Paul L. Caron

Monday, January 14, 2013

Starkman: E-Filing and the Explosion in Tax-Return Fraud

EfileWall Street Journal op-ed:  E-Filing and the Explosion in Tax-Return Fraud, by Jay Starkman:

Tax-identity theft exploded to more than 1.1 million cases in 2011 from 51,700 in 2008. The Treasury Inspector General for Tax Administration last summer reported discovering an additional 1.5 million potentially fraudulent 2011 tax refunds totaling in excess of $5.2 billion.

Why has identity theft rocketed through the IRS? Because American taxpayers, urged on by the IRS, have taken to filing their income-tax returns electronically and arranging for refunds to be directly deposited into bank accounts. E-filing is appealing because it provides an electronic postmark confirmation that the return was filed on time. When it is combined with direct deposit, a refund can arrive in as little as seven days. In 2012, 80% of individual returns were e-filed, fulfilling an initial goal Congress set in 1998. The result is an automated system in which the labor burden is transferred to the taxpayer.

Fraudulent tax returns can come in the form of tax-identity theft, refund fraud, or return-preparer fraud and are difficult to prosecute. With e-filing, evidence of fraud is difficult to find. There are no signed tax forms, envelopes or fingerprints, and e-filing promises quick refunds. ...

The national taxpayer advocate has recommended that taxpayers be allowed to tell the IRS to accept their return only when filed on paper, thus preventing e-file tax-identity theft. So far the IRS has failed to allow this. Less effective methods are to request an "electronic filing PIN," available at, and file Form 14039, "Identity Theft Affidavit," so that the IRS might apply additional return-screening procedures. Sadly, conventional credit-monitoring services are useless against income-tax identity theft.

In sum, e-filing helps the IRS with audit selection, costs the Treasury billions through fraud, and transfers many costs of tax administration to you.

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"The result is an automated system in which the labor burden is transferred to the taxpayer."

Before e-filing existed, all taxpayers (or their tax-preparers), filled in the forms with the information and data required and then mailed it to the IRS. The IRS would then have to take the numbers from the form and enter it into their system. Errors could occur during the data entry, of course. The IRS had to employ a large number of people to do this data entry task.

With the advent of e-filing, all taxpayers who choose to e-file STILL must fill out the (now electronic) forms with their information. The IRS however, does not have to employ nearly people to do data entry as before, and have also eliminated a possible source of error in the process.

How can this be characterized as "transferring all of the labor to the taxpayer"? It cannot.

The taxpayer is doing less work to prepare their returns. Furthermore, e-filing has the added benefit of having a software interface that can check for errors and inconsistencies before the return is filed.

The taxpayers returns are more likely to be correct than before.
There is no delay involved with sending paper through the mail.
The IRS has to hire fewer people to do data entry.

How exactly is any of this BAD?

How exactly does e-filing increase the probability of fraud? It has always been up to the taxpayer to provide correct information to the IRS. Having that information transmitted electronically to the IRS does not increase fraud. Garbage in equals garbage out. Just like always.

Identity theft? Much easier to intercept mail than to hack the e-filing system. In the case cited, the criminals obtained their info from "some database", not via the e-filing mechanism. If anything, this example highlights flaws in the database the IRS has. They should know who is dead - certainly the Social Security Administration would be a good place to get this information from.

Once again, the WSJ blatantly displays their ignorance.


Posted by: TioMoco | Feb 26, 2013 3:10:15 AM

Looks to me like the growing pains of a first generation of e-filing. The problem of getting taxpayers to file electronically seems to have been accomplished (btw, I don't, I use paper forms) but the question of security (and validity) seems to not have been really addressed.

It was inevitable that the system would attract a relatively large amount of fraud even if the fraud only amounts to a percent or two of total returns filed (am I correct??). When money is involved, it does not take many fraudulent refunds to make something worthwhile.

Posted by: Russell | Jan 15, 2013 7:40:42 PM

Don't worry --- our criminal justice system will deter the bad actors! Or the exact opposite.

The financial penalty for engaging in a $1.3 million identity-theft tax refund conspiracy to defraud the U.S. government? Perhaps $250,000.

The financial penalty for a 79-year old widow not paying $700,000 in taxes on accounts she inherited from her husband. $23,000,000. Paid in full.

More details on two very distinct cases from the US DOJ this month:

Fairness and due process are pretty much dead ideas. Because penalties and taxes are based on "how much you got," the converse is that we live in a society where it pays to have nothing. So the worse of the worst get away with crimes of moral turpitude, meanwhile the weight of criminal prosecutions fall on those foolish enough to have something to lose.

If I were going to place an epithet on our nation's tombstone, perhaps it would read "malum prohibitum."

Posted by: Anthony E. Parent, Esq. | Jan 15, 2013 8:48:23 AM

The IRS computers check e-filed returns against the Social Security database to verify certain return data. There is no reason they should not be able to do the same level of verification against bank accounts before the refund is transferred to the account.

Posted by: willis | Jan 15, 2013 8:08:04 AM

That's what we in DC call a "Win-win-win."

Posted by: holmes | Jan 15, 2013 7:56:19 AM

Government being inept.....again?
So what else is new?
The Tax Code is no longer a means of raising revenue.
It is now a club to be used for ones friends and against ones enemies.
This is no accident.
Revolution is coming.

Posted by: ebola131 | Jan 15, 2013 7:46:56 AM