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Thomas Wechter
Identity Theft: What Is It And What Is the IRS Doing About It?

Tax related identity theft results in serious consequences for victim taxpayers resulting in delayed refunds or enforcement action for unreported income.

December 8, 2011
by Thomas Wechter, JD, LLM

Tax related Identity theft is a serious and growing problem for the Internal Revenue Service (IRS). The number of IRS-identified tax-related identity thefts has grown from 51,702 in 2008 to 248,357 in 2010. For the processing year 2011 (through September 10, 2011) the IRS has identified over 851,602 returns with $5.8 billion in associated fraudulent tax refunds that involved identity thefts.

What Is Identity Theft?

Identity theft takes place when someone uses another’s Social Security number (SSN) and their name to claim a refund in taxes. There are two primary types of tax related identity theft:

  1. When an individual uses someone’s name and/or SSN to file a fraudulent tax return to generate a tax refund; and
  2. When a person’s identity is used to obtain employment, which in turn results in the issuance of a W-2 reporting wage income wrongly attributable to the innocent taxpayer.

The increase in identity (ID) theft cases may be the result of criminals becoming more proficient in devising schemes to steal identities because identities are becoming more available on the Internet. Thieves are targeting populations that have no filing requirements, such as the elderly and children and deceased taxpayers whose SSNs and identity are readily available from the Social Security Administration (SSA).

What If Your Client Is a Victim of Identity Theft?

A taxpayer will not know that they have been victimized until the receipt of a notice for a claimed refund or a collection notice for the taxes on wages from employment related identity theft. After calling the IRS in response to the rejection letter or the collection notice, the IRS customer service assistor will research the taxpayer’s account to determine whether a tax return has already been filed or whether the employment identity theft W-2 is suspect. In either case, the assistor will request that the taxpayer file a paper tax return, attaching an Identity Theft Affidavit, Form 14039 (PDF) or a police report and a valid government issued document, such as a copy of a Social Security card, passport or driver’s license. If an assister observes a duplicate filing using the same SSN, a letter will be sent to both the identity thief and the legitimate taxpayer requesting validation of identity to determine who the legitimate taxpayer is. Usually, only the legitimate taxpayer will respond. The taxpayer will also be referred to the IRS Identity Protection Specialized Unit (IPSU) for information and guidance.

Formed in 2008, the IPSU was to be the central point of contact for the resolution of ID theft-caused tax issues. Although in theory the IPSU was to provide end-to-end case resolution, in practice IPSU simply monitors a victim’s account every 60 days. The IPSU attempts to coordinate with up to 16 different IRS functions to obtain the necessary relief for the ID-theft victim. A brief review of the IRS website and the various documents turned up under a search of “identity theft” will reveal that there is no central unit in the IRS to deal quickly and efficiently with identity theft cases from beginning to end. The various functions of the IRS all hand le identity theft cases, but there is no coordinated effort among the functions, with cases worked differently in each function.

The IRS website also refers a victim taxpayer to the Taxpayer Advocate Service (TAS). Under the TAS, if the victim taxpayer’s case meets the criteria for TAS-handled cases, such as proof of Economic Burden or Systemic Burden, an advocate will work with the taxpayer from beginning to end to resolve all of their issues.

Detection and Resolving Instances of Tax-Related ID Theft

Once the IRS has confirmed that identity theft is involved, the IRS will place identity theft indicators on the victim taxpayer’s account. As a result any income tax returns using the victim taxpayer’s SSN will be systematically screened using a series of business filters in an attempt to distinguish legitimate tax returns from fraudulent tax returns. If the tax return does not pass these business rules, a tax examiner will conduct a manual review.

In the 2011 filing season, the IRS began issuing Identity Protection Personal Identification Numbers (PINs) to taxpayers who the IRS has previously identified as victims of ID theft. The PIN indicates that the taxpayer has previously provided the IRS with information that validates the taxpayer’s ID and that the IRS is satisfied that the taxpayer is the valid holder of the SSN. Tax returns with a PIN are inputted and processed as the valid tax return. A new PIN will be issued each subsequent year in January for the new filing season for as long as the taxpayer remains at risk for identity theft, usually three years. Under the pilot program, the IRS issued PINs to over 50,000 taxpayers who were ID-theft victims.

In January, 2011, the IRS launched a pilot program for the tax year 2010 returns using a new indicator to “lock” SSNs of deceased taxpayers. If a locked SSN is included on a tax return, the new indicator will prompt the IRS to automatically reject the return.

Prevention of Identity Theft

The IRS has embarked upon a taxpayer outreach initiative to provide taxpayers with the information they need to prevent and resolve tax-related ID-theft issues. The IRS website provides the latest identity theft information and prevention strategies. In addition, the site also provides key information from other federal agencies, including the Federal Trade Commission (FTC), which are dealing with ID theft. The IRS issued tax tips with the Top 10 Things Every Taxpayer Should Know about Identity Theft and followed that with Publication 4535 (PDF),  which explains ways to avoid becoming a victim of identity theft.

To prevent taxpayers’ SSNs from falling into thieves’ hands with access to paper-payee statements, the IRS implemented a pilot program in 2009 for the calendar years 2009 and 2010 and extended the program in 2011 to allow information return filers to truncate individual payee’s nine-digit identifying number on paper-payee statements. The pilot program only applied to a limited number of paper information returns, such as Forms 1098, 1099 and 5498 and only to SSNs. The program has been criticized because it does not apply to all taxpayer ID numbers (TINs), not just SSNs, to all information returns, not just Forms 1098, 1099 and 5498 and to all statements and documents provided taxpayers whether paper or electronically.

Taxpayer Advocate Service Proposals to Identify Earlier and Reduce ID Theft

Nina Olson, national taxpayer advocate, has testified and written extensively on identity theft, including the topic in her annual reports to Congress beginning in her 2005 Annual Report to Congress. Most recently, she testified before Congress in support of an increased IRS budget to allow for the creation of a specialized identity theft unit and to present recommendations to improve the IRS response to identity theft cases. Previously, the IRS adopted the recommendations of the national taxpayer advocate, including the creation of an Identity Theft Affidavit, issuance of PINs to victims, etc., in some form or other.

In her testimony on May 25, 2011, she recommended the following:

  1. Allow taxpayers the option to turn off the ability to file electronically;
  2. Utilize information return reporting earlier in the filing season to verify a taxpayer’s return before refunds are made;
  3. Work with the Social Security Administration to keep SSNs out of the public domain; and
  4. To retire decedents’ SSNs.

Conclusion

With the alarming rate of increase of tax-related ID theft, the IRS needs to implement an overall strategic plan to detect identity theft earlier in the processing of tax returns and to assist victims of identity theft from beginning to end. To learn more about protecting your client’s identity and what to do if they are a victim of ID theft see the Top 10 Things Every Taxpayer Should Know about Identity Theft and Identity Theft Prevention and Victim Assistance (PDF) on the IRS website.

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Thomas R. Wechter, JD, LLM (Tax), is a partner with Duane Morris LLP in the Chicago office and concentrates his practice in tax planning for individuals, corporations and partnerships and in tax controversy matters in front of the IRS and before the Tax Court, U.S. Court of Federal Claims and the District Courts.