. IRS officials stated that, of the 27,764 employers who had  requested an extension for time to file W-2s, as discussed below, IRS  approved approximately 6,500 (23.4 percent), which account for  approximately 1.1 million W-2s (13.9 percent) of the 7.9 million late filed  W-2s. Because IRS has not yet started to assess penalties, it does not  yet know how many of these will be subjected to a penalty.

Generally, an employer must pay a penalty for failing to file an information  return timely or correctly unless an exception applies, such as being  granted an extension. However, IRS has changed how it enforces late  filing penalties by not mailing some proposed penalty notices to  employers who fail to file W-2s timely. For example, IRS mailed all  penalty notices to employers who failed to timely file in 2014. However, it  did not mail all penalty notices for 2015 and 2016 to employers who failed  to file W-2s timely. IRS officials told us that, due to a lack of resources to  manage all the penalty cases, they began applying a risk-based selection  process to prioritize compliance efforts. Moreover, officials told us they  did not collect data to track how many penalty notices IRS did or did not  mail for late-filed W-2s, nor the associated penalties IRS proposed to  assess for 2015 and 2016.

By law, there are some exceptions to the enforcement of penalties on  those who fail to file correct information on or before the required filing  date, and who fail to include all of the information required to be shown on  the return, or include incorrect information, without correction. However,  by not mailing all penalty notices, as it did in the past, IRS is not using a  tool to collect, at the least cost, the proper amount of tax revenue, is not  enhancing or promoting voluntary compliance, and it is missing an  opportunity to educate and help the employer understand his or her legal  obligations and rights. Additionally, without timely W-2 data to complete  pre-refund checks against filed returns, IRS risks releasing fraudulent and  noncompliant refunds or burdening legitimate taxpayers whose returns  could be cleared with the W-2 data. IRS officials told us that they are  monitoring the effect of not mailing all notices on the number of late  filings. However, as of November 2017, IRS did not have plans to track  and evaluate the extent to which the late W-2s are associated with  fraudulent or noncompliant refunds.

In addition, IRS does not mail penalty notices until up to a year and a half  after the missed deadline. For example, IRS will not assess and mail  penalty notices for the approximately 260,000 employers who filed W-2s  or other information returns late in 2017 until summer 2018. In part, this is  because IRS waits to compile all late-filed information returns, not just W- 2s, some of which are not due until April. Further, late-filing penalty  amounts increase incrementally until August 1 for employers who file or  correct information returns after the filing deadline. Finally, for 2017, IRS  did not finish transcribing and processing the more than 40 million paper- filed information returns until about late September. However, IRS  officials have not assessed the options for mailing penalty notices for late  W-2s earlier or communicating with the employers earlier in the process.  These officials told us that the penalty notice process is consistent with  IRS’s enforcement procedures. They further added that mailing multiple  penalty notices could increase burden and cost for both the taxpayer and  IRS. However, quickly responding to employers that filed late increases  the potential for compliance, thereby increasing the availability of W-2  data for systemic verification to detect and prevent fraud and  noncompliance. Finally, because it takes up to a year and a half for IRS to  identify the late filing and mail the penalty notice, it is possible that the  employer could have filed W-2s late two years in a row without IRS  notifying him/her of the first late filing.

W-2 extensions. In 2017, IRS received 27,764 employer requests for an  extension of time to file W-2s, which is substantially higher compared to  prior years. IRS officials attribute the increase in extension requests to the  new early filing deadline. IRS also began requiring employers to provide  reasonable cause and only file their requests on paper. Prior to 2017,  employers could file for an automatic 30-day request for extension,  electronically or on paper. Because IRS manually processed all requests  to determine if the cause was reasonable, IRS did not complete its  processing until November 2017. Consequently, employers would not  know until after the extended deadline whether IRS granted them the  extension.

