The Internal Revenue Service doesn’t know how many identity thieves are filing fraudulent tax returns, and the agency risks issuing approximately $26 billion in fraudulent tax refunds tied to identity theft in the next five years, a watchdog told lawmakers Tuesday.

(Daniel Acker/Bloomberg)

The IRS received 2.2 million fraudulent tax returns in 2011 and found that 940,000 of the returns, with $6.5 billion in associated fraudulent refunds, involved identity theft, according to J. Russell George, head of the Treasury Inspector General for Tax Administration (TIGTA). George told lawmakers that the IRS cannot definitively say how many identity thieves are filing fraudulent returns on an annual basis.

An analysis by TIGTA found that the IRS is failing to detect other instances of fraud-related identity theft. The watchdog found about 1.5 million additional undetected tax returns that are potentially fraudulent, with refunds exceeding $5.2 billion. If those concerns are not addressed, George said the IRS could dole out about $26 billion in fraudulent tax refunds resulting from identity theft over the next five years.

George testified Tuesday before subcommittees of the House Ways and Means Committee that maintain oversight of the IRS and Social Security.

At the same hearing, IRS Deputy Commissioner Steven T. Miller told lawmakers that “the IRS cannot stop all identity theft.”

“However,” he added, “we have improved and we are committed to continuing to improve our programs.  We can and will continue to work to prevent the issuance of fraudulent refunds and we can and will continue to work with innocent taxpayers to clear their accounts and/or get them their money faster in a courteous and professional manner.”

Separately, IRS spokesman Terry Lemon disputed TIGTA's five-year estimate, saying in an e-mail, "Our increased compliance and prevention efforts mean we are stopping more refund fraud than ever before."

The IRS announced plans this year to crack down on suspected identity theft as part of broader efforts to prevent tax fraud. The agency also is stepping up internal reviews to spot false tax returns before issuing refunds, according to George. New screening procedures flag potentially fraudulent returns for closer scrutiny, and once a taxpayer’s identity has been confirmed, the tax return is processed and a refund is issued. If a taxpayer’s identity cannot be confirmed, the IRS is supposed to suspend issuing any refunds.

As a result of its new program, the IRS said it had stopped $1.3 billion in potentially fraudulent tax refunds as of mid-April, George said.

The findings to be shared with Congress on Tuesday are part of a new TIGTA report on customer service at the IRS. In its report, the watchdog faults the IRS for failing to quickly assist identity theft victims who often wait more than a year to resolve cases.

According to TIGTA, an individual who attempts to electronically file a tax return in February might discover that an identity thief has already filed a return in his or her name and obtained a fraudulent refund. Over the course of several months, TIGTA said the legitimate taxpayer might attempt to contact the IRS several times. Once an agency official acknowledges the fraud and begins an investigation, it might take until the following January to resolve the case.

“This is just plain wrong,” Rep. Sam Johnson (R-Tex.) said at Tuesday’s hearing.

Much of the delay is due to budget cuts, according to Rep. Xavier Becerra (D-Calif.), who said at Tuesday’s hearing that the IRS budget this year is $305 million less than what it had in fiscal 2011. The cuts mean there are 5,000 fewer employees processing returns and assisting taxpayers.

“I think we need to figure out a way to do better in the future, but there is no easy answer now on the horizon,” Becerra said.

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This post has been updated since it was first published.