In its annual release in 2016, the Federal Trade Commission noted that reports of identity theft increased more than 47% from 2014 to 2015 (https://www.ftc.gov/news-events/press-releases/2016/03/ftcreleases-annual-summary-consumer-complaints) and tax-related identity theft is a big part of this fraud. Identity theft has been the top category for frauds reported to the FTC for the past 15 years.
Identity theft can take many forms. Thieves can obtain personal information (e.g., birth dates, Social Security numbers, bank and other financial accounts) to access financial accounts or use the personal information to establish accounts that are then used to make purchases or obtain loans for which the taxpayer may be on the hook. Almost half of all personal information is obtained from lost or stolen mobile devices: laptops, tablets and smartphones.
From a tax perspective, if a taxpayer is victimized and the action amounts to a theft under state law, any unreimbursed losses are deductible as a theft loss (Code Sec. 165(c)). Key points about a theft loss deduction:
• The taxpayer must itemize deductions.
• The first $100 is not deductible.
• Only losses in excess of 10% of adjusted gross income can be deducted.
Obtaining protection. Some homeowners’ policies provide coverage for identity theft; others do not but often coverage can be added for a modest cost. Individuals can obtain separate identity protection insurance. Alternatively there is protection through a credit monitoring service to help detect identity theft before significant financial losses occur. Some credit monitoring services also provide credit repair services to help an individual get back to pre-identity theft condition, and obtain reimbursement for lost wages when taking time off to combat a theft. Each policy or service may set limits on coverage, require deductibles, or have other conditions. At present, premiums for identity theft insurance and the cost of identity theft protection services, such as LifeLock and Identity Guard, are not deductible; these costs are viewed as a nondeductible personal expense.
Tax-Related Identity Theft
Tax-related identity theft occurs when a thief uses a taxpayer’s identity to obtain a bogus tax refund. The taxpayer may be unable to e-file his/her legitimate tax return for the year because one has already been filed under the taxpayer’s Social Security number. Even worse, a thief may use a taxpayer’s personal information to get a job and the thief’s employer reports the income but the taxpayer, unaware of the income, omits it from his/her return and then receives a bill from the IRS for unpaid taxes.
The IRS has been working to combat tax-related identity theft and was able to detect and stop more than 3.8 million suspicious returns in the 2015 filing season (IRS, Global Identity Theft Report (May 31, 2015)). Nonetheless, identity theft continues to top the IRS’ Dirty Dozen Tax Scams (https://www.irs.gov/uac/newsroom/irs-wraps-up-the-dirtydozen-list-of-tax-scams-for-2016). These scams occur when criminals impersonating IRS agents try to collect bogus taxes on the threat of arrest, deportation, loss of licenses, and other actions as well as phishing where identity thieves try to steal personal information. In response to the phone scams, the IRS said in an internal memorandum on May 20, 2016, that it would not make any initial audit contact
with a taxpayer by phone, only snail mail
will be used for this purpose.
Report identity theft. If a taxpayer knows that his/her personal information has been compromised, the taxpayer can file Form 14039, Identity Theft Affidavit; this puts the IRS on the alert. The form is mailed to the IRS, along with a copy of the Social Security card, driver’s license, passport, military ID, or other government-issued form of identification.
Obtain an IP PIN. A taxpayer can obtain an Identity Protection Personal Identification Number (IP PIN), which is a six-digit number used in place of a Social Security number when filing a tax return. The IRS will issue an IP PIN under three scenarios:
• Taxpayers who the IRS has identified as ID victims. The IRS expects to send about 2.7 million IP PINs by mail later this year for use in the 2017 filing season.
• Taxpayers who file Form 14039.
• Taxpayers who live in Florida, Georgia, and the District of Columbia, which are areas that are part of a pilot program on combating ID theft.
An IP PIN can be obtained online by using “Secure Access Steps,” which is an online authentication process. Details about this process are in IRS Fact Sheet 2016-20 (https://www.irs.gov/uac/how-to-register-for-get-transcript-online-using-new-authentication-process).
Use IRS resources. The IRS recognizes the severity of the identity theft problem and has numerous resources to help taxpayers. These include:
• Fact Sheet 2016-3: IRS Identity Theft Victim Assistance: How it Works.
• IRS Identity Theft Protection Specialized Unit at 800-908-4490.
• Publication 4524, Security Awareness to Taxpayers.
• “Taxes. Security. Together.” This is a joint campaign by the IRS, state tax administrators, and the private-sector tax industry to encourage taxpayers to protect personal and financial data online and offline.
• Taxpayer Guide to Identity Theft at https://www.irs.gov/uac/taxpayer-guide-to-identity-theft, which contains information and links.
• YouTube video on tax-related identity theft (https://www.youtube.com/watch?v=1EvfqG-6L5w).
Identity Theft Services
If a company’s data is breached and it offers identity theft services to customers who may be impacted, the IRS has determined that the value of the services is tax free (Announcement 2015-22, IRB 2015-35, 288). Identity theft services include credit reporting and monitoring services, identity theft insurance policies, identity restoration services, or other similar services intended to prevent and mitigate losses due to identity theft resulting from the company’s data breach.
This tax-free treatment extends to an employer providing identity theft services to employees following a data breach of the employer. The value of this fringe benefit to employees is not treated as taxable compensation. It is not reported on Form W-2; it is not subject to employment taxes.
However, employers offering identity theft services to employees as a fringe benefit in the absence of a data breach, then the value of the benefit is taxable to employees and subject to employment taxes.
The National Taxpayer Advocate’s most recent report advised the IRS to help victims of identity theft more quickly resolve their account problems and obtain their refunds (https://taxpayeradvocate.irs.gov/Media/Default/Documents/2016-JRC/Area_of_Focus_1_IRS_should_provide_ID_theft_victims_with_a_single_point_of_contact-1.pdf).
A bill introduced in Congress in September, Data Breach Insurance Tax Credit Act (H.R. 6032)( https://www.congress.gov/bill/114th-congress/house-bill/6032), would allow those in a trade or business to claim a tax credit for 15% of the cost of data breach insurance. Whether or not this measure will pass remains to be seen.
The matter of identity is not going away; if anything it is growing. Tax breaks can be helpful in dealing with some of the financial costs of those who have been victimized.
Executive Editor Sidney Kess is CPA-attorney, speaker and author of hundreds of tax books. The AICPA established the Sidney Kess Award for Excellence in Continuing Education in his honor, best-known for lecturing to over 700,000 practitioners on tax. Kess is senior consultant for Citrin Cooperman and is consulting editor to CCH.