We’ve been partnering with the IRS and state revenue agencies on fraud detection for more than a decade, but over the past few years, we’ve observed a significant shift in the volume and complexity of fraudulent activity. Fraudsters are getting smarter, leveraging new technologies and elaborate techniques to exploit vulnerabilities.

Let’s dive into what we’re seeing and discuss why tax agencies must adapt their strategies to combat these emerging threats effectively:

Data-Driven Fraud and Identity Theft

Historically, most fraudsters relied on a “spray and pray” approach, casting a wide net and hoping for success. Today, we’re seeing more sophisticated schemes informed by intelligence fraudsters have collected. Specifically, there’s been a surge in multi-directional attacks that include fabricated data submitted to other government agencies, which is then used to substantiate information found on a subsequent fraudulent return.  This tactic exposes vulnerabilities in traditional third-party verification processes.

For example, rather than attach a simple fabricated W2 as part of their fraudulent tax return submission, a fraudster will also generate and submit the same W2 through official channels in adjacent agencies that once represented the “truth” from a revenue agency’s perspective (e.g., Departments of Labor, Social Security Administration).

Taxpayer-Assisted or Enabled Schemes

Schemes in which the taxpayer is a participant in fraud – either as a willing accomplice or an unwitting enabler – are also on the rise. According to the FTC,

Romance or relationship scams, for example, have surged in recent years. In 2023, the Federal Trade Commission (FTC) reported over 64,000 romance scam complaints, totaling $1.1 billion in losses – and that amount doesn’t include financial damage done to governments through the issuance of fraud-encouraged payments.

In these situations, scammers convince victims to turn over crucial digital identity credentials or to receive and transfer money under false pretenses, making victims unknowingly help launder money or participate in tax fraud.

The Contagion Effect

Social media has become a powerful tool for fraudsters to share best practices and spread successful schemes globally. When one fraud tactic proves effective, it quickly gains traction among scammers worldwide, leading to more widespread and brazen activity. Social media is rife with images – doctored and otherwise – of refund checks and successful direct deposits, which encourages users to seek out and share personal information with online promotors in hopes of joining in the profit.

Likewise, when a government agency adjusts a business process or enacts a strategy that hinders an ongoing scheme, the news quickly spreads on online forums or in preparer communities, allowing bad actors to more rapidly adjust their strategies.

Adapting to the Challenge

The rapid evolution of fraud tactics highlights the need for tax agencies to mature their fraud detection strategies. Agencies must invest in data science, behavioral analytics, and artificial intelligence to stay ahead of bad actors. They must also keep the taxpayer experience in mind and carefully balance the level of friction caused by preventative measures.

Identifying which returns are fraudulent and initially stopping a payment is only half the battle, though. As agencies improve front-line detection, fraudsters are becoming more willing to “fight” for their refunds (especially those that are high value). Similarly, as the volume of fraudulent returns grows, so does the backlog of cases, forcing agencies to make hard decisions about how to allocate limited resources to work them.

This is why working with the right partner on fraud detection programs is so important. The technology itself won’t solve the problem. Agencies should collaborate with experts in systems integration, organizational change, and enterprise data management that can help them identify data silos or conflicting processes that make fraud prevention efforts less effective.

-Brian Bird, Sr. Vice President of Analytics and Ilya Gerner, Vice President, Fraud Analytics