Systemic Verification

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. For example, if IRS suspected that  the return was IDT refund fraud, it directed it to the Taxpayer Protection  Program to verify the taxpayer. Systemic Verification Shows Promise but Legacy Information Technology and Issues with Employer W-2 Filing Limit Its Success

		Early W-2 Data and the Refund Hold Helped IRS Prevent Fraud and Noncompliance for a Limited Number of Tax Returns

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). Paper W-2 processing. 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. 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. 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

		IRS Completed Its Analyses of Potential Changes to the Refund Hold but Did Not Fully Assess the Benefits and Costs and Taxpayer Burden

IRS officials examined the effectiveness of the February 15 refund hold  by analyzing how systemic verification results differ under several  hypothetical scenarios. 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. 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. In February 2017, IRS reported that it is taking steps to  implement this recommendation. 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. 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. 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. 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. Further, it is not clear how the  analysis informs IRS’s broader fraud risk management efforts and other  compliance strategies. (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. 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. Appendix I: Objectives, Scope, and Methodology

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.
Why GAO Did This Study

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.

What GAO Found

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.

What GAO Recommends

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.