Many Unhappy Returns: The Need for Increased Tax Penalties for Identity Theft-Based Refund Fraud

Abstract

The growing problem of fraudulent tax returns being submitted based on stolen identities is a “tsunami of fraud,” and victims, lawmakers, and law enforcement are struggling with how to deal with the fallout. The issues surrounding identity theft-based tax fraud are complex. Current IRS efforts to stem the tide involve pouring resources into assisting victims, updating IRS processes to detect and prevent refund fraud, and increasing the number of criminal investigations and prosecutions it pursues. The IRS’s approach and pending proposed legislation are not enough to address the problems created by identity theft-based tax fraud. This article argues the IRS and Congress must use a holistic approach to attack this specie of tax fraud. To that end, this article supports enhanced criminal penalties and proposes new civil tax penalties aimed specifically at identity theft tax fraud.

This article pursues two goals. First, it documents and explains the problem of identity theft-based refund fraud, highlighting particular issues with respect to tax compliance. In so doing it analyzes existing civil and criminal tax penalties to punish and deter identity thieves, an analysis which reveals that existing criminal penalties are insufficient and that there is no directly applicable existing civil penalty. Second, to address the gaps in existing law, the article proposes standards for Congress to use in crafting a comprehensive penalty scheme to apply to identity theft-based refund fraud.

This article proceeds in three parts. Part I addresses the nature and scope of identity theft tax fraud, explaining the consequences such fraud has on tax administration, fair enforcement, and public confidence in voluntary compliance, which is the bedrock of our tax system. Part II explores the inadequacy of existing criminal and civil penalties. Part III then proposes legislative action, evaluates proposed and pending legislation, and makes specific recommendations for enhanced criminal penalties and the creation of a new civil penalty aimed specifically at identity theft-based tax fraud.

Keywords: identity theft, tax, tax procedure, voluntary compliance, tax refund fraud, civil tax penalties, criminal tax penalties

JEL Classification: K34