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Analysis: The Most Significant Threat to Tax Administration

June 29, 2017

The IRS’ Electronic Tax Administration Advisory Committee (ETAAC) held its annual meeting and released its annual report yesterday. Advisory committees are fairly common in Washington, DC—and the IRS itself has several of them. ETAAC is unique in that it is statutory, created as part of the IRS Restructuring and Reform Act of 1998, and its members are drawn from state tax agencies, tax professional associations, tax software providers, financial institutions. Yesterday’s meeting is noteworthy for two reasons.

First, its participants—industry and agency leaders—met in the spirit of collaboration, understanding they had a common and urgent purpose. Collaboration in DC is not as frequent an event as many would like to see and a partnership that spurs public sector innovation is a rare sight.

Second, the group addressed an issue of critical importance – identity theft tax refund fraud. Arguably, this type of fraud is the most significant threat to our tax system. Our system is predicated upon voluntary compliance. Each taxpayer is asked to self-assess and to pay over what he or she owes. The reach of cybercriminals—both foreign and domestic—into our tax administration system costs the Treasury billions of taxpayer dollars in fraudulent refunds. Not to mention the costs to individual taxpayers, including heartache, grief, and time to unravel. Overall, identity theft-related fraud undermines confidence in our tax system and the IRS in particular.

The report demonstrates that the advisory group is focused on the right issues:

  • Educating and protecting taxpayers. The report understands the importance of meeting taxpayers where they are. For instance, millions of self-prepared e-filed returns are being rejected because taxpayers cannot remember either their prior year adjusted gross income or self-selected PIN. That’s a problem—and the IRS should be encouraged to assess new identity proofing technologies.
  • Strengthening cyber defenses. Return preparers, particularly independents and unlicensed, are a point of vulnerability. The agency does not provide a clear and full statement of the security regulations, standards, and requirements applicable to a tax pro’s e-file participation. It should provide simple, clear, actionable advice to this community. For example, if the IRS leveraged industry expertise and merged existing disparate documents (e.g., various IRS publications, including Publication 4557, Safeguarding Taxpayer Data, and Federal Trade Commission advice) while assuming most preparers are not technologically proficient, the agency would be well on its way to producing accessible and useful advice.
  • Detecting fraud and responding quickly. Many industry players are positioned to see what appears to be fraudulent activity. The IRS should improve information sharing between itself, the tax industry, and state tax authorities.

Identity theft tax refund fraud started small—a crude and unsophisticated enterprise—but it has evolved over time and today organized crime syndicates are involved. As the report suggests, “Criminals are incented by the potential availability of billions of dollars in refunds, particularly driven by refundable tax credits intended to help low and moderate income Americans. The criminals are smart, nimble, motivated, and well-funded.”

The IRS cannot fail to address this issue. Too much is at stake for those at risk and too many are at risk, including the most vulnerable among us, and the setbacks are too painful—for instance, shuttering the FAFSA system.

The Service and its advisory committee partners have recognized a significant threat, and have joined forces to take timely, decisive action. While federal advisory committee annual reports don’t get much readership, federal policymakers and those that provide oversight would be well served by taking note.

(Analysis and insights by Bob Kerr)

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