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Advocate: Frozen IRS Refunds a Growing Problem

The Internal Revenue Service freezes tens of thousands of tax refunds it deems questionable without telling people that they're suspected of fraud, the nation's taxpayer advocate said Tuesday.

Taxpayer Advocate Nina Olson detailed the program, called the Questionable Refund Program, in her annual list of the worst problems facing taxpayers. Her office, which helps sort out disputes with the IRS, has seen a mounting number of people seeking help to claim frozen refunds.

"It is a central tenet of American law that the government must notify an accused person of the offense it suspects he committed and must give the accused person an opportunity to present exculpatory evidence to show his innocence," Olson said in her report.

In response, the IRS said the program temporarily delays a small number of refunds and has stopped "literally billions of dollars of false refunds to criminals of the legitimate tax dollars paid by honest taxpayers."

The Questionable Refund Program is run by the IRS Criminal Investigation office and uses computer programs and other methods to screen tax returns claiming refunds for indications of fraud. It temporarily freezes returns that might be fraudulent.

The IRS tries to validate the taxpayers' right to the refund and lifts the freeze if no fraud is found. If the refund cannot be validated, it permanently freezes the refund for further investigation.

The IRS does not inform taxpayers that they're suspected of fraud. Under the program's rules, a taxpayer isn't told anything until six months after trying to find out what happened to the refund.

Once frozen, some tax returns are referred to other IRS offices for an audit. Olson said many probably aren't examined or resolved. Refunds claimed on tax returns determined to be fraudulent remain frozen for an undisclosed number of years until the IRS sees the taxpayer file a number of legitimate returns.

Olson said she agrees that the IRS must investigate potential fraud before issuing refunds. But, because her office handles more frozen refunds than any other issue, she decided to study a representative sample of the cases the taxpayer advocate service handled over 18 months.

That study showed no evidence of fraud in 66 percent of the cases, and taxpayers were given a full refund. In another 14 percent of the cases, taxpayers were given a partial refund. Taxpayers got some or all of their claimed refund in 80 percent of the cases.

Nearly 75 percent of the total pool studied were low-income families claiming the earned income tax credit, designed to reduce poverty among the working poor.

The IRS said the taxpayer advocate's study used a "significantly biased sample." It cannot, therefore, be concluded that the majority of taxpayers whose refunds are frozen under the program deserved those refunds. Innocent taxpayers are more likely to search out a refund, they said.

"From 1999 until today, the IRS has stopped over $3.1 billion in fraudulent refunds exclusive of two claims totaling $1.8 billion in processing year 2004," the agency said in response to the report.

The tax collectors said the cases involved sensitive criminal investigations but that Criminal Investigation "acknowledges that communications with taxpayers on potentially fraudulent returns is an issue." The IRS started last March sending letters to some taxpayers who inquired about their refunds.

Olson said the program may violate taxpayers' rights by determining fraud and characterizing taxpayers as criminals without notifying the taxpayers of the government's suspicions or giving taxpayers an opportunity to back up the information provided on the tax return.

"At a minimum, this procedure constitutes an extraordinary violation of fundamental taxpayer rights and fairness," she said. "In our view, it may also constitute a violation of due process of law."