IRS officials told us that, for 2017, they notified about 10,000 employers  who requested but were not granted an extension that they would not be  penalized this year. Officials also notified these employers that they would  be penalized next year under the same conditions. In November 2017,  IRS officials said that they are reviewing the extent to which extension  requests made in 2017 affected systemic verification. For 2018, IRS plans  to continue requiring employers to file extension requests on paper.

section_title: IRS’s Analyses of the Refund Hold Are Limited, Hampering Their Usefulness for Decision Making and IRS Has Not Explored Additional Uses of Systemic Verification
subsections: section_title: IRS Completed Its Analyses of Potential Changes to the Refund Hold but Did Not Fully Assess the Benefits and Costs and Taxpayer Burden
paragraphs: IRS officials examined the effectiveness of the February 15 refund hold  by analyzing how systemic verification results differ under several  hypothetical scenarios. For example, IRS could extend the refund hold  date beyond February 15 when more W-2 data are available for systemic  verification before issuing refunds. While the law states that IRS cannot  release refunds with EITC or ACTC before February 15, IRS has  discretion to continue to hold all refunds until it can verify W-2 data, and  has the authority to expand the refund hold to all taxpayers, not just those  who claimed EITC or ACTC. Further, the law does not preclude IRS  from releasing refunds with EITC or ACTC on a rolling basis after  February 15, or in conjunction with an extension of the refund hold.

In October 2017, the National Taxpayer Advocate (NTA) told us that she  supports potential modifications to the refund hold. In addition, in a June  2017 annual report to Congress, the NTA stated that holding the refunds  for all taxpayers longer so that IRS can verify W-2 data could help IRS  prevent tax refund fraud before refunds are issued. The NTA also  recommended that IRS research the benefits and costs of delaying refund  payments.

During the 2017 filing season, IRS reviewed limited preliminary systemic  verification data to assess potential changes to the February 15 refund  hold. In October 2017, IRS completed its final analysis, which included  more data on taxpayers who filed after the February 15 refund hold and  estimated potential amounts of protected refunds. However, both  analyses have limitations.

We assessed IRS’s preliminary analysis of the 35.7 million returns filed by  all taxpayers (those who claimed EITC or ACTC and those who did not)  before February 15 and which were subjected to systemic verification.  IRS’s analysis included actual results from systemic verification for these  tax returns for each week between February 15 and March 15 after  reprocessing the returns when new W-2 data became available. Our  assessment of IRS’s preliminary analysis showed that by both extending  the refund hold date beyond February 15 and expanding the refund hold  to all returns:  IRS could have verified more than twice as many returns. By  March 15, IRS could have verified wage information for more than  twice as many returns before issuing refunds—30.5 million compared  to 14.3 million verified by February 15. By only holding returns until  February 15, IRS would be unable to verify W-2 data for 20.2 million  (56 percent) tax returns, representing $66.6 billion in refunds, before  releasing the refunds.

IRS could have detected about $3 billion—twice as much–in  potential fraud and noncompliance. If IRS had held all taxpayers’  refunds until late February or early March, it could have detected  about twice as much potential fraud or noncompliance before issuing  refunds, as shown in figure 4, because it had more W-2 data available  at that time compared to February 15. For example, if IRS held all  taxpayers’ refunds until March 1, it could have identified $2.87 billion  compared to $1.47 billion as of February 15, about a 95 percent  increase. If IRS held all taxpayers’ refunds until March 8, it could have  identified even more in potentially fraudulent or noncompliant refunds  before issuing them ($3.18 billion compared to $1.47 billion as of  February 15, an increase of about 116 percent). However, these  potential fraudulent or noncompliant refunds do not represent  potential refunds that IRS could protect. This is because IRS limits the  number of cases it selects for review due to the large volume of work  this represents and limited staff available. Further, some returns that  IRS selects for review are false positives—legitimate tax returns  erroneously selected for review.

Our Fraud Risk Framework provides a comprehensive set of overarching  concepts of fraud risk management and leading practices that serve as a  guide for agency managers to use when developing efforts to combat  fraud in a strategic, risk-based way. For example, a leading practice in  the Fraud Risk Framework emphasizes risk-based preventive activities  for strategically managing fraud risk to help avoid a costly and inefficient  “pay and chase” model. Additional leading practices call for federal  agencies to continuously monitor and evaluate the effectiveness of  preventive activities and to consider the benefits and costs of its control  activities. Further, key concepts in the Fraud Risk Framework highlight  the importance of measuring outcomes to adapt fraud detection and  prevention activities. Additionally, we have reported that program  evaluation provides agencies with objective information on program  effectiveness and efficiency. Program evaluation is necessary to inform  and improve IRS’s fraud risk management activities.

However, when we compared IRS’s preliminary analysis to the Fraud  Risk Framework and program evaluation standards, we found that it was  limited in several areas:  IRS has not documented an evaluation plan, goals, or strategy  related to the refund hold. To ensure an evaluation’s credibility,  agencies should develop evaluation plans with clearly defined  program goals and researchable evaluation questions. However, IRS  did not have documentation detailing an evaluation plan or program  goals that includes the purpose of the analysis and the research  questions it is assessing. Moreover, IRS plans to continue assessing  the effectiveness of the refund hold on systemic verification.

