Tax Identity Theft is a BIG DEAL! The federal government is paying out BILLIONS in fraudulent refunds and MILLIONS of people are affected. In this relatively long post, I'm going to tell you how the fraud usually works, how it affects you, what the Feds are doing about it, and State by State what the states are doing and how it affects you. Then I'm going to tell you what you can do about it.
The way this usually works is that identity thieves get your (and possibly your children's) names, Social Security Numbers and birthdays through some form of data breach. A lot of big retail companies, insurance companies, federal and state agencies, and even the IRS have had data breaches that have probably affected you, whether you know it or not. The identity thieves use this information to electronically file fake tax returns. They are not technically stealing YOUR refund, but they are basically inventing a refund out of thin air. They make up a W-2 and file a tax return in your name, having the refund deposited on a prepaid debit card like some stores offer. The IRS doesn't get W-2 data until later in the tax season, so they have no good way of knowing the W-2 was made up.
If this happens to you, when you e-file a tax return, it will reject because you (or your kid's) data has already been used on a tax return. This will now require you to mail your tax return in. You would usually file an identity theft affidavit with it (possibly requiring a police report), and include proof of your identity such as a copy of your driver's license or birth certificates. It can take a while for this to get sorted out and for you to get your refund (weeks or months) but you will eventually get it.
The easiest way for the IRS to combat this would be to delay refunds until they have the W-2 data and can safely issue refunds. They could also disallow prepaid debit cards, or send checks when there is potential identity theft involved. None of these options are politically palatable, so the IRS is relying on some techno stuff and working with the big tax prep companies to try to stop this. They also have some long term plans to add codes to W-2's (This is being tested this year, so some W-2's will have codes, but using or not using these will not impact your filing). None of this is likely to put a big dent in things.
The States face a lot less political pressure and are doing a lot of things to prevent ID fraud. Last year one state blocked Turbo Tax filed returns for a while until more security measures were put in place. I'm going to go state by state to tell you what they're doing. Since a lot of it's similar, I'm going to list the more common things below, with a letter code and advice on what to do, and then just use the codes for each state, with more details if necessary.
Before I get to the details, here's some general advice: Don't share your families Social Security numbers with anyone you don't have to. Keep this information safe and secure in your home. Don't use fly by night tax prep services. File early if possible. Use an address on your return that you will definitely be able to get mail at. Keep this address updated with the IRS and your State. Also, buy the best tax book nobody's buying: Everyday Taxes.
Here are the State's ID Theft measures (I am relying on information from State DOR websites and other sources - the information may not be completely accurate or may become outdated):
A: Requiring or requesting driver's license information on a tax return. For most states this is optional, but your refund might be delayed if you don't provide it. Alabama won't let you e-file without it. Some states require extra processing without it. My advice is to provide this to your preparer or put it in the tax software you used when asked. Make sure to enter it accurately.
B: Flipping suspicious tax return refunds from direct deposit or debit card to paper check. The idea here is that an identity thief won't have the picture ID needed to cash the check. Not much you can do here except make sure you use a good mailing address, and keep it updated with the state if you move. Also be aware if your mail is at risk by thieves and take action if it is.
C: Online or phone security questions for random or computer selected people. These will generally be letters sent to the mailing address on the return requesting you (and your spouse possibly) to answer security questions to verify your identity. This is usually done online or over the phone. Failing to get the answers right will result in having to take some onerous actions to prove that you are YOU. Ohio did this a couple years ago and it was a nightmare! Make sure you use a good address on the return, and update it with the state tax department if it changes. Have your tax return and the letter handy when responding. (If I have a phone number for assistance with this I will put it in parentheses after the 'C' code.)
D: State may request additional documentation of identity by mail. Make sure you use a good address on the return, and update it with the state tax department if it changes.
E: State will not process refunds until March 1st. This is to allow verification of income documents. You can still file earlier, but you won't get you refund until mid March at the earliest.
Here's the state rundown:
Alabama: A (DL info required for e-file), B , C (800-535-9410)
Arizona: Arizona's site indicates that they are taking efforts, and that these efforts may delay refunds, but don't specify what they are.
Arkansas: None I can find
California: A, C
Colorado: A (returns will require special processing actions if DL not provided)
Connecticut: B, C (855-842-1441)
Washington DC: A, B (If 1st time Direct Deposit (DD), DD info changed, or gap in filing will not get DD), C (202-727-4829)
Hawaii: They have not specified specific actions they are taking but say that SOME refunds may be delayed for up to 16 weeks. They advise filing early for the best chance of not having a delay.
Idaho: A, C, D
Illinois: A, B (all first time filers will get refund as a check), E
Indiana: C (317-233-1642)
Iowa: A, B
Kansas: None I can find
Louisiana: A, C (225-219-0102)
Maine: None I can find
Massachusetts: A, C (800-771-7144)
Michigan: A, City of Detroit refunds will all be checks
Minnesota: Does NOT want Driver's License submitted
Mississippi: A (Special processing will be required if Driver's License not provided)
Missouri: None I can find
Montana: A, C
New Jersey: They have not specified any specific security measures but do identify that they are watching for it and may delay some refunds to prevent it.
New Mexico: A (Special processing will be required if Driver's License not provided)
New York: A
North Carolina: None I can find
North Dakota: A, In addition, they have stated that they are taking steps to prevent ID theft and that these steps may delay refunds.
Ohio: A, C (855-855-7579)
Oklahoma: A, C, D
Oregon: A, C
Pennsylvania: A, C
Rhode Island: A
South Carolina: A, B, E
Utah: A, C (801-297-2200), E (If Utah DOR gets all documents from employer and employee refund might be processed faster than March)
Virginia: A (Special processing will be required if Driver's License not provided), B (If name on account doesn't match tax return the refund will be sent via check), C (804-404-4185)
West Virginia: None I can find
Wisconsin: A, C (608-264-4598)