Delay in Detecting Use of Stolen Business EINs means Opportunity for Tax Fraud
The IRS has processes in place to verify the validity of the EIN on W-2 forms associated with income and withholding reported on tax returns. In other words, it can confirm the EIN was actually issued by the IRS.
For example, the IRS’s e-file system rejects e-filed tax returns if the EIN used to report income is not valid, such as a fictitious EIN or a number that was entered incorrectly. This system is not foolproof, and some do slip through, as was the case for the 8,046 returns discovered in the TIGTA audit for the 2011 tax year. For calendar year 2013, by May 27, 2013 the IRS reportedly had already rejected more than 1.1 million e-filed tax returns because an invalid EIN was used to report income and withholding.
However, as the TIGTA report shows, there is a significant gap in effectiveness when the tax fraud involves the use of stolen EINs - those that are legitimately issued and belong to a legitimate business.
This is because the IRS may not have access to third-party reported Form W-2 information at the time individual tax returns are processed, and is unable to verify income and withholding reported on tax returns when they are processed (i.e.- match the income and withholding reported on an individual tax return to a third-party Form W-2).
The Employee Wage Reporting and Review Process
Each year, employers must send Copy A of Form W-2 (Wage and Tax Statement) to the Social Security Administration to report each employee’s wages and tax withholding for the previous calendar year. A Form W-2 must also be given to each employee. W-2 forms are sent to Social Security along with a Form W-3 (Transmittal of Income and Tax Statements).
Employers are required to file a Form W-2 for wages paid to each employee from whom:
- Income, Social Security, or Medicare taxes were withheld, or
- Income tax would have been withheld if the employee had claimed no more than one withholding allowance or had not claimed exemption from withholding on a Form W-4 (Employee's Withholding Allowance Certificate)
In this process, the following deadlines generally apply:
* If this date falls on a Saturday, Sunday or legal holiday, the deadline is the next business day.
- January 31st - Deadline to distribute Forms W-2 to employees
- February 29th* - Deadline to file using paper Forms W-2
- March 31st* - Deadline to file using Business Services Online
- April 15th - Deadline for employees to file their individual tax returns
The Problem that Creates the Opportunity: The IRS does not begin to receive and match W-2 information until after the January 31st deadline for W-2 distribution. Knowing this, criminals commonly file their fraudulent returns as early as possible, with the expectation that it could be quite some time before the IRS actually has an opportunity to compare the reported wage and income information to the actual wage and income information reported by the employer. By that time, the fraudulent individual tax return has already been processed, and the fraudulent refund has already been received.
Clearly, with 752,656 fraudulent federal tax returns using 277,624 stolen EINs - resulting in fraudulent refunds issued totaling more than $2.2 billion in tax year 2011 alone - criminals have an understanding of the process, and their expectations have merit.