Fraudulent Tax Returns Up 181%

The number of taxpayers trying to bamboozle the IRS and collect bigger refunds has shot up this filing season.

The IRS identified 335,341 tax returns claiming $1.9 billion in fraudulent refunds as of March 4, 2011, according to the findings of an audit conducted by the Treasury Inspector General for Tax Administration. That’s a whopping 181% increase from the same period last year.

While the IRS has become more effective in its screening process, a weak economy has also driven more people to cut corners, said Tim Gagnon, assistant academic specialist of Accounting at Northeastern University.

“When the economy gets really bad, people get more touchy about how much they’re paying in taxes and look at where they think they can push the envelope a little more,” said Gagnon. “100 extra dollars really makes a difference to people now.”

Many taxpayers tried to boost their refunds or reduce their tax liability by claiming deductions and credits they didn’t qualify for, TIGTA found.

For example, the Earned Income Tax Credit, aimed at helping lower-income taxpayers, has been a large source of fraud, with people falsely lowering their income to qualify or claiming children they don’t have. The IRS estimates that 23% to 28% of EITC credits are wrongfully paid to Americans every year, totaling $11 to $13 billion.

Child tax credits have also been abused, with more taxpayers unable to provide legitimate social security numbers for their children.

The adoption credit, which grants qualifying adoptive parents refunds of up to $13,170 for each child, also appears to be attracting fraud. TIGTA has identified 1,081 individuals who claimed the credit in excess of the limit — amounting to $3.9 million in erroneous refunds.

Another problem: returns claiming the first-time home-buyer tax credit which grants new home owners credits of up to $8,000  for home purchases with ineligible purchase dates.

And taxpayers also claimed vehicle credits, like the qualified plug-in electric drive motor vehicle credit, for cars that didn’t qualify.

Another reason for the huge increase is ramped up enforcement efforts on the part of the IRS.

Prisoners were of particular interest this filing season. As of March 4, the IRS had selected 63,501 tax returns filed by prisoners to screen. That’s up 88% from the same period last filing season, TIGTA found.

In a previous review of the IRS, TIGTA reported that most tax returns filed by prisoners were not being screened, making the group a prime target for enforcement, said Gagnon.

“You somewhat have to question what a person in prison has for income and plus, a big question is, what’s their biggest risk when filing their taxes? Fraud? They’re already in jail,” he said.

Gagnon thinks the surge in fraudulent returns mean a surge in audits is also on the way. And following the trend of recent years, he expects most of these audits to be conducted by mail to save the IRS resources.

The IRS is also getting more efficient at reviewing tax returns and identifying errors or false information, thanks to the increase in electronic filing. The number of e-filed returns surged to a record high this year, topping 100 million for the first time in history a nearly 9% increase from last year, according to the IRS.

When taxpayers file their taxes electronically, it’s much easier for the IRS to analyze them, said Gagnon.

Not all of the so-called “fraudulent” returns are a result of taxpayers trying to scam the system, said Gagnon.

Many taxpayers were in such a pinch financially last year that they were less likely to hire a professional to prepare their taxes often resulting in more incorrect claims, outdated deductions and other common errors.

For example, if you were laid off from your job and became self-employed, you were subject to a whole new set of rules you may not know about, and more likely to make a mistake.

Plus, the tax code changed in December and the final touches were agreed upon so late in the year that many taxpayers had already begun preparing their returns and may not have been informed of the new guidelines.

TIGTA plans to publish the final results of its review later this year.