IRS Fraud Detection System Leads to Refund Delays

The tax refund delays this tax season could be tied not only to new identity theft detection filters, but also to overly tight business rules written into the IRS’s Electronic Fraud Detection System.

National Taxpayer Advocate Nina Olson, who heads the Taxpayer Advocate Service at the IRS, wrote about the problem in a report to Congress last month (see Taxpayer Advocate Sees Threat from Increased IRS Automation and Workload). The Electronic Fraud Detection System is a data-mining program that automatically screens all tax returns with refund claims in an effort to identify dubious-looking wages, withholding credits, number of dependents and other suspicious items.

Each tax season, the IRS writes new business rules for the EFDS based on the patterns of fraud it detected last time around. This tax season, the IRS stepped up its efforts to deter identity thieves who typically try to claim refunds early in tax season before most taxpayers file their returns. The agency installed new screening filters that were designed to improve its ability to spot illegitimate tax returns.

However, that effort led to tax refund delays of a week or more for early filers whose returns got caught in the system (see IRS Warns of Tax Refund Delays and IRS Refund Delay and Real-Time Tax System).

But even before this tax season, many legitimate claims for refund were getting delayed by the filters in the EFDS. Olson’s report noted that last year, the system flagged 1,054,704 returns for further review, a 72 percent increase over 2010. However, because the IRS has automated this process, it does not have nearly enough people on hand to weed through all the cases that are automatically directed to its Accounts Management Taxpayer Assurance Program when a refund claim is flagged.

As Olson’s report noted, “There is no easy way to distinguish proper claims from improper ones. Filters are, at once, both under-inclusive and over-inclusive, and inevitably block large numbers of proper refund claims. When that happens, the IRS must have sufficient personnel to assist the legitimate taxpayers who are harmed. If, for example, the IRS stops one million refund claims and has a 90-percent accuracy rate, it would need sufficient personnel to quickly work through the claims of 100,000 legitimate taxpayers who were inadvertently caught up in the net.”

Instead, what happens is that many taxpayers end up bringing their complaints to their tax preparers or to the Taxpayer Advocate Service. In fiscal year 2011, TAS received more than 21,000 pre-refund cases. According to a TAS study, 75 percent of the taxpayers ultimately were found to be eligible for the blocked refunds, but taxpayers had to wait an average of nearly six months to receive them. The average amount of the blocked refunds was upwards of $5,600.

Now, with many taxpayers who filed early this season still waiting for their tax refunds, it’s likely that the IRS will need to do a lot more fine-tuning of its filters and business rules, if not a complete overhaul, to prevent similar delays and taxpayer anguish next tax season.