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From 2008 to 2009, the U.S. unemployment rate increased significantly from 5.3 percent to 9.2 percent, leaving many Americans jobless and at risk of losing their employer-sponsored health care. Through the American Recovery and Reinvestment Act of 2009 (ARRA) and subsequent amendments, employees who were involuntarily terminated between September 1, 2008, and May 31, 2010, became eligible to continue their health care coverage for up to 15 months at reduced rates. Previously, the Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) allowed certain former employees to maintain health coverage by paying the entire cost of coverage. Under ARRA, former employees pay 35 percent of insurance premiums while employers pay the remaining 65 percent. Employers are reimbursed through a tax credit against their payroll tax liability or through a tax refund if the credit exceeds their payroll tax liability. The Congressional Budget Office estimated that the cost of this program to the federal government would be $25.1 billion. According to the Internal Revenue Service (IRS), as of March 20, 2010, employers had claimed approximately $2.2 billion in COBRA credits. Employers claiming COBRA credits use quarterly or annual payroll tax returns to report the number of former employees on COBRA and the amount of premiums paid. These returns do not require employers to provide any supporting information about individuals enrolled in COBRA or premiums paid on their behalf, potentially allowing unscrupulous employers to lower their payroll taxes by fraudulently claiming COBRA credits. Based on this potential vulnerability, we performed covert testing of the effectiveness of IRS's internal controls for preventing businesses from submitting fraudulent tax returns to obtain COBRA tax credits and subsidies. To determine the effectiveness of IRS's internal controls, we performed covert testing to identify what controls, if any, IRS had in place to detect suspicious tax returns. We created five fictitious businesses for tax filing purposes. Because these were new businesses, the fictitious companies had never filed corporate income tax returns with IRS. Thus, our companies filed employer payroll tax returns without any prior records as established businesses. For three of the five businesses, we filed quarterly federal tax returns using IRS form 941 in each of the four quarters of 2009. For the remaining two companies, we filed annual federal tax returns using IRS form 944 in December 2009. In several quarters and at the end of the year, we requested refunds of varying amounts for different companies. In some cases, we paid small amounts of monthly payroll taxes to appear legitimate. For companies selected for audit by IRS, we prepared fictitious documentation, including lists of fictitious employee names with no prior tax records on file with IRS, Social Security numbers, and dates of involuntary termination. We used publicly available information, hardware, and software to create fake invoices from an existing health insurance carrier and proof of employer payment of COBRA premiums. At the end of our undercover tests, we interviewed IRS officials to determine what internal controls are in place to detect fraudulent COBRA premium claims and reviewed IRS files related to our five fictitious companies. Our work was limited to testing whether new companies could fraudulently claim COBRA subsidies without being detected.

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