The government sent out more than $1 billion in fraudulent refunds last year and offered this explanation Thursday for the bad checks in the mail: The Internal Revenue Service has too few resources to pursue every tax fraud case.
IRS investigators never even looked at an estimated $742 million in fraudulent refunds, according to a report by the Treasury Department office that monitors the agency. When they did identify an additional $264 million in bad refunds, it was too late to stop them from being issued.
The report noted that the IRS must divide its limited resources among numerous areas of compliance. "However, this is a significant revenue loss to the federal government and that must be addressed," said J. Russell George, the Treasury's inspector general for tax administration.
The number of improper refunds filed appears to be growing rapidly, the report said. "The problem is becoming unmanageable, and the IRS cannot afford to continue handling it in the same manner as in the past," according to the report. It urged the tax agency to make the refund screening program — known as the Questionable Refund Program — a priority.
The IRS has estimated that the tax gap — the difference between taxes owed and taxes actually paid — at about $290 billion a year. Of that, about 57 percent comes from individuals understating incomes or overstating deductions and exemptions.
IRS spokesman Terry Lemons said the agency has made significant improvements over the past two years. "We stop the vast majority of fraudulent refunds and we prosecute people who try to cheat the system," Lemons said.
George's report recommended the IRS divert resources to go after such fraud cases. But Lemons said that could hurt other operations and mean fewer dollars from enforcement activities.
Lemons said the agency issued more than $470 billion in refunds in 2006 and 2007.
The report said the IRS fraud detection centers stopped more than $1.2 billion in fraudulent refunds in 2007, compared with $412 million in 2005, the last year the detection system fully functioned.
Because the system picks up only those refunds with higher dollar values, about 500,000 potentially fraudulent refunds did not enter the centers' screening process. Had those refunds been included, the centers would have identified an additional $742 million in fraud, the report estimated.
In 2006, because of a technical problem in the fraud detection system, the IRS succeeded in identifying and stopping only $189 million in fraudulent refunds while paying out an estimated $894 million, the report said.
The Treasury's inspector general, in a separate report Thursday, lauded the IRS for what it said was a "generally successful" 2008 filing season during which returns and refunds were processed in a timely fashion.
This report said the IRS did a good job in overcoming several obstacles, including changes involving the alternative minimum tax. The agency was also responsible for sending out checks to more than 130 million people as part of the economic aid plan signed into law in February.