As seen with the massive TurboTax refund scam earlier this year, refund fraud and other tax-related identity theft has really taken off.
Fending off these fraudsters isn't easy. But lawmakers could choose to make some fairly straightforward changes that would go a long way toward preventing more of these crimes, federal and state tax officials told the Senate Finance Committee this week.
Here are some of their recommendations.
Make prepaid debit cards easier to identify: Prepaid debit cards have become the currency of tax fraudsters, since they're hard to trace and the money is easily transferable.
In many instances, identity thieves used the cards to collect tax refunds after filing false state tax returns through TurboTax earlier this year. John Valentine, chairman of the Utah State Tax Commission, told lawmakers that the direct deposit information on the suspicious returns found in Utah had been changed from the prior year's return.
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"We couldn't tell whether we were refunding to a prepaid debit card or ... to a legitimate bank account," he said.
State tax agencies and the IRS could more easily flag a suspicious return if lawmakers required the financial industry to have an identifier in the routing and account numbers that indicated it's a prepaid debit card, Valentine said. "We already do it with checking and savings accounts but not prepaid debit accounts."
Require employers to file W-2s with tax agencies earlier: Currently, employers are required to send employees their W-2 forms by the end of January. But they don't have to send a copy to the IRS and Social Security Administration until March 31, after many people have already filed their returns and claimed their refunds.
That makes it very hard for the IRS and state tax agencies to confirm that the person claiming the refund is using the correct information, said Timothy Camus, the Deputy Inspector General for Investigations at the Treasury Inspector General for Tax Administration.
One distinguishing factor in the scam that affected TurboTax users was that the criminals appeared to use information from victims' 2013 state tax returns. If the state tax agencies had the victims' current W-2s in hand to cross-check the information that might have raised a red flag on the scam even sooner.
Camus, Valentine and the IRS itself have recommended that lawmakers require employers to send W-2s to the IRS closer to the time they send them to filers.
Don't let third-party filing fees be deducted from a refund: Another common problem with the fraudulent state tax returns filed through TurboTax were so-called "refund transfers."
Basically, the fraudsters opted to have third-party filing fees, like the one TurboTax or other tax software vendors might charge, deducted from the refund. So the criminals had nothing at risk in the transaction, the third-party filers got paid and the states were out the refund.
Valentine's recommendation: "Prohibit the practice of applying refunds to payment of fees for filing services."
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Doing so may deter a fraudster from filing at all if he has to pay the third-party filer himself and it may make it easier to track him down as well.
Do more to educate the public: Phone scams involving fraudsters posing as IRS agents is the No. 1 tax scam this year. And older adults are one of the biggest targets.
"They answer their phones because they grew up in a time where they were taught it's rude not to answer the phone and listen to the caller on the other end," said Ellen Klem, who runs consumer education for Oregon's Office of the Attorney General.
Klem said one easy way to curb this fraud is through more education and awareness.
"Let people know this is a notoriously awful scam and it's not rude to hang up the phone. The more information and awareness we can get out there the better."
