While thieves continue to steal identities and file for fraudulent refunds, the IRS reported modest success in the ongoing battle over refund fraud.

Stolen identity refund fraud thieves are both creative and successful. Most initially were “lone wolves” who would steal the identity of a single person and electronically file an early tax return to claim a refund. The thieves have steadily increased in sophistication. Some now have implemented “robocalls” and created small call centers.

In 2013, the Treasury Inspector General for Tax Administration (TIGTA) estimated a cost to the government of $26 billion over five years for tax refund fraud. As the IRS steadily moves the nation to a system involving eFiling, there are continued opportunities for new, creative types of refund fraud. In response to this challenge, the IRS has implemented multiple strategies to battle the thieves.

1. Staffing – There now are over 3,000 IRS employees who are involved in the fight against refund fraud.
2. Security Summit – The IRS conducts an annual meeting and brings together its staff, state tax authorities and private tax software employees. The conference discusses the latest methods for fighting fraud.
3. Impersonation Calls – The IRS has received 1.5 million reports of tax scammers who impersonate IRS agents. When the IRS receives a report, it calls the number and informs the tax scammers that they are subject to federal prosecution. The IRS urges the tax scammers to stop their unlawful efforts.
4. Phone Disconnect – The IRS then will call the phone company providing service to that number and arrange for the phone line to be disconnected.
5. Phone Flooding – With a strategy similar to the hacker “denial of service” method, IRS computers will flood the phone line with calls and make it difficult for the scammer to use the line to call potential victims.
6. Software Filters – The IRS now has over 200 different software modules on their computers that seek out and identify stolen identity refund fraudsters.
7. Phone Authentication – The PIN number and “Get Transcript” system now have additional authentication. The IRS computer may send a code to the cell phone of the individual that is used for a higher level of security.

Editor’s Note: This battle against refund fraud will continue. The Justice Department is also pursuing and regularly convicting identity thieves. As the thieves move offshore, it will be important for the other types of protection by the IRS to be enhanced.

Fraudster Attack on CPAs and Tax Preparers

The world of identity theft continues to evolve. In IR-2016-103 (10 Aug 2016) the IRS explained a new attack on tax preparers. Fraudsters send tax preparers an email claiming to be from their tax software company. The tax preparer is urged to click on a link in order update his or her tax preparation software.

When the tax preparer clicks on the link, an executable file then installs software on the computer that will send keystroke information to the thief. With this keystroke information, the identity thief will be able to steal passwords, login information and even some client information.

The IRS has launched a campaign with the title “Protect Your Clients: Protect Yourself.” There are several warnings and strategies as part of that campaign.

1. Phishing Scams – Be careful and do not click on links. Many tax software companies have automated their updates. If the update is not automated, go to the website of the tax preparation company and click on the link to update your software.
2. Anti-Virus Software – Most anti-virus software will automatically update each day to provide additional protection against new strains of each virus. You also should periodically run a “deep scan” to clear your computer of any potential virus code.
3. Staff Education – Many small and mid-sized offices have a network that serves multiple staff. A new staff member may infect the network by inadvertently clicking on a link. Train all new staff members to follow these security practices.
4. Remote Access – Many employers now allow some employees to “telecommute.” If this is an option, there must be secure and encrypted access to the company network. A qualified technology person should create a virtual private network (VPN) or other method for secure access.
5. Secure Routers – Many network routers now include sophisticated security software. This router with security software will block or filter viruses at the entry point to your network.

The IRS urges all tax professionals to view Publication 4557, “Safeguarding Taxpayer Data, A Guide for Your Business.”

Annuity Remainder Trust May Avoid 5% Probability Test

In Rev. Proc. 2016-42; 2016-34 IRB 1 (8 Aug 2016), the Service published optional language that permits a charitable remainder annuity trust to disregard the 5% probability test under Rev. Rul. 77-374 and Rev. Rul. 70-452.

Under Rev. Rul. 77-374, a remainder annuity trust may not have a greater than 5% probability that the trust corpus will be exhausted prior to the death of the last surviving annuity recipient. However, if a qualified Sec. 664(d)(1) trust with annuity payments for one or more lives includes a Sec. 664(f) termination provision with the “precise language” of Rev. Proc. 2016-42, the 5% probability test will not apply.

The provision is as follows:

“The first day of the annuity period shall be the date the property is transferred to the trust and the last day of the annuity period shall be the date of the Recipient’s death or, if earlier, the date of the contingent termination. The date of the contingent termination is the date immediately preceding the payment date of any annuity payment if, after making that payment, the value of the trust corpus, when multiplied by the specified discount factor, would be less than 10 percent of the value of the initial trust corpus. The specified discount factor is equal to [1 / (1 + i)]^t, where t is the time from inception of the trust to the date of the annuity payment, expressed in years and fractions of a year, and i is the interest rate determined by the Internal Revenue Service for purposes of section 7520 of the Internal Revenue Code of 1986, as amended (section 7250 rate), that was used to determine the value of the charitable remainder at the inception of the trust. The section 7520 rate used to determine the value of the charitable remainder at the inception of the trust is the section 7520 rate in effect for [insert the month and year], which is [insert the applicable section 7520 rate].”

Editor’s Note: The provision will terminate the remainder annuity trust if the corpus falls to 10% of the initial value (with the discounting formula). If the inter vivos annuity trust passes the 5% probability test, many counsel will not include this provision in the trust document. It should be included in inter vivos remainder annuity trusts that fail the 5% probability test and in testamentary remainder annuity trusts because the Applicable Federal Rate for the date of death is unknown.

Applicable Federal Rate of 1.4% for August—Rev. Rul. 2016-18; 2016-31 IRB 1 (17 July 2016)

The IRS has announced the Applicable Federal Rate (AFR) for August of 2016. The AFR under Section 7520 for the month of August will be 1.4%. The rates for July of 1.8% or June of 1.8% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2016, pooled income funds in existence less than three tax years must use a 1.2% deemed rate of return. Federal rates are available by clicking here.