msnbc.com staff and news service reports
updated 1/10/2006 5:06:39 PM ET 2006-01-10T22:06:39

The Internal Revenue Service annually freezes tens of thousands of tax refunds it deems questionable, delaying payments for months in many cases without telling filers they are suspected of fraud, the nation’s taxpayer advocate said Tuesday.

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Taxpayer Advocate Nina Olson detailed 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.

Richard Speier, acting chief of the IRS Criminal Investigation office, said the tax agency is “very comfortable” that when it determines that someone committed a fraudulent act that “we do have that correctly identified.”

Speier said the IRS acknowledges it could do a better job of communicating with these taxpayers. Overall, the program temporarily delays a small number of refunds but stops billions in false refunds from being paid to criminals, the agency said.

But Olson said a random survey of affected taxpayers showed that 80 percent eventually got some or all of the requested refund, although the had to wait an average of more than eight months. The taxpayers in the sample had a median adjusted gross income of $13,330, and the median refund ultimately received was about $3,500, indicated that the affected individuals suffered "significant hardship" due to the delay, Olson said in her report.

The IRS said the sample was biased because it was based on people who sought the help of the advocate, and so were more likely to be innocent.

Olson's report lists a total of 21 problems encountered by taxpayers that she ranks as the "most serious," including:

  • Private debt collection. The IRS plans to begin a new program this year that will for the first time use private debt collectors to seek payment from delinquent taxpayers. Private debt collectors should get training comparable to that provided for collectors who work directly for the IRS, Olson said.
  • Taxes on Social Security payments. The IRS taxes Social Security payments without sufficient review, "causing undue burden on a vulnerable population of taxpayers," the report said.
  • Refund anticipation loans. Most customers of these costly short-term loans have low to moderate income. Fees on the loans can equate to more than 100  percent of the loan value on an annualized basis, the report notes.  The IRS could help reduce demand for the loans by speeding delivery of refunds, especially for poorer filers who may not have bank accounts.
  • Identity theft. The IRS needs to do a better job of coordinating help for victims of this crime, the report said.

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 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 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.

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 cannot be used to conclude that the majority of taxpayers whose refunds are frozen under the program deserved those refunds.

“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 IRS said the cases involved sensitive criminal investigations but acknowledged 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.

The Associated Press and MSNBC.com's Martin Wolk contributed to this report.

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