The Law That Could Delay Your Tax Refund

The IRS has opened the doors to begin receiving 2016 tax returns, but some early filers may find they are left waiting weeks before their refund arrives. That's thanks to a new law intended to reduce cases of tax fraud.

Refundable tax credits are prime targets for fraud. The Protecting Americans from Tax Hikes Act of 2015, more commonly called the PATH Act, made a number of changes to the tax law. The provision that will affect some taxpayers most immediately and directly is how the IRS handles early tax returns claiming the earned income tax credit or the additional child tax credit. The earliest any refund will be issued for these returns is Feb. 15.

Nate Smith, director at financial firm CBIZ MHM, says these credits can result in taxpayers receiving thousands of dollars back from the government, making them a prime target for scammers. "Anytime you involve a credit that's refundable, there's heightened interest for [fraud]," he says.

That fraud comes at a sizable cost for the government. IRS officials told Congress last April that they had identified more than 42,000 fraudulent returns in the first two months of the 2016 filing season. "It wasn't one or two people, but it was large, organized fraud," says Jim Daniels, managing director with UHY Advisors in Albany, New York. Those returns were trying to claim $227 million in refunds.

Added tax prep questions, more time for review. The PATH Act is working to address fraud in several ways. Paid tax preparers are already required to perform certain due diligence when filing a return claiming the earned income tax credit. Now, they will also have to take added steps to verify information on returns that are claiming child tax credits or the American opportunity tax credit. Then, by holding early returns claiming the earned income tax credit or additional child tax credit, the IRS will have extra time to weed out fraudulent refunds.

"Previously, they would issue that refund and try to catch up with [any fraud] later," says Byran Bibbo, a financial advisor with The JL Smith Group in Avon, Ohio. Sometimes the problem wouldn't be caught until a taxpayer whose identity had been stolen for a fake return tried filing their own paperwork. Those situations not only resulted in lost money for the government, but delays for the identity theft victim in having their refund processed as well.

Now, the government is hoping that by delaying payments a few weeks they can better check for inconsistencies. "Generally, it goes though a computerized review where certain numbers are compared to other numbers," Smith says. "If the situation is outside a normal expectation, then it will be flagged." For example, if a taxpayer's income has dropped dramatically after being consistent for years or doesn't match W-2 data submitted by an employer, there may be reasons to take a second look at the return.

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Watch out for high-fee loans. While the IRS expects to start issuing refunds for the earned income tax credit and additional child tax credit returns on Feb. 15, tax preparers say it could be a few weeks after that before money starts landing in people's bank accounts.

That could be a problem for some, Bibbo says. "A lot of the people who do get the earned income tax credit file early to get that big refund," he says. They may be counting on that money to pay bills or cover other expenses.

Taxpayers may be tempted to take out a tax refund advance loan to cover them until the government processes their return. "The effect of that is if you can't get money out of one pocket, you're going to get it out of another pocket," Daniels says. Some tax preparers are even offering interest-free loans specifically to help those expecting a delay in their earned income tax credit refund. The problem, Daniels says, is that even though these loans may be interest-free, they could have high fees attached to them. Rather than get a loan, people may be better served by reducing expenses or negotiating with billers to delay a payment.

The best advice Bibbo has is to be patient and remember that although the law may have some temporary inconveniences, it will benefit everyone in the long run. "It's a good thing for taxpayers all around."