IDT refund fraud occurs when a refund-seeking  identity thief files a fraudulent tax return using the legitimate taxpayer’s  identifying information. However, IRS only begins matching W-2 information from  employers to tax returns in July. 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. Matching tax returns to W-2s  is an example of these checks. 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

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  has also requested funding to support timelier processing of W-2s. IRS issues most refunds before it has access to employers’ W-2  data. Treasury’s Proposal for Accelerated W-2 Deadlines is Intended to Benefit IRS and Taxpayers

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). 2014). 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. 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. 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. Implementing a lower e-filing threshold would have the ancillary benefit  (described above) of supporting pre-refund matching. Matters for Congressional Consideration

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. Recommendations for Executive Action

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. 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. SSA also said that it transmits  wage data to IRS immediately upon receiving electronic W-2s. Appendix II: Objectives, Scope, and Methodology

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). 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. GAO. GAO. GAO. GAO. GAO. GAO.
Why GAO Did This Study

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.

What GAO Found

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.

What GAO Recommends

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.