With the extended federal filing deadline past, most Americans have filed their 2020 returns. But for many, the process of resolving their tax situation isn’t over yet.
Among the many tax complications filers face in the wake of the first year of the pandemic is fallout from an explosion of unemployment fraud, much of it related to identity theft. Payouts of unemployment insurance to thieves using stolen identities have been reported to the IRS by state unemployment insurance agencies, and victims have not only had to take steps to secure their identities but have had to try to establish that they never received the fraudulently claimed benefits and thus owe no taxes for them.
The federal government and state agencies have undertaken new efforts to counter ongoing unemployment fraud schemes and have issued guidance to help victims of 2020 tax year fraud correct the record. But given the scale of the fraud — estimated to be in the tens of billions of dollars — the number of victims, and the potential delays and confusion faced by taxpayers, experts say government entities may need to take more steps help fraud victims and commit to long-term strategies to prevent what transpired in 2020 from happening again.
An Unprecedented Surge
As the COVID-19 pandemic forced the closure of businesses, in March 2020 Congress and the Trump administration authorized, via the Coronavirus Aid, Relief, and Economic Security Act (P.L. 116-36), substantial additional unemployment benefits for unemployed workers and benefits for people who normally wouldn’t qualify for such relief, such as independent contractors. But by spring of that year, it was already clear that unemployment fraud — a perennial scam — had ballooned in light of the jump in unemployed persons and the sheer volume of benefits available.
The Office of the Inspector General with the Department of Labor reported at the end of March that if 10 percent of extended unemployment benefit funds were paid out improperly, the amount would equal around $89 billion, “with a significant portion attributable to fraud." According to the inspector general's office, initial investigations "indicate [unemployment insurance] program improper payments, including fraudulent payments, will be higher than 10 percent."
The explosion of unemployment theft was the result of several factors. Andrew Stettner, a senior fellow at the Century Foundation and a social insurance policy expert, told Tax Notes in April that extensive theft of people’s identities in recent years, such as the hacking of major credit bureaus, laid the groundwork for massive fraud. The rush to provide a large amount of expanded benefits to citizens who were suddenly laid off “was absolutely a perfect storm” to trigger it, Stettner said.
Observers also noted that unemployment insurance agencies were under pressure to provide payments to people quickly and had an unprecedented amount of claims to deal with, and they argued that many unemployment insurance agencies lacked adequate processes for vetting claims.
Most states had no system in place for administering pandemic-related unemployment assistance programs authorized by Congress, and the federal government “opted for looser requirements in favor of rapidly distributing funds,” according to a March 2021 letter by Ohio Gov. Mike DeWine (R) and Lt. Gov. Jon Husted (R). The letter, addressed to President Biden, called for “a national, coordinated response” to the fraud.
“Unfortunately, the bad guys seem to be a lot more creative than the good guys,” said California state Assembly Member Cottie Petrie-Norris (D), who is backing legislation to reform California’s Employment Development Department (EDD), which has come under intense criticism in the state for the billions of dollars’ worth of fraudulent claims it approved.
As evidence of fraud grew, new efforts to counter it emerged. Federal and state agencies coordinated their responses, and law enforcement stepped up efforts to arrest and prosecute thieves. The federal Consolidated Appropriations Act included provisions requiring additional screening at the state level to weed out fraudulent applications, along with funding for state unemployment insurance agencies. Many states have turned to third-party service providers to help combat fraud — including a major one called ID.me. However, ID.me also has been accused of excessively delaying legitimate payouts of benefits to people in need.
The anti-fraud measures are an improvement, Stettner said, but he added that states “have to make sure they don’t go overboard."
Taxpayers Fight Back
While governments continue working to counter fraud, many victims have been working to ensure that they won’t be on the hook for taxes owed on fraudulently paid benefits.
Some taxpayers found out they were victims of fraud when they received a Form 1099-G — used to report unemployment compensation and other government payments — from a state unemployment insurance agency for benefits paid out to fraudsters in their name. Others found out when they received a notice from an employer of claims made in their name or received debit cards loaded with unemployment payments, or even when their legitimate unemployment claims were denied in light of payments made to fraudsters using their stolen identity.
The IRS receives copies of Form 1099-Gs reporting unemployment income paid out in the name of identity theft victims. State and federal agencies advise victims to seek a corrected Form 1099-G from the agency that issued the form to show the IRS that they actually never received the fraudulent payout and therefore don't owe taxes on it. That process is even more complicated for victims who had benefits claimed in their names in multiple states.
Some victims — for example, those for whom a Form 1099-G was sent to an old or incorrect address — may be unaware that they need to seek a corrected form.
Some taxpayers “may not receive a Form 1099-G, but later learn from the IRS or another party that their identity was used to file for [unemployment insurance] benefits unbeknownst to them,” according to a February notice by the Justice Department’s National Unemployment Insurance Fraud Task Force.
Sources noted that a provision in the American Rescue Plan Act (P.L. 117-21) that excludes the first $10,200 in unemployment benefits from taxation for those taxpayers earning less than $150,000 should negate the federal tax issue for some victims of identity-theft-related unemployment fraud, provided the fraudulent payout was less than that amount.