In May 2016, we recommended that IRS develop an overall  compliance strategy that includes refundable credits, such as EITC  and ACTC. In February 2017, IRS reported that it is taking steps to  implement this recommendation. However, it is unclear how IRS plans  to incorporate the results of its analysis of systemic verification into its  overall compliance and fraud risk management strategy.

IRS did not determine how many potentially fraudulent or  noncompliant refunds it issued before verifying against W-2  data. A key benefit of obtaining W-2 data early in the filing season is  to verify that the information matches before issuing the refund. In its  preliminary results, IRS reported the number and amount of refunds it  identified as potentially fraudulent or noncompliant before issuance  only for taxpayers that claimed EITC or ACTC and whose refunds IRS  held until February 15. Of the 22.1 million taxpayers who filed before  February 15 and did not claim these credits, IRS identified  approximately 196,000 returns filed by taxpayers claiming nearly $580  million in refunds as potentially fraudulent or noncompliant. IRS did  not report the number of refunds that were issued before IRS had  identified them as potentially fraudulent.

IRS has not fully assessed the burden on the taxpayers who  were subjected to the refund hold date. We have reported that a  key concept in tax administration is reducing unnecessary taxpayer  burden, which is the direct time and money that taxpayers spend to  comply with tax laws, including costs for paid tax preparation. Three  economic experts we interviewed cited key factors that IRS could  consider in assessing the burden to taxpayers as a result of the  refund hold. For example, experts told us that IRS could examine  changes in taxpayer behavior, such as waiting to file a return later, or  shifting from using Free File to paid preparation that can offer refund- related financial products such as an advance on their refund.  These experts also indicated that IRS could compare the amount of  fraud or noncompliance that IRS prevented among taxpayers claiming  EITC or ACTC against taxpayers who do not claim these credits. All  experts we interviewed agreed that more than 1 year of data might be  needed to assess short-term and long-term effects of the refund hold  on taxpayer behavior and patterns of fraud and noncompliance.

IRS officials told us that they have added a question to IRS’s  customer satisfaction survey to determine how taxpayers got their  information about the refund hold. They have also indicated they are  analyzing taxpayer behaviors related to the timing of filing and  taxpayers’ use of refund-related financial products. However, IRS has  not provided us with the revised survey or its results, nor provided  documentation of what is included in the analyses. IRS officials told us  that they have limited resources to conduct research and have not  completed the work because they are prioritizing other research  efforts.

The limitations of IRS’s preliminary analysis prevent IRS from fully  understanding the effectiveness of systemic verification and refund hold,  and hampers IRS’s broader fraud risk management and compliance  efforts. IRS officials stated that they did not document an evaluation plan,  include key data, determine how many refunds were issued before  detecting potential fraud and noncompliance, nor assess taxpayer  burden. Without a documented evaluation plan that includes key data to  assess the success of preventing fraud and noncompliance before  issuing refunds, IRS risks relying on insufficient information to make  decisions on potential changes to the refund hold date and those  subjected to it. For example, by not assessing taxpayer burden, IRS does  not understand how taxpayers are affected by the current hold date or  whether extending the hold or expanding it to all taxpayers would  increase taxpayer burden.

IRS completed its final analysis of the refund hold in October 2017 and  provided us with a draft. Based on our initial review, IRS’s findings  correspond with those in the preliminary analysis discussed above in that  IRS could detect much more potential fraud and noncompliance if it held  refunds longer. However, there were key differences between the  preliminary analysis and IRS’s final analysis. First, IRS assessed two  potential refund hold dates after February 15—February 28 and March 1,  when IRS receives the majority of W-2s. Second, IRS included all returns  that would be affected by the two extended refund hold dates rather than  only those that filed before February 15. Third, IRS estimated the total  amount of fraud and noncompliance that it could protect under these two  extended refund hold dates. Finally, IRS based its estimates on returns  that had completed final processing rather than returns that had not  completed processing.

