While taxpayers get ready to file their 2015 tax returns, they should remain vigilant against attempts from those looking to steal their identities to claim fraudulent tax refunds. Fraudulent activity involving electronically filed state income tax returns was so prevalent during last year’s tax season that software e-filing giant TurboTax had to temporarily suspend its services in all states. This issue affects everyone – even Joe Garrett, Alabama’s Deputy Commissioner of Revenue, who was one of many identity theft victims during last year’s tax season, as reported by The Wall Street Journal.
Most states continue to combat identity theft and tax fraud on a daily basis. Michigan, for example, is asking certain taxpayers to complete a quiz as an additional layer of security to prevent the issuance of fraudulent tax refunds. In addition, Vermont’s Attorney General recently issued a warning to employers regarding a scam involving W-2 forms.
To learn more about what states are doing to combat tax fraud, Bloomberg BNA interviewed Andrew Schaufele, Director of Maryland’s Bureau of Revenue Estimates, which is housed in the Maryland Comptroller’s Office. Mr. Schaufele discuss the key factors that have led to tax fraud becoming a hot topic in recent years and what taxpayers can do to prevent such fraud from happening to them.
In addition, Mr. Schaufele talks about how instrumental Maryland’s data-driven analytics system, which is part of its Teradata Data Warehouse, has been in uncovering returns claiming fraudulent tax refunds within the state.
Bloomberg BNA: Why has tax fraud become such a hot topic recently?
Schaufele: Several factors have coalesced in recent years. First, a broad consideration, the public has become keenly aware of their “digital footprint” and the prevalence of identity theft. It is hard to find a single individual that has not had a personal experience with some sort of identity theft, most notably credit card theft or fraudulent use of identifying information such as a Social Security number.
Second, the criminals have evolved in their use of technology. I believe there are three types of criminals perpetrating tax fraud crimes: the small time criminal that has a few stolen social security numbers and files a relatively small number of fraudulent returns; the tax preparer that increases the level of refund claim by either taking advantage of a legitimate taxpayer or by convincing a taxpayer to bend the rules; the organized criminal and criminal organizations that dedicate significant resources to fraud. Web based software and electronic filing has made preparation of tax returns simple and low cost for all three types; however, perhaps most significantly, the organized criminal has advanced up the learning curve. They now have better datasets (stolen information) and the technological capability to automate return filing at federal and state levels of government. The marginal cost per fraudulent return is likely minimal.
Third, the addition of computer chip technology into the credit card and retail industries dealt a major blow to credit card fraudsters. While the new technology will certainly not eradicate credit card fraud, the fraudsters always adapt, it has at a minimum raised the cost of business for fraudsters. Such measures incentivize them to dedicate resources towards other markets. We realized that a higher incident of organized attacks was imminent when we saw that the high-profile hacks had shifted from retailers to organizations with broad swaths of personal information including Social Security names, addresses, birth dates, etc. It was no longer Target and Home Depot -- it was Carefirst, Anthem, the federal Office of Personnel Management (OPM), and myriad other homes to personal information. Then, of course, came the IRS breach where full transcripts of tax returns were stolen. After tallying up the publicly reported breaches from 2014 and 2015 that were thought to have been focused on personal information and adjusting for redundancy (e.g., the same person in the Carefirst breach was in the OPM breach), we estimated that information for 75 million individuals had been stolen over essentially a one-year period. That information is then sold on the “dark web.”
Bloomberg BNA: What type of taxpayers are most impacted by tax fraud?
Schaufele: All taxpayers are impacted one way or another. The indirect impact is clear: less resources for government leads to either reduced services or increased taxes. More directly, as in the example above where taxpayers are taken advantage of by preparers, these taxpayers tended be of lower-income backgrounds, generally those most in need of speedy refunds and the benefits of any earned income tax credits to which they might be entitled. With the results from our fraud model this year and subsequent investigation, we have suspended the processing of returns from 66 different tax preparation locations. The investigations of these locations and individuals are pending. Relatedly, we recently announced the indictment of a Liberty Tax Franchisee and eight of her employees. Their scam was simple, pay $50 to homeless individuals and drug addicts for their personal information, then they would file fraudulent returns with that information claiming refunds well in excess of cost. All of these events are unbearable, but this one is truly disgusting.
Of course, those that have their identities stolen are impacted as well. If a taxpayer has had a fraudulent return filed with their information each of their subsequent legitimate filings takes more time to process and they must submit an Identity Theft Affidavit to the IRS.
There is also an impact to those that are perhaps not directly impacted. For example, increased vigilance impacts processing. This is another area where our modeling has made significant strides. Several years ago, we had a litany of stand-alone metrics for identifying potentially fraudulent refunds. Those metrics led us to review approximately 110,000 tax returns per year. We were identifying fraud in only 5 percent to 10 percent of those, meaning that we had to slow refunds for a substantial number of legitimate filers. The fraud model is capturing more money with the required review of half the original number of returns and we are “hitting” on approximately 60 percent of those we review. Our Comptroller is passionate about customer service and we found this to be an effective tool in support of that goal.
Bloomberg BNA: What is the most surprising information gleaned from the system?
Schaufele: For me, the most surprising information has been the number of professional preparers that are allegedly engaged in defrauding the State and individuals. It is always difficult to comprehend the limits that some people will go to in order to better themselves at the expense of others. There are truly some morally defunct individuals out there. While the majority of our taxpayers and preparers are honest, these few create problems for all. In response to this, the Comptroller has introduced legislation in this year’s legislative session that seeks to broaden the investigative powers of the office to go after these types of individuals and to shut them down while we investigate.
Bloomberg BNA: Is there anything in particular that taxpayers should do to prevent tax fraud?
Schaufele: Protecting your personal information is critical but almost impossible unless you want to live off the grid. That said, being vigilant about which websites have your information and only providing Social Security numbers when it is absolutely necessary (it is not necessary under many applications where it is requested). The Maryland Comptroller has provided guidance for taxpayers that can be found here and here.
Taxpayers should carefully review their returns that are prepared by others for suspicious activity, such as whether a tax preparer deducts fees from their refund, does not sign their tax return, or fails to include their preparer taxpayer identification number “P-TIN” on the return. In the event that a taxpayer suspects fraud, they are asked to immediately report the issue to the Comptroller’s Office by calling 1-800-MD-TAXES (1-800-638-2937) or 410-260-7980 in Central Maryland, or by emailing TAXHELP@comp.state.md.us.
Additionally, it helps if a taxpayer files their return as early as possible. If a taxpayer’s return has been filed and accepted, we automatically disallow any subsequent attempts with those Social Security numbers.
Bloomberg BNA: What do you see happening in the future with regards to tax fraud on the state level?
Schaufele: The future battle is going to be dealing with tax information that looks almost identical to what the taxpayer would normally file. The criminals are building databases of accurate information, including W-2s. Employer breaches specifically for W-2 records are becoming more widespread. This creates complexities from a modeling standpoint as well as an investigative standpoint. That said, we’re anticipating this advancement and working towards solutions. We might even already have a few tricks up our sleeves.
To read the rest of Mr. Schaufele’s interview with Bloomberg BNA, check out the April 15th issue of the Weekly State Tax Report.
Continue the discussion on Bloomberg BNA's State Tax Group on LinkedIn: Are states doing enough to combat tax fraud?
For more information about individual income taxes, check out Bloomberg BNA’s Individual Income Tax Navigator by signing up for a free trial of the Bloomberg BNA Premier State Tax Library today.
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