Fraudsters are relentless but tax agencies are tenacious in their pursuit of illicit acts.

In recent years, synthetic identity fraud has emerged as a significant threat to businesses and tax agencies. Unlike traditional identity theft, where criminals steal real personal information, synthetic identity fraud involves creating entirely new identities by combining real and fake information. This type of fraud is particularly concerning when it targets tax agencies.

Synthetic identities combine real and fake information, creating identities that don’t match real people. Business entity fraud is similar, involving fictitious businesses and has deeper, more far-reaching implications than personal identity theft.

Tax agencies are traditionally well-equipped to handle personal identity fraud, but business entity fraud presents new challenges. It’s crucial to verify the individuals behind these entities.

Each new business is a completely new entity, making it harder to detect fraud. Although the prevalence of fake business entities may not be as high, the impact is profound.

How synthetic identity fraud targets tax agencies

Scammers use fake identities to get tax registration numbers. They are cunning in the process – submitting numerous made-up identities to see which ones can slip through the system. It’s a brute force attack.

Once a tax ID issued, the business has a veneer of legitimacy. It can then be used for various fraudulent activities like opening bank accounts to launder money or employment fraud. People looking for jobs may provide their personal information to what appears to be a legitimate business, only to have it misused.

While synthetic identity fraud remains the most common form of personal identity theft, business entity fraud is on the rise. For tax agencies, it’s false tax returns. By creating shell companies that appear legitimate but do not conduct any real business, crooks can submit tax returns and claim refunds. This type of fraud can go undetected for years, causing significant financial to tax agencies.

The unsuspecting impact of synthetic entities

Citizens are at risk. Scammers can set up fake businesses, complete with websites and licenses, to trick people into making deposits. With the rise in synthetic identity fraud, consumers need to be more cautious. Fake businesses can also deceive people in property rentals and job offers.

People looking for jobs are particularly vulnerable. Desperate for work, they might send application fees and personal information, including Social Security numbers and employment histories, to what appear to be legitimate businesses. They use this information for their own gain, often selling it on the dark web.

This spans every industry, from sales tax collection and online sales to employment and vehicle fraud. Fraudsters may ask for deposits to hold items or offer services like tax preparation, legal assistance, or notary services, all under the guise of legitimacy.

The cost of fraud

Preventing fraud is far more cost-effective than trying to recover funds from fraudulent entities. Fraud is typically a short-term game for fraudsters, who create and use entities until they are detected and then move on. This makes it nearly impossible to recover funds from non-existent entities. Such losses mean that taxpayers end up footing the bill through increases in taxes to fund essential services like fire departments, schools, and infrastructure.

There’s good news. Many agencies implemented various measures to protect taxpayers and prevent fraudulent activities.

Recently, a state department of revenue identified and stopped over $500 million in identity theft and related refund fraud schemes.

In 2023, IRS Criminal Investigation initiated more than 2,676 criminal investigations, identified over $37.1 billion from tax and financial crimes, and obtained an 88.4% conviction rate on cases accepted for prosecution.

Fighting fraud with data and AI

Government agencies must stay one step ahead of fraudsters and the generative AI methods they are using to cheat the system.

Tax agencies can use traditional AI fraud detection models to detect anomalies. These models can analyze data points to identify fraudulent synthetic identities and business applications.

But generative AI (GenAI) introduces a twist by enabling mass production of identities. Unlike manually created fake entities, AI-generated identities can be produced and tested repeatedly. The bad actors can train models to pull registration information from various websites and generate the necessary data to fill out forms.

To catch a cheat, tax agencies must beat them at their game. In this case, it means using traditional AI to detect GenAI-created applications. However, AI can combat false information by analyzing patterns, language and context to aid content moderation.

AI can:

• Compare new content against known data sources and flag inconsistencies or potential fabrications.
• Analyze unusual phrasing, context mismatches, and other linguistic cues that might indicate the content was generated by AI.
• Provide real-time monitoring for quickly identifying and responding to false information.

A tax agency’s fraud detection framework is not robust enough, these synthetic identities can easily slip through.

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