In its final analysis, IRS estimated that it could detect about $7.1 billion in  potential fraud and noncompliance if it held refunds with EITC or ACTC  until March 1, of which it could protect about $533 million. This is about  $468 million more than what IRS protected by holding refunds with EITC  or ACTC until February 15. Further, IRS estimated that it could have  protected $100 million in fraud and noncompliance had it held all taxpayer  refunds until February 15—$35 million more than it protected with the  current hold and verification process. IRS further estimated that by  holding all refunds until March 1, it could protect about $895 million.

Various factors account for the differences between what IRS could  detect as potential fraud and noncompliance and what it estimated that it  could protect. First, IRS limits the number of cases it selects for review  due to the large volume of work required to review all returns flagged by  systemic verification and other fraud filters and limited staff available.  Second, some returns that IRS selects for review are false positives— legitimate tax returns erroneously selected for review—so not all the  returns will be confirmed as fraud or noncompliant.

In its final analysis, IRS had not addressed the limitations noted above for  the preliminary analysis. However, IRS expects to further explore the  possibility of holding refunds beyond February 15. IRS also plans to  complete additional analyses, including the effect of W-2 extension  requests on systemic verification and taxpayers’ use of refund-related  financial products. As IRS continues analyzing the effectiveness of the  refund hold date on systemic verification, the limitations we outlined  above will continue to prevent IRS from fully understanding the  effectiveness of systemic verification and refund hold, and hamper IRS’s  broader fraud risk management and compliance efforts.

section_title: IRS Has Not Analyzed the Benefits and Costs of Additional Uses of Early W-2 Data and Systemic Verification
paragraphs: As noted, the Fraud Risk Framework emphasizes the use of fraud  prevention activities to help federal agencies avoid the costly and  inefficient “pay-and-chase” model. However, IRS has not assessed the  benefits and costs of additional uses of early W-2 data to prevent fraud  and noncompliance before issuing refunds. For example, IRS has not  determined the value of using W-2 data to address employment fraud or  underreporting prior to issuing refunds. Employment fraud is a type of  identity theft refund fraud that occurs when an identity thief uses a  taxpayer’s name and Social Security number to obtain a job and claims a  refund. Underreporting occurs when a taxpayer underreports income or  claims unwarranted deductions or tax credits. With its Automated  Underreporter program, which is utilized after the filing season and after  refunds have been issued, IRS electronically matches income information  reported to IRS by third parties, such as banks and employers, against  the information that taxpayers report on their tax returns.

With earlier W-2 information, IRS can detect more possible employment  fraud or underreporting before issuing refunds. For example, if IRS has  two W-2s reporting wage income for a taxpayer, but that taxpayer did not  report both on his or her tax return, the taxpayer may have underreported  his or her income or could be a victim of employment fraud. IRS officials  stated that they are not using systemic verification to review such  instances before issuing a refund because it would require them to follow  the deficiency process. IRS typically begins this process when it has  completed all of its compliance checks later in the filing season when it  has most third-party data available for verification. IRS then sends the  taxpayer a notice that informs him or her that IRS has proposed an  adjustment to taxes owed because the third-party data IRS received does  not match what the taxpayer reported on his or her tax return. The notice  also informs the taxpayer of his or her right to challenge any resultant tax  increase with the U.S. Tax Court.

IRS officials told us they do not want to issue the notice earlier because  that could encourage taxpayers to file in Tax Court before IRS has  completed its review. IRS officials stated that they did not see the  potential benefits of taking intermediate steps before sending a notice of  deficiency, such as holding the refunds and corresponding with the  taxpayer to resolve the discrepancy. However, while IRS had not  explored this or other potential uses of W-2 data, IRS officials  acknowledged that it would be worthwhile to consider additional  opportunities of earlier W-2 data.

Earlier availability of W-2s and other information returns can help IRS  identify and prevent fraud and noncompliance before issuing refunds.  However, without assessing the benefits and costs, IRS does not know  the extent to which it can use earlier W-2 data for other pre-refund  compliance checks.

section_title: Conclusions
paragraphs: During the 2017 filing season, IRS’s ability to detect and prevent fraud  and noncompliance improved because it received significantly more W-2  data earlier and utilized it to verify wage, withholding, and other  information on millions of tax refunds. Based on these results, systemic  verification shows promise for preventing fraudulent refunds and reducing  noncompliance. Nevertheless, the agency faced challenges that limited  its success in implementing systemic verification.

