Tax Fraud and Noncompliance:

IRS Can Strengthen Pre-refund Verification and Explore More Uses

GAO-18-224: Published: Jan 30, 2018. Publicly Released: Jan 30, 2018.

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Jessica Lucas-Judy
(202) 512-9110
lucasjudyj@gao.gov

 

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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.

 

This is a photo of a 2017 W-2 Wage and Tax Statement form.

This is a photo of a 2017 W-2 Wage and Tax Statement form.

Additional Materials:

Contact:

Jessica Lucas-Judy
(202) 512-9110
lucasjudyj@gao.gov

 

Office of Public Affairs
(202) 512-4800
youngc1@gao.gov

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.

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 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.

For more information, contact Jessica Lucas-Judy at (202) 512-9110 or lucasjudyj@gao.gov.

Recommendations for Executive Action

  1. Status: Open

    Comments: In April 2018, IRS stated that it would review the source data from which late filing penalty notices are issued to analyze the correlation between late-filed Forms W-2 and potentially fraudulent or noncompliant individual income tax returns. IRS stated it would complete this analysis by June 15, 2019.

    Recommendation: 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)

    Agency Affected: Department of the Treasury: Internal Revenue Service

  2. Status: Open

    Comments: In a written response in April 2018, IRS said that it disagreed with this recommendation. IRS stated that it does not have all the information required for calculating and sending late penalty notifications prior to the beginning of the next filing season. However, in its response, IRS did not consider other options that could be available prior to finalizing penalty calculations, such as communicating with the employers earlier in the process. As noted in our report, 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. 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 will continue to discuss options with IRS regarding this recommendation.

    Recommendation: 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)

    Agency Affected: Department of the Treasury: Internal Revenue Service

  3. Status: Open

    Comments: In November 2018, IRS provided its assessment of the February 15 refund hold. In it, IRS reiterated its findings regarding the benefits of the refund hold, including its potential savings if the hold were modified to include all taxpayers, extended to a later date when more W-2 data are available, or both. However, IRS did not include any assessment of costs to achieve the potential savings, such as the costs for IRS to review any additional returns that would be identified under a modified refund hold and an assessment of taxpayer burden. IRS also did not determine how the February 15 refund hold informs IRS's overall compliance strategy for refundable tax credits, which it completed in April 2018, and its fraud risk management strategy. Based upon its assessment, IRS decided not to make any changes to the scope and timing of the refund hold without being directed to do so by the Department of the Treasury or Congress. Without a complete assessment of the benefits and costs, including taxpayer burden, IRS is making a decision based upon incomplete information.

    Recommendation: 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)

    Agency Affected: Department of the Treasury: Internal Revenue Service

  4. Status: Open

    Comments: In November 2018, IRS provided its assessment of the February 15 refund hold. In it, IRS reiterated its findings stating the benefits of the refund hold, including its potential savings if modified to include all taxpayers, extended to a later date when more W-2 data are available, or both. However, IRS did not include any assessment of costs to achieve the potential savings, such as the costs for IRS to review any additional returns that would be identified under a modified refund hold and an assessment of taxpayer burden. IRS also did not determine how the February 15 refund hold informs IRS's overall compliance strategy for refundable tax credits, which it completed in April 2018, and its fraud risk management strategy. Based upon its assessment, IRS decided not to make any changes to the scope and timing of the refund hold without being directed to do so by the Department of the Treasury or Congress. Without a complete assessment of the benefits and costs, including taxpayer burden, IRS is making a decision based upon incomplete information.

    Recommendation: 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)

    Agency Affected: Department of the Treasury: Internal Revenue Service

  5. Status: Open

    Comments: In April 2018, IRS stated that it would identify and assess ways in which the earlier receipt of W-2 data can be used to address noncompliance prior to refund issuance. As part of this assessment, IRS will consider legal and operational actions that may be required for successful implementation. IRS stated it would complete this assessment by June 15, 2019.

    Recommendation: 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)

    Agency Affected: Department of the Treasury: Internal Revenue Service

  6. Status: Open

    Comments: In April 2018, IRS stated that, after it completes actions in response to recommendation 5, it will evaluate identified actions within the scope of IRS's authority and implement those that support sound tax administration. IRS expects to complete this evaluation by June 15, 2019.

    Recommendation: 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)

    Agency Affected: Department of the Treasury: Internal Revenue Service

 

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