The IRS will not flag, identify or otherwise note a SSN that may be subject to identity theft and subsequent tax fraud. Go figure.

by Wilson Elser

Nearly every day there’s another news story about another company suffering a data breach, either as a result of a lost or stolen device or because the company was hacked. Talk to any number of knowledgeable attorneys skilled in handling breaches, and each will guide you through a similar process for providing notice, obtaining credit monitoring or identity restoration, and complying with regulatory and other legal obligations. Yet no matter the recommendations, the antiquated processes in place at the IRS make it practically impossible for companies to protect someone from a fraudulently filed tax return.

With all the media attention, one would assume the federal government would be leading the charge to protect individuals’ information. Not so – the processes in place at certain federal agencies make it more difficult to take steps to protect information from a breach.

Take, for instance, the IRS. According to a government report released in September 2013, the IRS had issued approximately $3.6 billion in fraudulent tax refunds for 2011 tax returns. Electronic filing and direct deposit has made it easier for criminals to file fraudulent tax returns and collect the refunds. How does this happen? A criminal hacks into an accountant’s server and obtains all the information on the accountant’s clients. He begins to file fraudulent tax returns using the stolen social security numbers (SSNs) and comparable wage and deduction information – to be relatively consistent with prior returns – and changes the address to which the refund should be issued. Once the tax return is filed, the IRS issues a debit card to the new address, and the criminal collects the money. Or, the fraudulent return is wired to a certain bank – regardless of whether a previous return was deposited in the same account.

Now think about the accountant who was breached. The accountant discovers the breach relatively quickly, obtains a breach response vendor who provides credit monitoring and identity restoration, and notifies everyone whose information may have been breached. What most people don’t know is that identity restoration cannot provide much, if any, assistance with a fraudulent tax return. This is because the IRS will only work with the individual who has suffered the fraudulent return or someone with a properly authenticated power of attorney.

Continuing with the scenario, imagine the accountant has a list of everyone whose SSN may have been breached and wants to work with the IRS to protect those individuals. The IRS will tell him that it is required to accept any tax return that has been filed – it cannot refuse to do so because that would be against its charter. Regardless, common sense says that there should be some electronic way to highlight or flag the SSNs that have been exposed in a breach to help prevent fraudulent returns from being filed. At a minimum, one would think a company that has experienced a breach with actual fraud would be able to work with the IRS to protect the individuals impacted by that breach.

No such mechanism exists. The IRS will not flag, identify or otherwise note that any group of SSNs may be subject to identity theft and subsequent tax fraud. Instead, the IRS will tell you to bring every single person whose information has been breached to a local office and have them prepare a power of attorney and file their tax returns in person. Or, the individual must wait until after the fraud has occurred before the IRS will take any action. This must change. Obviously, while cyber criminals have moved into the information technology age, the IRS has not.

With today’s technology, monitoring systems, instant communication and volume of data, the IRS should implement a protocol to (1) identify groups of SSNs that have been involved in a breach and are likely to be used in a tax fraud and (2) flag them to protect these individuals from harm before the harm occurs without requiring hundreds or thousands of people to line up outside the local IRS office to file powers of attorney.

While in a perfect world breaches would never happen, the reality is that so long as our information is electronically available, we must be prepared for the consequences if that information is stolen. A holistic response is required – not just protecting the information, but identifying new ways to prevent criminals from using stolen information. Until we do so – and the federal government agrees to be part of the solution – criminals will continue to see value in stealing sensitive information.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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