Similar to taking action to assess the potential for processing more W-2s  early in the filing season, IRS can take additional steps to increase the  availability of more W-2 data. By not collecting data to track late W-2  filings, IRS could not measure the extent to which late W-2 filings are  associated with fraud and noncompliance. Further, by not taking earlier  action to improve enforcement of penalties for late W-2 filings, IRS is  missing an opportunity to encourage compliance with the W-2 filing  deadline and verify more wage information before releasing refunds. As a  result, IRS risks releasing fraudulent and noncompliant refunds. We have  also previously identified action Congress could take to increase the  availability of W-2 data to IRS early in the filing season. In August 2014,  we suggested that Congress provide the Secretary of the Treasury with  the authority to lower the electronic filing requirement from 250 W-2s to 5  to 10 W-2s. This action would also have the benefit of reducing SSA’s W- 2 paper processing costs by millions of dollars each year.

In addition, the February 15 refund hold for EITC and ACTC claims  afforded IRS an opportunity to verify return information with early W-2  data before issuing refunds. IRS took steps to collect and assess  preliminary data on systemic verification and the refund hold during the  filing season. In addition, IRS completed its final analysis that considers  different scenarios for holding refunds longer and the potential revenue it  could protect. However, IRS’s efforts are not guided by an evaluation plan  to assess the results of systemic verification in preventing fraud and  noncompliance before issuing refunds. Developing and implementing an  evaluation plan that fully assesses the benefits and costs of that hold date  would help IRS determine the effectiveness of systemic verification, its  fraud risks, and the effect of the refund hold on taxpayer burden. IRS  would then be in a better position to modify the refund hold under its  existing authority and balance detecting and preventing fraud and  noncompliance with taxpayer burden. Further, it is not clear how the  analysis informs IRS’s broader fraud risk management efforts and other  compliance strategies. Finally, with these data, IRS has the potential to  improve tax enforcement in other areas such as for underreporting or  employment fraud. While IRS has measures in place to address these  issues after paying refunds, taking action before issuing refunds can  prevent fraud and noncompliance and save IRS time and resources.

section_title: Recommendations for Executive Action
paragraphs: We are making the following six recommendations to IRS.

The Acting Commissioner of Internal Revenue should collect data to track  late W-2 filing penalty notices and the extent to which they are associated  with fraud and noncompliant returns. (Recommendation 1)

The Acting Commissioner of Internal Revenue should assess options for  improving enforcement of late W-2 filing penalties, for example, by  mailing notices before the next filing deadline. (Recommendation 2)

The Acting Commissioner of Internal Revenue should develop an  evaluation plan to fully assess the benefits and costs, including taxpayer  burden, of modifying the February 15 refund hold, and determine how this  effort informs IRS’s overall compliance strategy for refundable tax credits  and fraud risk management. (Recommendation 3)

Based on the benefits and costs assessment in Recommendation 3, the  Acting Commissioner of Internal Revenue should use IRS’s existing  authority to modify the refund hold such that it minimizes the risk of  releasing fraudulent or noncompliant refunds. (Recommendation 4)

The Acting Commissioner of Internal Revenue should assess the benefits  and costs of additional uses and applications of W-2 data for pre-refund  compliance checks, such as addressing underreporting, employment  fraud, and other fraud or noncompliance before issuing refunds.  (Recommendation 5)

Based on the assessment in Recommendation 5, the Acting  Commissioner of Internal Revenue should implement any identified  changes to improve pre-refund compliance checks. (Recommendation 6)

section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this product to Treasury and SSA for review and  comment. IRS provided written comments, which are summarized below  and reproduced in appendix II. SSA responded in writing with no  comments (see appendix III). SSA and Treasury provided technical  comments, which we incorporated as appropriate.

In its written comments, IRS did not state whether it agreed or disagreed  with our recommendations, but outlined planned steps to address five of  the six recommendations. If implemented as planned, IRS’s proposed  actions for recommendations 1, 4, 5 and 6, could meet the intent of the  recommendations. However, for the third recommendation to develop an  evaluation plan to fully assess the costs and benefits of modifying the  February 15 refund hold, it is not clear whether IRS’s planned actions will  fully satisfy the recommendation. IRS stated that it would assess and  evaluate options for improvements to its refundable tax credits and fraud  risk management strategies. However, IRS did not specify whether this  evaluation would fully assess the benefits and costs, including taxpayer  burden, of modifying the February 15 refund hold. As we reported, a  documented evaluation plan that includes key data to assess the success  of preventing fraud and noncompliance before issuing refunds will help  IRS make better-informed decisions on potential changes to the refund  hold date and those subjected to it. This includes, for example, assessing  taxpayer burden to understand how taxpayers are affected by the current  hold date and whether extending the hold or expanding it to all taxpayers  would increase taxpayer burden.

