Maybe the time and energy the IRS spent investigating tea party groups could have been better spent managing…the IRS?

In another embarrassment for the behemoth bureaucracy, reports have surfaced that in 2011 the IRS inadvertently sent tens of millions of dollars in tax refunds to “unauthorized” workers at a handful of addresses.

More than $86 million went to just ten addresses across the United States with over $46 million going to a single Atlanta address that filed 46,000 returns. The culprits were largely from Atlanta, Georgia and several cities in California.

What’s going on? The IRS created identification numbers (Individual Taxpayer Identification Numbers or ITINs) for those working in this country illegally and ineligible for a social security number.

(We might ask why the IRS is legitimizing illegal workers in the first place, but we’ll assume it’s so that they can pay the tax piper like every other worker come April 15th. Wouldn’t it be legally appropriate if the IRS then dropped the dime on illegal workers to the Immigration and Naturalization Service? )

Criminals and undocumented workers soon figured out they could exploit the system to obtain ITINs and submit bogus returns obtaining undeserved "refund" windfalls at the expense of law abiding tax payers like you and me.

These revelations are new to us but not to the IRS. Two IRS employees blew the whistle on this fraudulent activity prompting the Inspector General of the Treasury to launch an audit. The audit report published last year makes damning conclusions about how the IRS fell down on the job:

TIGTA substantiated many of the allegations set forth in the IRS employees’ complaints. The complaints alleged that IRS management is not concerned with addressing questionable applications and is interested only in the volume of applications that can be processed, regardless of whether they are fraudulent. The audit found that the ITIN application review and verification process is so deficient that there is no assurance that ITINs are not being assigned to individuals submitting questionable applications. Because of lax documentation requirements to obtain an ITIN, tax fraud can go undetected. Management also eliminated successful processes used to identify questionable ITIN application fraud patterns and schemes.

I laud the IRS’s goal to process tax returns claims expeditiously, but that should not be at the expense of accuracy.

The IRS seems to be getting itself together though–at least on this. At the beginning of this year the IRS apparently put new controls in place to curb misbehavior including requiring original documentation for applications and asking applicants to appear in person.  Last month the Treasury Department issued a new report finding significant improvements in how questionable ITIN applications are identified. The numbers on such activity reported in 2012 –though eye-opening- were actually down from those reported in 2011. With these new controls the incidences should be even lower next year.

Criminals and dishonest people will try to take advantage of any situation they can. Human nature drives man to pursue his own self-interest. However, the IRS was at fault for neglecting to establish processes that would detect and prevent such fraudulent activities when they first instituted ITINs or when problems became apparent.

I would go even a step further and ask why they are enabling illegal employment in the first place with these ITINs? I’m not sure these tax ID numbers can be justified, especially if the prevalence of abuse outweighs what is actually collected from illegal workers. It would be interesting to know out of all of the ITINs tax filings what percentage and value in dollars were flagged as fraudulent? If we learn that questionable filings represented even a third of all ITIN tax filings or a third of the returns, it may be time to reconsider ITINs.

And without diving into the immigration debate, an argument can be made that if illegal employment is a driver behind illegal immigration, the IRS’s legitimization of illegal workers via ITINs is counterproductive to any sort immigration enforcement and immigration reform efforts.

For an agency with such immense power and reach, it’s critical the policies and procedure of the IRS are scrutinized and weighed against other competing national interests. Kudos to the brave IRS workers who came forward to report activity that may have continued to fly under the radar.