Before the Protecting Americans from Tax Hikes Act was enacted, IRS did not receive the majority of W-2 data until after most refunds had been issued. As we reported in 2014, IDT refund fraud took advantage of IRS’s “look-back” compliance model. Under this model, rather than holding refunds until completing all compliance checks, IRS issued refunds after conducting selected reviews. Since IRS did not receive most employer- reported W-2 data until late in the filing season, IRS did not begin matching that data to tax returns until July, following the tax season. However, with the Act’s new reporting deadline, as of February 17, 2017, IRS received over 214 million W-2 forms from SSA, an increase of 125 percent from the same time last year (see fig. 1). For the 2017 filing season, IRS used the W-2 data it had available to verify wages and withholding reported on all tax returns during initial processing. Under the new legal requirements of section 6402(m) of the tax code, IRS held refunds for returns claiming the EITC or ACTC (EITC/ACTC returns) until February 15 regardless of whether IRS had the W-2 data available to verify wage information and had determined the corresponding refund was valid (see fig. 2). IRS, in consultation with the Department of the Treasury (Treasury), elected not to hold any refunds for returns without EITC or ACTC (non-EITC/ACTC) because it was not required to do so, as discussed later in this testimony. However, all returns—with EITC or ACTC and without EITC or ACTC—are subject to IRS’s verification process as well as other fraud filters. While IRS conducts quality and enforcement checks throughout return processing, preliminary data suggest that by using its W-2 systemic verification, including allowing time to input the data for matching, are important steps in IRS’s ability to determine whether the refund amount claimed and taxpayer are legitimate for returns with EITC/ACTC as well as for returns without those credits. Specifically, we found that: For returns where the taxpayer claimed the EITC or ACTC, preliminary data show that IRS verified the wage information for over 35 percent of these returns before February 15. Moreover, the refund hold allowed IRS time to check returns using its systemic verification when it received more W-2 data. For example, IRS reported it reprocessed about 1 million returns during the hold period as more data became available. As a result, IRS said it identified approximately 162,000 returns claiming about $863 million in refunds as potentially fraudulent. According to IRS, those refunds were not allowed to be released on February 15, and the returns were directed for follow up. However, IRS was unable to verify wage information for over 58 percent (7.7 million) of tax returns with refunds claiming the EITC or ACTC—for a total of $38.1 billion—before February 15. This was in part due to the timing of when W-2 information was available, as discussed later in this statement. IRS did not hold returns that did not claim the EITC or ACTC unless the return was selected by its other filters (such as for potential IDT refund fraud). On such returns, while IRS also used available W-2 information, it did not hold refunds solely because W-2 information was not available. Preliminary data show that using systemic verification, IRS verified wages of 8.6 million (41 percent) of returns that did not claim the EITC or ACTC before February 15. However, IRS was unable to verify wage information reported on over 58 percent (12.3 million) of these tax returns for a total of $28.1 billion, as not all W-2 data were available and IRS was not required to hold these returns. IRS faced challenges related to the availability and timing of the W-2s while implementing its W-2 systemic verification process. As noted previously, IRS was unable to verify wage income for the majority of both EITC/ACTC and non-EITC/ACTC returns received by February 14, because it did not have W-2 information available for those taxpayers. There were three reasons for this delay: 1. IRS received electronic W-2 data from SSA daily, but because IRS is using older technology in this instance (a legacy system), it could only load the data weekly. For EITC/ACTC returns, the law provided an approximate 2-week delay between the W-2 due date (January 31) and the refund release date (February 15), to allow time for IRS to load the data and verify wage information on the returns before releasing the refunds. 2. Some W-2 data were delayed past February 15 because employers requested extensions or missed the new deadline. This year, IRS allowed employers a one-time 30-day, non-automatic extension to file W-2 data if the deadline would cause undue hardship that would also prevent the employer from furnishing the W-2s to employees by January 31 (such as if a flood damaged the documentation and equipment needed to file). This is a change from prior years in which employers could request one 30-day extension from either the due date on the last day of February (if filing on paper) or last day of March (if filing electronically). 3. While SSA begins receiving W-2 forms on paper in December, it did not begin to transmit these data to IRS until March 2017. SSA officials reported that they cannot report the number of employers who filed paper W-2s until they complete transcribing those forms for tax year 2016. As of February 15, SSA estimated that it had approximately 17.4 million paper W-2s. As of March 31, 2017, SSA had processed and transmitted to IRS about 3.8 million of these. Consequently, IRS processed refunds without W-2 information for those taxpayers whose employers had submitted paper W-2s. As of March 29, IRS officials were still assessing the W-2 systemic verification process and its outcomes. IRS does not yet know the full effect of its W-2 systemic verification process on the number of IDT fraudulent refunds it was able to prevent paying. However, as noted earlier, IRS officials reported that the initial review of the W-2 verification process for EITC/ACTC returns showed that IRS identified approximately 162,000 returns worth about $863 million as potentially fraudulent that it would not have identified without the early W-2 data coupled with the refund hold. IRS’s fraud filters did not select these returns for further review; however, the W-2 systemic verification process did because IRS received the W-2 data before it would have released the refunds on February 15. IRS officials also reported a decrease in the number of IDT cases this filing season compared to last year. Through February 28, 2017, the number of new cases decreased by 51 percent compared to the same time last year (from 63,102 to 30,850). However, it is difficult to determine whether this decline is due to IRS’s efforts, fewer attempts by fraudsters, or other factors. IRS is continuing to review its verification process before determining what steps it needs to take, if any, to improve its fraud selection filters. IRS officials stated that they are confident that IRS did not systematically release EITC/ACTC refunds covered by the new hold requirement prematurely. IRS said its pre-filing season testing confirmed that the holds would work as intended, and that it conducted individual reviews of EITC/ACTC cases in which data indicated that a refund may have been released early. IRS identified nine such cases, but the payouts occurred after February 15. IRS is considering a number of scenarios that may require legislative action, including adjusting the timing of holding refunds it has not yet verified, and releasing refunds for wages it has verified. One concern that officials noted about the refund hold was the potential effect on the economy. According to IRS officials, in consultation with Treasury, IRS opted not to hold all refunds until February 15. Although IRS has authority to hold these refunds, officials explained that doing so would have too great of an effect on the economy on top of the refunds they were required to hold by law. For example, there could be impacts to business models of large retailers that rely on the cycle of federal income tax refund distribution, especially in communities with lower- income taxpayers, according to IRS officials. Even a short delay in a one- time cash infusion, especially if it represents a significant portion of some taxpayers’ income, can cause them to delay paying bills or making important spending decisions. In addition, IRS officials said that the surge in refunds released February 15 could have had a significant impact on check-cashing businesses and retailers and the amount of cash required on hand to pay refunds to taxpayers. For EITC/ACTC returns, IRS estimated the effect on the economy to be about $60 to $64 billion in total refunds that IRS would not release to taxpayers until February 15. If IRS also held non-EITC/ACTC returns, it estimated those refund amounts would affect the economy by an additional $40 billion. While implementing tax law changes, it is important that IRS ensures timely and quality service. During the filing season, IRS enforces tax laws, provides service to tens of millions of taxpayers, and processes over 100 million tax returns. In recent years, IRS has experienced declining resources and an increased workload. We have reported that IRS’s budget declined by about $900 million between fiscal years 2011 and 2016. Furthermore, full-time equivalents (FTE) funded with annual appropriations declined by 12,000 (13 percent) between fiscal years 2011 and 2016. The President’s fiscal year 2018 “Budget Blueprint” released in March 2017 proposes funding IRS below the fiscal year 2000 level, after adjusting for inflation (see fig. 3).