Regarding the second recommendation in our draft report to assess  options for improving enforcement of late W-2 filing penalties by mailing  notices before the next filing deadline, IRS stated that the timing of the  receipt of a W-2 account file from SSA and the overall complexity of the  process precludes notices from being issued prior to the start of the next  filing season. Specifically, IRS noted that it assesses penalties on  approximately 40 different types of information returns—in addition to W- 2s—and that the penalty calculation is complex. For W-2s, IRS explained  that it receives a reconciled file from SSA in December that identifies  those employers that should not be penalized. Finally, IRS noted that  issuing penalty notices on a piecemeal basis would burden the taxpayer  and potentially lead to erroneous notices. We recognize that there are  challenges to issuing penalty notices, or other communications, before  the next filing season. However, there are also benefits. As we reported,   earlier communication with the employer, whether it includes a penalty  assessment or not, increases the potential for compliance, helps  taxpayers avoid filing late in the subsequent year, and increases the  availability of W-2 data for systemic verification to detect and prevent  fraud and noncompliance. However, we continue to believe that  assessing the options for improving enforcement of late W-2 filing  penalties, such as through earlier communication, would help IRS identify  potential opportunities to encourage compliance with the W-2 filing  deadline and verify more wage information before releasing refunds. We  intended the recommendation to be inclusive of other options beyond  mailing notices earlier. As a result, we clarified the recommendation to  make mailing notices before the next filing deadline an example.

We are sending copies of this report to the appropriate congressional  committees, the Acting Commissioner of Internal Revenue, the Acting  Commissioner of Social Security, the Secretary of the Treasury, and other  interested parties. In addition, the report is 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) 512-9110 or lucasjudyj@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on  the last page of this report. Key contributors to this report are listed in  appendix IV.

section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: Our objectives in this report were to assess  the Internal Revenue Service’s (IRS) performance in detecting fraud  and noncompliance using systemic verification, and the Social  Security Administration’s (SSA) performance providing timely Form  W-2, Wage and Tax Statement (W-2) data to IRS; and  the extent to which IRS analyzed the effectiveness of the refund hold  on systemic verification as well as opportunities for IRS to apply  systemic verification to other efforts to detect fraud and  noncompliance.

To answer the first objective, we obtained and analyzed IRS documents and data, including documents  describing the implementation of IRS’s systemic verification of W-2  data and preliminary systemic verification data on the 2017 filing  season, and used this information to determine how IRS used early  W-2 data;  reviewed the Protecting Americans from Tax Hikes Act of 2015 (the  Act) and related tax laws and regulations to understand IRS’s  systemic verification matching W-2 data against individual income tax  returns affected by the Act (taxpayers claiming the Earned Income  Tax Credit (EITC) or the Additional Child Tax Credit (ACTC)), as well  as other returns not affected by the Act (those not claiming EITC or  ACTC), and statutory requirements for penalties, electronic filing, and  authority to hold refunds;  reviewed IRS laws, regulations, and policies on penalty assessments  for filing W-2s late, IRS data on late W-2s for 2017, and interviewed  IRS officials to understand the process for assessing penalties;  interviewed officials from IRS’s Wage and Investment division (which  is responsible for managing filing season operations) on the  challenges in implementing systemic verification, as well as planned  improvements;  interviewed officials from IRS’s Information Technology Applications  Development unit to understand the technological capabilities of IRS’s  Information Return Master File and related systems and identify  system limitations and improvements. We compared IRS’s actions to  IRS’s Strategic Plan, which includes objectives to strengthen refund  fraud prevention by using third-party data and analytics for timely,  informed decision making, and to innovate technology systems to  support IRS’s business needs. We also compared IRS’s actions to the  Standards for Internal Control in the Federal Government, which call  for management to design and implement internal controls within  programs based on the related benefits and costs; observed and interviewed SSA employees processing and  transcribing paper W-2s at the SSA’s Wilkes-Barre Direct Operations  Center in Wilkes-Barre, Pennsylvania to understand how this work is  performed and the time required for completing it;  reviewed our prior reports, including reports on the filing season, tax  credits, and identity theft, and evaluated IRS’s actions to implement  selected prior recommendations; and  interviewed SSA managers and staff who oversee and process paper  Form W-2 data and transmit the data to IRS, and obtained and  analyzed SSA goals, documents, and data, including data on costs for  processing paper W-2s.

