As Tax Day Approaches, Identity Theft a Growing Threat

Tax season opens the door for fraudsters.

Tax preparation
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The recently released flick Identity Thief, starring Jason Bateman and Melissa McCarthy, may be a slapstick comedy, but for millions of Americans, identity theft isn't something to laugh about. The crime is increasingly wreaking havoc not just on their credit scores, but their tax returns as well, delaying refunds and creating other headaches.

The IRS reports that the number of its criminal investigations into identify theft has nearly tripled, from 276 in fiscal year 2011 to 898 in fiscal year 2012. Some identity thieves file hundreds or even thousands of returns using tax software.

Jim Kealing knows these frustrations firsthand. The Valencia, Calif.-based certified public accountant says his clients haven't encountered tax-related identity theft over his 30-year career. However, the same can't be said of Kealing and his wife. Someone in Miami filed the couple's 2010 tax return using Kealing's Social Security number, and the IRS flagged their joint return as a duplicate. Kealing didn't discover the problem for more than a year, and it took about nine months to clear up the issue. Fortunately, he wasn't expecting a refund, which could have been delayed for months.

[See Avoid These 10 Common Tax Mistakes.]

Neal O'Farrell, executive director of the California-based Identity Theft Council, says identity thieves steal Social Security numbers in a variety of ways: breaking into mailboxes, homes, or cars, buying customer records from disgruntled employees, or having their significant other get a job at a law firm or doctor's office, where records may be easily accessible. "Our biggest worry is the case that we saw called Operation Rainmaker, where street-level drug dealers left the corners and took classes on how to file [tax returns] using TurboTax," O'Farrell says. Ultimately, law enforcement arrested 49 people involved in the operation and recovered $5 million in fraudulent refunds, cash, and other assets in Tampa.

Fraudulent filers are also becoming more sophisticated in their efforts to avoid detection. "They're putting more effort into the filing and making it look more genuine," says O'Farrell. For example, he says, "They'll do more research on the victim and make sure they have the right number of dependents."

In addition to filing phony returns, some fraudsters use stolen Social Security numbers to evade taxes. "Information is sold on a black market to individuals who might have difficulty gaining lawful employment in the U.S.," says Joe Reynolds, identity-fraud product manager for Hartford, Conn.-based insurer Travelers. "They'll fill out the employment application and put your Social Security number down. They'll work and choose not to have taxes deducted from their income. Then the IRS says, 'but we see that you earned income from XYZ job,' so they've deferred that tax liability back to you."

How to tell if it's happened to you. Reynolds says most consumers find out there's an issue through a letter from the IRS or a denial of Social Security benefits. "If you get an email from the IRS, you should immediately be on the alert," he says, adding that you may be a target of a phishing scam if such a message arrives in your inbox. "The IRS never communicates with taxpayers about specific tax returns via email."

Also keep an eye on your mailbox to make sure you're getting forms like 1099s and W4s as expected. "A lot of employers will provide that information electronically," Reynolds says, adding that it's a smart idea to file early if you can and use certified mail to confirm your tax return's arrival (unless you're e-filing.)

[Read: The 8 Most-Missed Tax Deductions and Credits.]

In some cases, fraud rings set up tax-preparation services as a front, so be vigilant in choosing an accountant or tax preparer. "Make sure they have a good reputation with the Better Business Bureau," says Reynolds. "When you find the right accountant, ask them lots of questions about how they're protecting your personal information. They should have a personal privacy policy that extends to their employees."