The number of prisoners who file false tax returns with the Internal Revenue Service has more than doubled in the last five years, according to a new Treasury Department report, and the amount of money the IRS has mistakenly refunded to those prisoners has nearly tripled.  Meanwhile, the report, from the Department's Inspector General for Tax Administration, accuses the IRS of failing to enforce a law passed by Congress in 2008 to crack down on false returns coming from the nation's prisons.

According to the study, in 2009, prisoners filed 44,944 false tax returns, attempting to claim $295.1 million in refunds.  The report says IRS officials caught the fraud in many cases and stopped $256 million of that from being refunded -- but the IRS did mistakenly pay $39.1 million in refunds to prisoners filing fraudulent returns.  The report also notes that there is some evidence that fraud is even more widespread than these figures suggest.

In any event, the numbers are up significantly from 2005, when 21,254 prisoners filed false returns, claiming a total of $80.4 million in refunds.  That year, the IRS says it stopped $67.5 million from being refunded, but that $12.8 million was refunded to prisoners filing false returns.

The report notes that money flowing into prisons is a source of constant concern for the authorities who run the institutions. "Prison officials indicated prisoners may use tax refunds to fund other illegal activity within the prison, such as drug trafficking," the report says.  "Prison officials believe that by reducing the flow of money into the prisons, they can also reduce other illegal activity."

To address the problem, Congress passed the Inmate Tax Fraud Prevention Act in 2008.  The bill authorized the IRS to share tax return data with the Federal Bureau of Prisons and also state prison officials.  Tax return information is highly confidential, and the IRS cannot give it out without specific approval.  "Any time the IRS wants to share information, even with another federal agency, Congress has to give them the authority to do that," says one Hill aide.  "That's what we did in 2008."

The next step was for the IRS to reach agreements with the Bureau of Prisons and with state prisons authorities on how the information would be used.  That's where the process has ground to a halt. "As of October 2010, the IRS had not completed the necessary agreements to share prisoner information," the Treasury report concludes.  "As a result, no information has been disclosed to either the Federal Bureau of Prisons or State Departments of Corrections."

The hangup, according to the report, is the IRS's concern over whether Bureau of Prisons officials can share tax information with legal counsel in the event a prisoner should file a lawsuit against the Bureau.  "The Inmate Tax Fraud Prevention Act does not address whether tax return information can be disclosed to legal counsel and/or the prisoner," the report notes. The report says the IRS has asked for and received an opinion on the question from the Justice Department, but does not reveal what the opinion is.  In any event, no action has been taken.

Given those problems, and given the fact that the Inmate Tax Fraud Prevention Act is set to expire at the end of 2011, it is possible there will never be any sharing of information between the IRS and prison officials.  Prisoner tax fraud will continue to grow, as will the refunds -- paid with taxpayer dollars, of course -- that are mistakenly sent to prisoners.

"This signals that prisoner tax fraud is a low priority for the federal government," says Republican Sen. Charles Grassley, ranking member of the Senate Finance Committee.  "The agencies need to take action and correction that impression.  While they wait, taxpayers are picking up a growing tab for prisoner tax fraud."