Government entities’ efforts to help victims leading up to the filing date largely involved outreach and messaging.
The California EDD released guidance saying that “anyone who receives a 1099-G from the EDD that is not accurate because of suspected identity theft should report this as fraud." The department pledged to “investigate and issue a corrected 1099-G as appropriate.” Other state unemployment insurance agencies, the IRS, and the Department of Labor have given similar advice.
The IRS’s guidance urged taxpayers to file their returns before receiving a corrected Form 1099-G if they didn't get one in time — anticipating that state workforce agencies wouldn’t have issued corrected forms for many victims by the federal filing deadline — and to report only their actual income, without adding in the fraudulently claimed benefits. While the May 17 extension likely helped ensure more corrected forms were ready by the time tax returns were due, there are still taxpayers waiting for their forms.
“Time estimates for how long this process takes vary by state,” according to the Department of Labor's unemployment identity theft webpage. “The state may require additional documentation (like filing a police report or a sworn affidavit) in order to open an investigation; they will review your case and make a determination."
Mark Luscombe, the principal federal tax analyst for Wolters Kluwer Tax & Accounting, told Tax Notes in late March that many unemployment insurance agencies are “understaffed and overworked doing the valid unemployment assistance.” He said at the time that filers without a corrected Form 1099-G should note on their federal returns if they had filed for one in order to alert the IRS.
Nina Olson, executive director of the Center for Taxpayer Rights, told Tax Notes that even when a corrected Form 1099-G is issued by an agency, “the IRS probably won’t process the amended one right away.” She said that if an agency doesn't issue a taxpayer's corrected form in time for the IRS to process it before performing document-matching to vet the taxpayer's return, the taxpayer could face further headaches because it could appear that they failed to report unemployment income.
Victims who didn't request corrected forms, such as those whose Form 1099-G was sent to the wrong address and thus haven't realized that they’re victims of identity-theft-related unemployment fraud, also are at risk of complications as returns are reviewed.
Jessica Jeane of the National Society of Accountants said in an email in April that “there will likely be lingering issues involving 2020 unemployment insurance benefits well past tax day, both in cases of fraud as well as those taxpayers who submitted their returns before the American Rescue Plan Act was enacted.”
For many taxpayers, having to set the record straight with the IRS is a source of anxiety and a burden. For some, failing to resolve the issue quickly could present financial challenges: For example, Olson said taxpayers might find that fraudulent unemployment benefit payments pushed their income too high to qualify for certain federal assistance.
In addition to the federal government, many states also tax unemployment benefits, another issue for victims.
Separately, the issue of unemployment fraud also has implications for businesses, whose unemployment insurance rates could increase if fraudsters claiming to be employees laid off by the company file for benefits and businesses don’t take steps to show government agencies that the claims are bogus.
“This is a big hassle for small businesses; they get these fake claims, and they have to file paperwork,” said Casey Mulligan, a former chief economist for the Council of Economic Advisers under the Trump administration who is with the University of Chicago. Larger employers can better handle the process for reporting such claims, but smaller employers — particularly in light of the other hurdles posed by the pandemic’s impact on businesses — may find it arduous to confirm that they never laid off, or never even employed, a claimant, he warned.
“You can fight back or pay the higher rate going forward,” Mulligan said.
Additional Efforts Urged
In light of the circumstances, some observers have argued that additional measures by the federal government may be necessary. Thirty-nine Republican members of Congress warned the IRS and the Department of Labor in a February 6 letter that even with guidance telling filers to exclude fraudulent payments from their returns, some victims that didn’t receive corrected Forms 1099-G by the filing deadline “will be wary of self-correcting this error for fear of adverse IRS action.”
The lawmakers also noted that “there will be cases that fall through the cracks,” such as when “a fraudster filed an unemployment claim using a stolen identity but using a different address,” leaving the victim unaware. Among other recommendations, they urged the IRS to “implement a ‘hold harmless’ process for those taxpayers whose 1099-Gs are flagged as unreported income if those taxpayers believe they are victims of identity theft or fraud, such that no penalties or interest will accrue against them.”
The office of Rep. Brad Wenstrup of Ohio, one of the lead authors of the letter, told Tax Notes that the IRS hadn’t indicated whether it would implement such a process. A reply letter from the Treasury Department and another from the Department of Labor highlighted guidance provided to victims and ongoing efforts to combat fraud. When asked about steps the agency was taking, a spokesperson with the IRS simply referred Tax Notes to the IRS’s main webpage providing guidance for unemployment fraud victims.
As of May 19, Republican lawmakers on the House Ways and Means Committee had introduced unemployment fraud response legislation, including a requirement for the IRS to establish a hold-harmless process for victims of identity-theft-related unemployment insurance fraud.
Stettner said federal agencies should be communicating with state unemployment insurance agencies about the issue. “They should ask the states, ‘How many people have requested [corrected forms]? What is your process for getting back to them? And when are you going to do it?'”
