For many years, it has been clear that identity theft is a grave threat to the fiscal sovereignty of millions of Americans. For its victims, many of whom are saddled with the new and unwelcome full-time job of battling fraudulent credit card charges and mounting debt, normal life can seem a long way off. Even those who do everything right, from hiring lawyers to disputing each new charge, can be in for a long, painful battle. And while there is nothing good about identity theft, it is at least fortunate that the problem has historically been largely contained to the individual – until recently.

Unlike other forms of identity theft, tax return fraud imposes costs on each and every taxpayer. The typical sequence of events involves a fraudster who acquires someone else’s social security number and address, files early for a return, and has the return direct deposited to a bank account or debit card, or sent to a mailbox that belongs to the thief. In the vast majority of cases, IRS issues the return, only to refuse the real taxpayer when he or she later attempts to collect it. In the cases where IRS deems the taxpayer to have been defrauded, the return is (rightly) reimbursed, often many months later and after a long, frustrating process. For people who rely on their tax return to cover essential expenses, the costs of such errors by the IRS are real and immediate. For taxpayers, the costs are diffuse but growing at an alarming rate.

While it is difficult for the Internal Revenue Service (IRS) to quantify the amount of money stolen each year in the form of fraudulent tax returns, or tax returns filed and received by persons claiming to be someone they are not, there is no doubt that it is rising. A November 2012 Government Accountability Office (GAO) report stated that as of September 30, 2012, the IRS had identified 641,690 known cases of tax fraud identity theft in 2012 alone. That is a rise of 165 percent from 2011, when there were just 242,142 such cases, and is more than 13 times the amount reported in 2008.

The total dollar amount of fraudulent tax returns issued by the IRS is inherently unknowable, since, as the GAO explains, “if a fraudulent return goes through IRS’s identity theft models and other programs, they are unable to tell if they failed to detect the fraudulent return.” In the IRS’s words, “we don’t know what we don’t know.” Treasury Inspector General for Tax Administration (TIGTA) J. Russell George claimed in a May 2012 report that the IRS could issue $26 billion in fraudulent returns over the next five years. Regardless, the amount of money lost to fraud each year is in the billions, and it is growing.

On a more encouraging note, IRS did manage to recover $754 million in fraudulently-issued returns between January 1 and September 30, 2012, and the number of direct investigative hours dedicated to identity theft at IRS has nearly quadrupled since 2008. Further, the IRS claims that it has stopped $12 billion in confirmed refund fraud this year. However, when one considers that another TIGTA report, this one from July 2012, found that a single address in Lansing, Michigan had been sent 2,137 different tax returns totaling $3.3 million, it is hard to know whether to be impressed or worried by IRS’s recovery totals. It may be that the extent of the problem is much larger than anyone realizes.

To be continued …

  -- Luke Gelber