The Treasury Inspector General for Tax Administration (TIGTA) reported last week that in 2011, the IRS paid out $3.6 billion in fraudulent refunds on tax returns filed by identity thieves. Even that amount was an improvement over the previous year when the total fraud was $5.2 billion. However, on Tuesday, TIGTA released a new report that found that though the IRS is making some progress against fraud, it is not using all available tools to prevent erroneous refunds and improper tax credits.
In 2007, the Small Business and Work Opportunity Tax Act amended the IRS code to increase the agency's ability to penalize taxpayers who claim excessive tax credits or refunds. A recent audit, however, found that the IRS has not properly implemented the law, and is following up in only a fraction of the cases where action may be warranted [emphasis added]:
TIGTA found that the IRS incorrectly interpreted the erroneous refund penalty law, which significantly limited the types of erroneous tax refund or credit claims to which the penalty would apply. The IRS assessed only 84 erroneous refund penalties totaling $1.9 million between May 2007 and May 2012...
[I]n the year after the IRS revised its interpretation of the law (June 3, 2012, through May 25, 2013), there were 709,123 individual tax credits disallowed by Campus Operations for which the IRS could have potentially assessed erroneous refund penalties totaling more than $1.5 billion.
The inspector general found no legitimate reason for the IRS's neglect of the law:
“I am troubled that even though the IRS has revised its interpretation of this law, it has still failed to establish processes to assess penalties on the majority of disallowed tax credit claims,” said J. Russell George, Treasury Inspector General for Tax Administration. “Taxpayers who seek refunds or credit claims that have no reasonable basis in law must be penalized, for they create unnecessary burden on both the IRS and the American people by straining resources and impeding tax administration.”
In response to the findings, IRS management "raised concerns about the costs and benefits of establishing processes and procedures... to assess erroneous refund penalties," but did not support these concerns with documentation or analysis.