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MSP #20: FRAUD DETECTION

The IRS Has Made Improvements to Its Fraud Detection Systems, But a Significant Number of Legitimate Taxpayers Are Still Being Improperly Selected by These Systems, Resulting in Refund Delays

TAS Recommendations and IRS Responses

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1.

TAS RECOMMENDATION #20-1

Expand the Security Summit by including participants from the financial sector, the banking sector, the commercial sector, and consumer and privacy advocate sectors.

IRS RESPONSE TO RECOMMENDATION: The recommendation as written has been fully implemented. The Security Summit currently includes partners in the financial and banking, commercial tax software, and payroll sectors.

CORRECTIVE ACTION: N/A

TAS RESPONSE: This response does not fully address the National Taxpayer Advocate’s recommendation. The Security Summit does not include representatives of the consumer and privacy advocate sectors. When considering how to detect and prevent refund fraud, it is critical that organizations from a variety of backgrounds have a seat at the table, thereby ensuring the free exchange of ideas and perspectives. Including consumer and privacy advocacy groups in the Security Summit would be another voice advocating for the protection of taxpayer’s information and how that information is being used to detect and prevent fraud. The Security Summit’s relevance and success will be limited if it is not brought in to include a wide array of participants. TAS will continue to advocate for the inclusion of representatives of these groups.

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Not Adopted

OPEN or CLOSED: Closed

DUE DATE FOR ACTION (if left open): N/A

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2.

TAS RECOMMENDATION #20-2

Revise the Security Summit’s charter to broaden its scope to include non-identity theft refund fraud.

IRS RESPONSE TO RECOMMENDATION: ​​The IRS does not plan to implement the recommendation. After significant discussion with our partners at the inception of the Security Summit in 2015, there was agreement to focus strictly on IDT. Non-identity theft fraud is a much broader concept that could include such varied topics as money laundering, abuses of refundable credits, cryptocurrency, business fraud, false deductions, or the underground economy.

CORRECTIVE ACTION: N/A

TAS RESPONSE: The Security Summit’s success and relevance will remain limited if participants are not given the liberty to discuss problems and solutions surrounding non-IDT refund fraud. The inclusion of non- IDT refund fraud in the Security Summit’s charter could be defined more narrowly than what the IRS set out in its response here. It seems likely that state departments of revenue would be interested in discussing non-IDT refund fraud with other stakeholders since it continues to plague those agencies, as well as the IRS. It is critical to the success of the Security Summit and to the IRS’s fraud prevention efforts that the Summit is designed in a way that promotes the free exchange of ideas and solutions to combat a variety of fraud, not just IDT fraud.

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Not Adopted

OPEN or CLOSED: Closed

DUE DATE FOR ACTION (if left open): N/A

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3.

TAS RECOMMENDATION #20-3

Reinstate the 11-week process thereby requiring the IRS to either release the refund or to take some other action on the account, such as requesting additional information from the taxpayer or sending a notice of disallowance.

IRS RESPONSE TO RECOMMENDATION: “In 2015, the Treasury Inspector General for Tax Administration (TIGTA) conducted a review of IRS Integrity & Verification Operation (IVO) processes to ensure that tax refunds are not erroneously released (TIGTA Reference Number: 2016-40-006, Improvements Are Needed to Better Ensure That Refunds Claimed on Potentially Fraudulent Tax Returns Are Not Erroneously Released). The TIGTA review identified fraudulent refunds for tax year 2013 returns that were systemically released due to the expiration of the 11-cycle refund hold, even though IVO had controls in place to put unexpiring refund markers on questionable returns. To address this issue, TIGTA recommended that the IRS instead place an unexpiring refund hold marker on the taxpayer’s account until after IVO’s review is complete to prevent erroneous refunds. The IRS implemented this recommendation on October 29, 2015, by developing a marker that generates an unexpiring refund freeze and allows for systemic release when income and withholding are verified.

This policy decision to implement an unexpiring refund freeze did not change any of the IVO processes in place to ensure that screening and verification actions are taken timely. Indeed, the IRS is committed to balancing increased detection of refund fraud and revenue protection with taxpayer burden concerns. Under recently enacted legislation, the due date for reporting employee and nonemployee compensation to the Social Security Administration (SSA) has effectively been accelerated to January 31, beginning in calendar year 2017. Enhancements to IRS systems that allow income information received from SSA to be processed and, in turn, leveraged for systemic income and withholding verification enable the release of refunds related to legitimate returns more quickly. As a result, refund inquiries requiring referral to IVO on Form 4442, Inquiry Referral, from other IRS functions were reduced by over 50% when comparing January 1 – September 30, 2016, to January 1 – September 30, 2017. Operational Assistance Requests from the Taxpayer Advocate Service referred to IVO were also reduced by over 35% for the same period.

