The recent data breach at Equifax is just the latest reminder of the threat that identity theft poses. Although most people are aware of the possibility of having their credit cards used fraudulently, many overlook the threat of return-related tax fraud. The IRS has a weapon at its disposal that could dramatically reduce the risk of identity theft crimes related to taxes, but thus far, the taxing agency has only made that weapon available to a small fraction of taxpayers. Recent events should prompt taxpayers to demand that the IRS release this key tool to everyone.

How tax-return fraud works

To take advantage of your personal information, identity thieves can file fraudulent tax returns with the IRS in order to collect incorrect tax refunds. When you later file your own actual return, the IRS will flag it as the second return it has received linked to your Social Security number. That will not only leave you fighting to get any tax refund that you might rightfully deserve, but will also force you to do some explaining to the IRS.

The problem with the current system is that all someone needs in order to file a tax return is your name and Social Security number. Thieves can provide false addresses and bank account information in order to funnel refunds into their possession. The IRS doesn't require any identity validation in connection with returns, and that leaves the door open to tax return fraud.

IRS building with traffic light in front of it.

Image source: Getty Images.

How the IRS started to fight back

The IRS is aware of the threat that identity theft and tax fraud pose. Last year, the IRS implemented a new set of guidelines designed to thwart return-related fraud. In particular, the IRS delayed the processing of refunds on tax returns that claimed popular tax credits like the Earned Income Tax Credit and the Additional Child Tax Credit until mid-February. Taxpayers didn't actually receive payments until late February or early March.

Yet one capability that the IRS has been reluctant to make available to the general public is its identity protection personal identification number program. Under the program, the IRS has assigned certain taxpayers a special six-digit code. In order to file your tax return, you have to include this code in the appropriate box. If the IRS doesn't see the code, it can flag the return as potentially fraudulent and hold back issuing any related refund until it can verify the return with the taxpayer directly.

Why identity protection PINs haven't already solved the fraud problem

Having all taxpayers use identity protection PINs would make it much more difficult for identity thieves to file fraudulent returns. In order to do so, they would have to obtain access to the PIN, as well as other key personal information. Given that there would be no reason for credit-reporting bureaus, financial institutions, and many other potentially vulnerable holders of key personal information to know an IRS-provided PIN, tax-return fraud would likely drop dramatically.

Yet so far, the IRS has tightly limited its use of identity protection PINs. In general, only those taxpayers who are specifically invited by the IRS to get a PIN through a letter or notice can sign up for the program. Under a pilot program, residents of Florida, Georgia, and the District of Columbia can also request a pin. But in the 48 other states, even those who have suffered known identity theft aren't able to get a protective PIN from the IRS, with eligibility generally limited to those who've already had their personal information abused for tax purposes. Instead, people who have been victims of general identity theft must call the IRS Identity Protection Specialized Unit at 800-908-4490 and hope that they aren't too late in stopping return-related fraud from occurring.

Expand IRS PINs

Given the scope of the Equifax breach, the IRS should act now to expand its PIN program to cover all taxpayers. The tax agency knows the potential scope of the problem: Identity theft is already one of the top tax scams among the popular Dirty Dozen list.

The IRS has worked hard to fight against identity theft, and its efforts have prevented billions of dollars from being lost. At this point, it makes sense for the IRS to go one step further to give every taxpayer who wants it the added protection that a PIN would provide.

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