How Tax Refunds Go to Inmates without Income

Last Updated Dec 8, 2010 2:13 PM EST

From the time we file our first tax return, we're led to believe that the IRS is all-powerful and all-knowing. Misreport your income by so much as a dime or puff your charitable contributions and you risk a term in the hoosegow. And that's no lie, unless you're already in the hoosegow.

According to a new report by the Treasury Inspector General for Tax Administration, the IRS didn't even bother to screen 88 percent of the 288,000 tax returns it identified as coming from prisoners to assess their fraud potential. (Wouldn't those be the first returns you'd look at -- those coming from people already found guilty of something?) Of those returns, some 49,000 submitted refund claims totaling $130 million which were unsupported by any wage information reported to the IRS by employers. While it's unclear how much of that was paid to prisoners, the amount could have been as high as $112 million, according to the inspector general's report. "Unscrupulous individuals, including prisoners, continue to submit tax returns with false income documents to the IRS for the sole purpose of receiving a fraudulent refund," said inspector general J. Russell George.
Here's the hitch. The IRS uses a data-mining program to flag returns that might be fraudulent. Once the computer spits out those returns, they are forwarded to Taxpayer Assurance Program examiners who review income and withholding information and compare it to whatever was reported on previous tax returns. If they sniff out something fishy, they contact the employer to verify the information on the filer's W-2 or 1099 forms. This tedious process takes a tremendous amount of time and effort.
There is an easy fix. The U.S. Department of Health and Human Services maintains a database called the National Directory of New Hires which contains national quarterly wage and employment information, including a worker's name, SSN, wage amount, employer name and employer address. (The database was originally created to help states to track down parents who wouldn't pay child support.) If examiners had access to this data they could immediately determine whether a flagged return was valid. But they don't. The law allows the IRS to access the database only for returns in which the individual claims the Earned Income Tax Credit, intended to supplement the wages of low-income earners, i.e., poor people. (Heaven forbid that the IRS examine the wage claims of non-poor people.) For that reason alone, the IRS was able to deny refunds to 4,500 prisoners -- because they stupidly claimed the EITC instead of merely inflating deductions for non-existent income.
Without the data, the Inspector General calculated that the IRS "needlessly expended 22,110 hours" screening tax returns only to conclude that they were not fraudulent. With the data, the examiners would catch more fraud, saving money for taxpayers. Legislation has repeatedly been proposed to give the IRS access to the data, but so far, no go. What has kept Congress from acting -- especially now with legislators frothing at the mouth for government cutbacks -- I can't begin to imagine.