The memorandum of understanding struck between the two agencies overcomes legal obstacles that hindered their own efforts and paves the way for states to make similar agreements that apply to their prisons.
"The impasse needed to end, and today it's over," Sen. Charles Schumer of New York said Wednesday, adding that the agencies responded quickly. "This agreement means that prisoners will no longer be able to bilk taxpayers out of millions of dollars."
Sen. Amy Klobuchar of Minnesota said the agreement effectively cuts through unnecessary red tape to "stop felons from scamming the system."
"It's shocking that inmates are ripping off the taxpayers right under the government's nose," said Sen. Bill Nelson of Florida.
The case shows "government agencies need to work together to prevent tax fraud wherever it occurs, but especially when we're being bilked from behind bars," said Sen. Sherrod Brown of Ohio, where roughly half of the 1,500 fraudulent inmate tax returns in 2009 came from a single prison, the London Correctional Institution in central Ohio.
The senators pushed the agencies to cooperate after a federal audit showed the practice continued, despite a 2008 law aimed at stopping it.
The Bureau of Prisons and the IRS, however, had already been cracking down on the scheme and made several arrests and recoveries of refunds.
But even though the 2008 measure gave the IRS the authority to turn over tax data to prison officials, there was a glitch in carrying out the law. While the IRS could flag suspicious behavior, the Bureau of Prisons felt it needed to share the information with the Justice Department before taking action against prisoners, in the event the prisoners sued.
But the IRS, under tax law, felt it couldn't share tax information with prison officials if they would share it with any entity outside the bureau, including the Justice Department.
"This memorandum of understanding allows us to receive information from the IRS when they suspect inmates have filed fraudulent taxes," said Bureau of Prisons spokesman Ed Ross. "Because of privacy issues, we were unable to do that prior."
Previous efforts since the 1980s have included a "lock box" in which the bureau voluntarily provided data that it could to the IRS and identified questionable refund checks before they were deposited.
"The IRS is committed to enhancing its processes to further minimize prisoner refund fraud," said IRS spokesman Michelle Eldridge, noting the effort has been under way for years. "We believe the agreement signed with the Bureau of Prisons will help us accomplish that."
According to the IRS, the number of bogus tax returns filed by federal and state prisoners doubled in five years to 44,944 as of 2009. The amount of fraudulent claims during that time rose to $295 million, up from $68 million five years before.
Prisoners nationwide have used their own names or the names of friends and associates to submit the false claims.
The cases included an inmate in an upstate New York prison who used the names and Social Security numbers of others to file 21 tax returns claiming refunds worth over $15,000. The prisoner filled out the returns in prison and had visitors submit them.