To answer the second objective, we  reviewed IRS documents that included internal working group meeting  minutes, planning documents, and management reports; assessed IRS’s data for 2017 and its preliminary and final analyses  on the systemic verification results and outcomes under different  scenarios for the 2017 filing season;  compared IRS’s efforts to detect and prevent fraudulent and  noncompliant refund payments with leading practices in our A  Framework for Managing Fraud Risks in Federal Programs (Fraud  Risk Framework) and program evaluation;  interviewed officials from IRS’s Wage and Investment division on the  benefits and costs of systemic verification and to determine whether  IRS conducted an economic analysis of the effects on taxpayers  burden as a result of holding all taxpayer’s refunds until February 15;  interviewed three economic experts to identify factors that IRS should  consider or study following implementation of the Act. We selected  economists based on their expertise in the field of tax policy and  refundable tax credits, and to ensure variation in perspectives on tax  issues. We asked similar questions of each economist and analyzed  their comments to identify commonalities. We used these interviews  to identify factors that IRS should consider in evaluating the refund  hold date and any potential changes to it. The views of the economic  experts are not generalizable; and  interviewed officials from the Department of the Treasury’s (Treasury)  Bureau of the Fiscal Service and Office of Tax Policy about their  actions to prepare for releasing a large volume of refunds on February  15 and to determine what analyses, if any, Treasury had conducted  on taxpayer burden related to the holding all taxpayer’s refunds until  February 15.

To assess the reliability of the data we used for this report, we reviewed  IRS and SSA reports on W-2 data and IRS reports on systemic  verification and its results. We also reviewed IRS reports on the  performance of its fraud filters. We examined systemic verification data to  identify obvious errors or outliers and assessed potential data limitations  that would affect use of the data for assessing performance. We also  interviewed IRS officials about their data quality procedures and the  reliability and limitations of these data. We determined that the data  presented in this report are sufficiently reliable for the purposes of our  reporting objectives.

We conducted this performance audit from March 2017 to January 2018  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 II: Comments from the Internal Revenue Service

section_title: Appendix III: Comments from the Social Security Administration

section_title: Appendix IV: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact

section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Joanna Stamatiades, Assistant  Director; Erin Saunders Rath, Analyst-in-Charge; Jessica Ard; Mark  Canter; Jacqueline Chapin; Jehan Chase; Felisa Garmon; Robert  Gebhart; Tom Gilbert; Andrew Howard; Kirsten B. Lauber; Japheth       McGee; Paul Middleton; Ed Nannenhorn; Sabine Paul; Bradley Roach;       and Robert Robinson made key contributions to this report.

Fast facts: Fraudsters used false identities to steal at least $1.68 billion in tax refunds in 2016.

To help address fraud and compliance issues, Congress moved up the deadline for employers to submit W-2s and had IRS hold refunds for those claiming certain tax credits beginning in 2017. These changes gave IRS more time to work on identifying discrepancies before issuing refunds.

We found this process helped IRS identify and prevent fraud, but IRS could do more to maximize its potential.

We made 6 recommendations, including that IRS take steps that would allow it to review more W-2s before issuing refunds and reduce the risk of fraud and noncompliance.

Question-summary annotations: questions: question: How have the EITC and ACTC affected taxpayer refunds since 2017?
answer: Beginning in 2017, as required by law, the Internal Revenue Service (IRS) held all refunds for taxpayers claiming the Earned Income Tax Credit (EITC) or Additional Child Tax Credit (ACTC) until February 15. IRS also took actions to verify wage and other information reported on tax returns before issuing refunds, referred to as systemic verification, but several factors limited its success.
child_questions: question: What role did W-2 forms play in fraud detection?
answer: IRS received over twice as many (over 214 million) Forms W-2, Wage and Tax Statement (W-2) by February 15 compared to the same time in 2016, and reported that W-2 data were responsible for improving fraud detection and reducing taxpayer burden.

question: To what extent did the IRS verify the held returns before releasing them?
answer: However, IRS was unable to verify over half of the returns it held until February 15 before issuing the refunds.
child_questions: question: Why was the IRS unable to verify all the returns?
answer: For example, IRS received W-2s daily but its information technology systems processed them weekly.

