States Go Old School to Fight Tax Fraud

D.C. and more than a dozen states are shunning paperless refunds to avoid being conned out of hundreds of millions of dollars.
by | March 22, 2017
Blank U.S. Treasury checks (AP/Matt Rourke)

As fraudsters go high-tech to scam governments for tax refunds, some states are employing decidedly low-tech ways of stopping them.

In 15 states and the District of Columbia, tax returns that are flagged as unusual are issued as a paper refund check. The old-school method comes as tax filers are more susceptible to having their identity stolen. "When there's a suspicious situation, we send paper checks because that has to go to a physical person," says D.C. CFO Jeff DeWitt.

Things that could flag a return include the filer having a new mailing address or using a bank account from previous years.

Fraud typically occurs during the first half of the tax season because scammers tend to file their fake refund before the actual taxpayer does. Last year, fraudsters conned the government out of $227 million in just the first half of the tax season, according to an audit by the Internal Revenue Service.

In Washington, D.C., paper checks have had a noticeable impact. Last year, the city prevented $25 million in fraudulent refunds from going out the door. In 2015, it saved $36 million. Since the District began employing the tactic two years ago, the total number of tax returns filed has decreased by 4 percent -- even as the population has increased. That, says DeWitt, is a sign that fraudsters are filing fewer fake returns.

In addition to a return to paper, states are also tackling tax fraud through other low-tech means: education and legislation. Veranda Smith, deputy director at the nonprofit Federation of Tax Administrators, points to Maryland, where officials are actively publicizing its efforts to clamp down on tax preparers who commit fraud by altering their clients' tax returns. Typically the preparer adds deductions and credits to the return, pockets the additional tax refund and sends the remainder to the client. Maryland, whose own attorney general was the victim of tax fraud in 2015, also has legislation pending that would give the state more authority to go after bad practitioners.

 

Trying to prevent tax fraud, however, is a bit like playing whack-a-mole: Close one route and criminals will find another.

In Smith's view, taxpayers and governments would be better served if refunds were withheld until the end of the tax season. That would give taxpayers time to file their returns and governments the chance to identify conflicting returns. Smith adds that taxpayers could also adjust their withholding so that they are taxed more accurately during the year.

But both ideas, she acknowledges, cut into a long tradition of tax refunds doubling for many as bonuses. "Politically," Smith says, "that love of the refund is something most elected officials do not want to touch."