We review the results of programming and processes implemented over the course of each filing season. During a review of processing year 2016, IVO became aware that there were limitations that prevented the Notice CP05, Information Regarding Your Refund – Refund Being Held Pending More Thorough Review, from being systemically generated on every return sent for income verification. As a result, for processing year 2017 we generated the Letter 4464C, Questionable Refund 3rd Party Notification Letter, through a batch process for all returns sent for verification to ensure that all taxpayers are notified of the refund delay. The Letter 4464C also provides the taxpayer with an expected timeframe for receiving the refund or other IRS correspondence requesting additional documentation to substantiate the income or withholding claimed on the return.; ”

CORRECTIVE ACTION: N/A

TAS RESPONSE: The IRS’s response does not address the National Taxpayer Advocate’s recommendation. The steps articulated in the above response focus on notifying taxpayers that their refund has been delayed, but does not implement timeframes in which actions must be taken, such as an 11-week time period, and then allowing exceptions if there are significant reasons as to why that time period must be extended. The fact that over one-third of the returns selected into the IVO program were held beyond 11 weeks illustrates the need for a safeguard on how long a refund can be held. Additionally, results from this year’s filing season are quite different than the IRS’s data set out above, and show the taxpayers being impacted by refund delays. IVO cases have increased and surpassed any other issue in TAS. Specifically, in fiscal year (FY) 2018, Pre-Refund Wage Verification is currently the number one issue among TAS case receipts (with a 180 percent increase from the prior year, through May), supplanting identity theft as the top issue for the first time since 2011.5 The IRS reiterates in its response that it is concerned about the burden on taxpayers in this program, yet time and time again it seems willing to accept high FPRs and long refund delays as collateral damage in its efforts to fight refund fraud.

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Not Adopted

OPEN or CLOSED: Closed

DUE DATE FOR ACTION (if left open): N/A

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4.

TAS RECOMMENDATION #20-4

Establish a direct phone line to the IVO unit and provide information via “Where is my Refund” application to those taxpayers whose refunds are held because of suspected fraud.

IRS RESPONSE TO RECOMMENDATION: The IVO currently uses multiple methods to conduct verification of income and withholding on potentially fraudulent returns, which can include front-end phone calls to employers for verification of the income claimed on the taxpayers return. All returns sent for verification during processing year 2017 will generate a Letter 4464C to ensure that all taxpayers are notified of the refund delay and possible third party verification. The Letter 4464C also provides the taxpayer with an expected timeframe for receiving the refund or other IRS correspondence requesting additional documentation to substantiate the income or withholding claimed on the return, as part of the appropriate disallowance treatment streams. Taxpayers can receive help by calling the regular toll-free number (1-800-829-1040), as listed on Letter 4464C. Phone assistors assigned to answer calls on this number are trained to respond to refund hold inquires and forward referrals to IVO in an expeditious manner, if required. Because income and withholding must be verified and substantiated by the employer or with additional documentation from the taxpayer, direct phone contact with the taxpayer within IVO would not expedite resolution.

The IRS intends to update the “Where’s My Refund” (WMR) application for those taxpayers whose refunds are held because of suspected fraud, when resources permit.

CORRECTIVE ACTION: N/A

TAS RESPONSE: The IRS’s response does not address the National Taxpayer Advocate’s concerns. Taxpayers are informed in the initial IVO notice of expected timeframes in which the matter will be resolved — approximately sixty days. But as has been mentioned previously, approximately one-third of the returns selected into the IVO program during the 2017 filing season were held beyond the timeframe set out in the notice. One way the IRS could improve customer service and eliminate the need for taxpayers to call the IRS is to be more informative in the initial Letter 4464C, Questionable Refund 3rd Party Notification Letter. For instance, the letter should instruct the taxpayer to verify their income documents versus what was reported on the return to ensure no filing inaccuracies. If a mistake was made, the letter should also instruct the taxpayer to file an amended return. This would alleviate the need for the taxpayer to contact the IRS to determine how to correct the problem when an inadvertent error was made. Also, the IRS should include procedural instructions for customer service representatives to provide this information when taxpayers contact the IRS.

When the refund has been held beyond that timeframe, it is reasonable that the taxpayer will call the 1-800 number listed on the notice to inquire about the refund. However, the assistor on the other line is unable to determine what return information is causing the delay, as they do not have access to the IVO case management system or instructions on how to correct reporting mistakes. Having the assistor contact the IVO program regarding the delay causes unnecessary back and forth between the IRS and the taxpayer and puts the customer service assistor in the position of determining whether or not the taxpayer’s inquiry is worthy of an IVO referral. It is important to note how drastically different this interaction is than the interactions the taxpayer may have with an assistor when the return is under audit, where the assistor would be able to provide specifics about what item is being examined and what the taxpayer needs to provide to resolve the issue. Although the IRS does not characterize a refund hold as part of verification of income and withholding as an audit, to the taxpayer, the experience feels like an audit and has thus been termed an “unreal audit” by the National Taxpayer Advocate. This is poor customer service, and leads to frustration on the part of the taxpayer and falls far short of the taxpayer’s rights to be informed and to quality service.

The National Taxpayer Advocate is pleased that the IRS is willing to make adjustments to its Where’s My Refund function, but finds its response to be too vague to be meaningful. If providing adequate customer service to taxpayers is truly a priority, along with a taxpayer’s right to be informed, it would have identified and secured the resources needed to make this change, and would have provided an expected completion date. Because of the vagueness of this response, the recommendation can only be deemed “unagreed to”.

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Not Adopted

OPEN or CLOSED: Closed

DUE DATE FOR ACTION (if left open): N/A

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