question: Why is the arrival of some W-2 forms delayed?
answer: Further, IRS has not assessed options for enforcing late W-2 penalties earlier. Additionally, about 9 percent (about 23 million) of W-2s were filed on paper, which IRS does not begin to receive from the Social Security Administration (SSA) until March.
child_questions: question: What requirements exist regarding paper W-2s?
answer: By law, employers who file 250 or more W-2s are required to file W-2s electronically, while those who file fewer than 250 W-2s may opt to file on paper or electronically.

question: What did GAO recommend to improve W-2 form handling?
answer: In August 2014, GAO suggested that Congress provide the Secretary of the Treasury with the authority to lower the electronic filing requirement from 250 W-2s to 5 to 10. This action could also have the benefit of reducing SSA's W-2 paper processing costs by $9.7 to $11.3 million per year. These issues reduce IRS's access to timely W-2 data, limiting its ability to prevent fraud and reduce noncompliance before issuing refunds.

questions: question: What were the findings of the IRS's analyses of the February 15 refund?
answer: IRS's preliminary and final analyses of the February 15 refund hold both showed that IRS could have detected significantly more in potential fraud and noncompliance if it held all refunds until late February, when it had more W-2 data available.
child_questions: question: To what extent were the analyses similar?
answer: There are differences between these analyses. For example, the final analysis included more returns and estimated total revenue IRS could protect by extending the refund hold and expanding it to all taxpayers.

question: What were the predicted effects of moving the refund date?
answer: In that analysis, IRS estimated that it could have protected $100 million in fraud and noncompliance had it held all taxpayer refunds until February 15—$35 million more than it protected by holding refunds with EITC or ACTC. IRS further estimated that moving the refund hold to March 1 for all taxpayers could protect $895 million compared to $533 million if it only held refunds with EITC or ACTC until that date.

question: How were the IRS's analyses flawed?
answer: For example, while IRS has plans to further explore holding refunds longer, it does not have an evaluation plan to assess the effectiveness of the refund hold on systemic verification. Also, IRS did not fully assess the benefits and costs, including taxpayer burden, of the refund hold, nor how its analysis informs its broader fraud risk management or compliance efforts.
child_questions: question: How do these flaws affect the IRS's decision making?
answer: As a result, IRS does not have sufficient information to inform a decision on potential changes to the refund hold date and those subjected to it. Finally, IRS has not assessed the benefits and costs of expanding systemic verification to use for pre-refund compliance checks in other areas such as income underreporting and employment fraud. Therefore, IRS may be missing opportunities to maximize use of early W-2 data.

questions: question: How prevalent was IDT in 2016?
answer: The agency estimates that at least $1.68 billion was paid in IDT refund fraud in 2016.
child_questions: question: How did the Protecting Americans from Tax Hikes Act of 2015 address this issue?
answer: To help address this issue, consistent with GAO's prior reporting, the Protecting Americans from Tax Hikes Act of 2015 advanced the deadline for employers to file W-2s to SSA to January 31 (about 1 to 2 months earlier than in prior years).
child_questions: question: How did this help the IRS combat fraud?
answer: This change allows IRS more time to match wage information to tax returns through systemic verification, and identify any discrepancies before issuing refunds.

questions: question: What was GAO asked to assess?
answer: GAO was asked to assess how well IRS implemented systemic verification.
child_questions: question: How did GAO assess the IRS's performance?
answer: GAO assessed IRS's performance using systemic verification and the extent to which IRS analyzed the effectiveness of the refund hold on this process.

question: What internal IRS data did GAO make use of?
answer: GAO analyzed IRS and SSA data and documents, observed SSA's paper W-2 process, and interviewed IRS and SSA officials.

question: How did GAO make use of current standards and policies?
answer: GAO compared IRS actions to laws; IRS policies; and standards for internal control, fraud risk management, and program evaluation.

questions: question: What were GAO's recommendations?
answer: GAO recommends IRS collect data to track late W-2 filing penalties and assess options for earlier enforcement; assess the benefits and costs of using existing authority to hold refunds longer, hold all refunds, or both, and expanding systemic verification to other areas; and take actions based on the assessments.
child_questions: question: How did the IRS respond to these recommendations?
answer: IRS listed steps to respond to 5 of 6 recommendations, but said it could not enforce penalties earlier.
child_questions: question: What was GAO's stance regarding IRS's response to the recommendations?
answer: GAO recognizes the challenges but clarified that assessing other options would provide benefits, as discussed in the report.