Stettner also said that the IRS, when reviewing returns, might take into account documents filed by taxpayers with their returns showing they had put in for corrected Forms 1099-G. He said he hopes the agency will tap the brakes on using Form 1099-G mismatches to automatically trigger letters given the circumstances and expressed confidence that the federal government is taking steps to accommodate the high number of fraud victims.
The IRS is "very aware" of the issue, Stettner said.
Olson, who was formerly the head of the Taxpayer Advocate Service, suggested the IRS could provide taxpayers with an opportunity to report that they were victims of identity-theft-related unemployment fraud, noting that such a reporting mechanism already exists for other tax fraud.
Allowing taxpayers to call in to “the identity theft unit and getting a flag on your account for [the automated underreporter unit] would help,” according to Olson.
Olson acknowledged that the IRS “may be swamped” with its own duties but argued that it has the experience and procedures in place to deal with identity theft that many unemployment insurance agencies do not. She also noted that the agency received increased funding for the current year. She said some taxpayers who have been victimized will reach out to the IRS anyway and that it could communicate with the relevant state unemployment insurance agency when a taxpayer reports being the target of unemployment fraud.
States may also need to take additional action to accelerate approval of corrected forms and detect fraudulent payouts that need to be addressed. Petrie-Norris told Tax Notes in April that California needs “a specific, coordinated response, and EDD needs a dedicated team who can help Californians navigate this nightmare and resolve this issue.”
The fraud reported so far may be “the tip of the iceberg, and EDD needs to do more now to get out in front of it,” Petrie-Norris said.
On the business side, Sarah Paul, a partner at Eversheds Sutherland (US) LLP, told Tax Notes she is concerned that the government hasn’t provided enough direction to employers regarding how they should proceed when they detect false claims.
“I would like to see a little bit more concrete guidance in terms of what employers should do” when they receive notices of employees filing for unemployment that are fraudulent, Paul said.
While taxpayers and agencies continue to deal with the fallout from 2020, there is still work being done to curb ongoing fraud and limit the potential for future fraud.
One area of focus is bolstering the ability of state unemployment insurance agencies to screen bogus applications. An October 2020 audit by the Department of Labor's Office of the Inspector General indicated that many states “still face resource and system challenges” hindering their fraud detection abilities. The recent efforts by states to strengthen their unemployment system vetting processes, particularly with the use of third-party service providers and the help of federal funds, appear to have cut back on fraud, but have also been criticized for slowing the ability of legitimate unemployment filers to get benefits.
Mulligan said that longer wait times were potentially the price of preventing fraud. He argued that further investments in improving administration of benefits would help curb fraud, arguing that private insurance companies are better at catching fraud because “they spend some resources on stopping thieves.”
Tax agencies have spent years developing more effective anti-fraud capabilities, according to Verenda Smith, deputy director of the Federation of Tax Administrators. She told Tax Notes that fraud attempts continue to get more and more sophisticated, and that the model used by tax agencies to counter fraud is resource intensive.
Countering fraud “is something that’s ongoing 12 months out of the year,” involving teams of specialists working full time and coordination with the IRS, accountants, software developers, financial companies, and others, Smith said.
Federal and state coordination may need to be expanded on an ongoing basis. In his letter to Biden, DeWine argued that a "state-by-state response is proving inadequate" for the current wave of fraud.
Some state unemployment insurance agencies may also need reform. California was one of the hardest-hit states, with potentially as much as $31 billion paid out in fraud, and Petrie-Norris said the state’s EDD — which has come under criticism for allowing significant fraud and simultaneously forcing many legitimate claimants to wait excessive amounts of time — failed early on to implement provisions to combat fraud that were explicitly recommended by the federal government, including cross-checking claims against prison records, resulting in large amounts of benefits being paid out to or in the names of incarcerated people.
Petrie-Norris said she’s introduced legislation that would “establish the EDD oversight advisory board” in order to “make sure we continue to make progress” addressing problems with the EDD — many cited for years in audits — “even when the EDD is out of the spotlight.”
Efforts to ramp up prosecutions of fraudsters, which have already produced a cascade of arrests around the country, will also help curb fraud over the long term, sources said.
“In my prior life as a prosecutor, I worked a lot with IRS criminal investigations,” Paul said. “A lot of prosecutions have come out [of] that [as] a result of the IRS putting a lot of effort into it.” She argued that similar prosecution of unemployment benefit thieves would act as a deterrent for that fraud as well.
While many press reports have noted the arrests of small groups of fraudsters, sources said other fraud, and much of the identity theft, has been carried out by sophisticated criminal enterprises — some that are in foreign countries — that need to be targeted. The Justice Department is pursuing those bad actors.
Some commentators noted that efforts to fight fraudulent tax returns have been aided by the development of the IRS’s personal identification number program, which helps taxpayers confirm their identity if their Social Security number has been stolen. Stettner said that other types of fraud, including unemployment fraud, might be curbed by the adoption of a stronger, centralized identity protection program administered by the federal government.
For example, login.gov, a system maintained by the General Services Administration, allows people to verify their identities and then use their account across multiple agencies. Stettner said that could be a tool that could be more broadly used by state unemployment insurance agencies in the future.
The GSA announced in February that it would “provide authentication and identity proofing services to a limited number of federally funded state and local government programs.”