Inspector general says IRS must do more to prevent fraudulent refunds

The Internal Revenue Service must improve how it monitors frozen tax refunds to prevent individuals from fraudulently receiving refunds and payments from the 2008 stimulus, according to a new report from the Treasury Inspector General for Tax Administration.

As part of the 2008 economic stimulus signed by President Bush last year, the IRS distributed more than 119 million payments to taxpayers totaling $96.3 billion. The IG investigated the success of the agency's criminal investigation division in preventing individuals who claimed false refunds on their tax returns from receiving stimulus payments, and found that a fraction of the total $96.3 billion -- $1.2 million -- were false stimulus payments. The review, however, also showed that the IRS paid $16.3 million in false annual refunds during that period.

The watchdog expressed particular concern over the IRS' ability to track annual refunds the agency has frozen for review. According to the report, the process for restricting taxpayer refund accounts is complex and confusing, and processing delays and systemic deficiencies have caused temporary freezes to be released improperly.

The IG estimated that if the IRS criminal investigation division did not take steps to monitor its false refund inventory adequately and ensure cases are reviewed for resolution before their temporary freeze expired, about $117.6 million in false refunds could be released during the next five years.

Additionally, the IRS is at risk of releasing more than $138 million in payments under the 2008 stimulus to individuals who file phony returns. Individuals who reclaim stimulus payments not issued in 2008 due to fraudulent returns during the 2009 season will have their refunds reviewed.

"We believe this high volume of returns, coupled with limited resources and other competing priorities, could cause the IRS to increase the dollar tolerance of the potentially false stimulus payments referred to examination function personnel," the report stated. "As a result, there is an increased risk that some of these stimulus payments could be issued."

In response to the report, Eileen Mayer, head of the criminal investigation division, disagreed with both the tone and statistics of the inspector general. Mayer said she appreciated the IG's acknowledgement that the error rate for 2008 stimulus payment was small, but "the overall tone of the report does not provide the reader with the significant efforts [the unit] has taken to reduce fraudulent refunds from being issued."

During the last two filing seasons, the IRS prevented more than $2 billion in false refunds from being distributed, Mayer wrote. She took issue with the inspector general's estimate that $117.6 million in false refunds could be released in the coming years, calling the methodology used "biased in its assumptions." According to Mayer, the watchdog did not account for any volume changes in returns, average refund amounts, processing improvements or future economic conditions when calculating the estimate.