The Internal Revenue Service drastically improved identity-theft detection last year, but the agency still issued billions of dollars in fraudulent refunds because of the problem, according to a watchdog report released Thursday.

The office of the Treasury Inspector General for Tax Administration said it found 1.1 million undetected tax returns filed with stolen Social Security numbers.

(Andrew Harrer/Bloomberg)

Those errors cost the government about $3.6 billion for fiscal 2011, but the amount represents a 30 percent decline compared to the previous year, the report said.

“Undetected tax-refund fraud results in significant unintended federal outlays and erodes taxpayer confidence in the federal tax system,” TIGTA wrote in its analysis.

According to the report, the IRS also missed 141,000 tax returns filed with stolen individual taxpayer identification numbers (ITINs), which are issued to workers who don’t qualify for Social Security numbers. The government paid out $385 million for those returns, the report said.

TIGTA has not previously tracked the ITIN numbers, meaning there is no data for comparison with previous years.

The inspector general’s office recommended that the IRS deactivate numbers for individuals who no longer have a tax-filing requirement and continue to analyze the characteristics of fraudulent returns. The agency agreed with those suggestions, according to the report.

TIGTA released a second report on Thursday that cited long delays in closing identity-theft cases. The IRS spent an average of 312 days in resolving such matters, according to the analysis.

“Identity theft is a growing epidemic, and I continue to be troubled by the lengthy case-processing  delays and tax-account errors experienced by victims of tax-related identity theft,” said Treasury inspector general J. Russell George.

The problem is partly due to the agency requiring staffers to answer telephone inquiries during the filing season, in addition to a lack of understanding about relevant protocol, the report said. Nearly three-quarters of the 183 IRS employees surveyed said the procedures for dealing with stolen identities are confusing.

TIGTA said the IRS should ensure that workers assigned to handle ID-theft cases work exclusively on those matters, develop clear and consistent processes for them to follow and provide ongoing training.

The IRS agreed with the recommendations, according to the report.

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