Wow! The IRS Will Pay Out This Much in Fraudulent Tax Refunds By 2016

Source: StockMonkeys.com via Flickr. 

It's tax time again. (Cue the dive under the blankets for a majority of Americans!)

Though few people enjoy the process of preparing their taxes -- a walk down memory lane consisting of receipt-hunting can be arduous and time-consuming -- tax time is also a critical source of income for millions of Americans. According to the Internal Revenue Service, more than 80% of taxpayers wind up getting a refund. These refunds help boost retirement savings accounts, can be added to an investment portfolio, are used to pay down debt, and can even boost retail sales. This last benefit is a big help to the U.S. economy since consumer spending makes up around 70% of GDP.

But, tax time is also becoming infamous for something else: tax-refund fraud.

Tax-refund fraud skyrockets
According to the IRS, the amount that it will be paying out in fraudulent tax refunds is expected to balloon by 223% to $21 billion by 2016, up from just $6.5 billion in 2013.

You might be wondering why. It has to do with a mixture of outdated software at the IRS offices which makes the detection of fraudulent returns difficult, and strict budgetary controls implemented by the federal government in order to curb deficit spending. For example, the IRS notes the need to cut $200 million out of its information technology budget in 2015, which will slow down the adoption of upgrades needed for its fraud detection software.

Source: Flickr user Don Hankins.

As the findings note, the biggest concern with tax-refund fraud is just how little information is needed. Criminals only need your name, birth date, and Social Security number in order to file false W-2s and collect a tax-refund check. CNBC further adds that the timing on most tax refunds could play a role in perpetuating fraud. The IRS begins accepting tax returns on Jan. 1, but has paid out approximately half of its refunds by March when accurate employment information is eventually submitted to the agency by employers. In other words, the IRS has few tools at its disposal to decipher whether a filing is fraudulent since it often doesn't have a complete or accurate data set to reference.

However, this doesn't mean that the IRS is completely without methods of locating red flags, either. Potential giveaways include multiple refund checks being sent to the same address, or multiple deposits posting to the same bank or debit account.

Additionally, the IRS has worked with past victims of fraud to set them up with an identity protection number for them to use when filing their taxes in the future. It's possible that this personalized identification number could become standard in the future.

Taxpayers need to be proactive
Taxpayers need to be proactive about protecting their identities in order to reduce the chance of falling victim to identity theft. While the IRS will work with identity theft victims, the process itself can take months or even longer than a year to work itself out.

Source: Flickr user David Goehring.

In fact, the IRS has devoted an entire section of its website to providing tips for taxpayers to better help them protect their identities.

At the top of that list is a reminder that the IRS doesn't contact taxpayers by email and it doesn't threaten taxpayers over the phone with jail time or deportation for failure to pay their taxes. The IRS encourages taxpayers to report these phishing examples directly to the IRS.

Also, the IRS recommends that you take regular precautions to protect your valuable personal information. For instance, never carry around your Social Security card and keep any document with your Social Security number in a safe place. The IRS suggests checking your Social Security Administration earnings statement on an annual basis and your credit report regularly as well. Lastly, provide your Social Security number only when it's absolutely necessary.

None of these methods are foolproof, but they'll certainly reduce your chances of being a tax-fraud victim.

Pay attention to these red flags
Another component to protecting yourself is to ensure that you're abiding by the rules and making accurate calculations in two areas where the IRS is really trying to crack down on fraud: Earned Income Tax Credits and personal deductions.

The Earned Income Tax Credit, or EITC, is a refund given predominantly to low-income, hard-working Americans. But, according to the IRS, it's one of its largest sources of tax fraud. Since some people due this refund have their effective taxable income reduced to zero dollars they may choose not to file a return thinking they'd get no refund, since their taxable income was already zero. This is where a criminal could swoop in and file a return with a workers' identification in hand and collect an EITC-based refund without the taxpayer finding out for quite some time. It's an area where the IRS has been clear that it plans to work hard to curb fraudulent refunds.

The other area where the IRS is diligently cracking down on fraud relates to deductions. The solution for taxpayers is simple: Don't lie. If you don't have the proper receipts for your deduction, or it's not allowed as a deduction, don't include it. If the IRS notes an inordinately high number of itemized deductions relative to your income you'd better have the receipts to prove it.

An improved IRS fraud detection system will eventually be in place, but for the time being implementing these suggestions should make filing taxes a smoother and safer process.