Here's how it works: Name yourself as the third party. That way, if an identity thief files a tax return in your name, hoping to snag your refund before you get the chance to file, the IRS would send any notifications or issues regarding the return to you. It essentially acts like a fraud alert and could give you enough time to stop your refund from finding its way to the wrong person. You can also use Form 8821 for your children, or a deceased spouse or parent, naming yourself as the third party so that you're notified if anyone tries to use their identity. (Again, provided there is a problem with the tax return file by the thief.)
So, while this is by no means a sure thing, criminals do make mistakes and when they do in this particular crime, it will cost them and not you. Form 8821 can serve like an early warning system, a canary in the mineshaft of your identity.
A better way?
Obviously, the form is no silver bullet for tax identity theft. It doesn't prevent identity thieves from stealing your identity and using it to file a false tax return. Nor can it guarantee that you'll be notified that your identity has been used for tax fraud. It works only after the fact, and only in cases where the IRS initiates a second round of communication after the fraudulent tax return has already been mailed out.
The IRS has tried a few reactive measures, though there may be a better solution. They may want to take their lead from amusement parks, many of which are using biometrics -- specifically fingerprint readers. The technology is now cheap enough for the federal government to require that all tax preparers have a biometric fingerprint reader device wherever they do business. If you were to prepare your own taxes and e-file, you would likely need a biometric device at home. (They can be had for around $100.) Take it a bit further, let the Congress give a $100 credit to home e-filers.
If this sounds too extreme, perhaps you will be more comfortable with another solution: transactional notification. Banks and credit card companies offer it already. In the simplest of terms, every time something happens with relation to your account, you receive an email or a text letting you know about it. With regard to tax fraud, identity thieves wouldn't even try because you'd know about anything they did immediately. It would cost the IRS some money, but nowhere near the $5.2 billion (that we know about) we're all losing through tax-related identity theft crimes.
It's time we stop accepting tax-related identity theft as a fact of life, and start thinking of real solutions to end it.
Adam Levin is chairman and cofounder of Credit.com and Identity Theft 911. His experience as former director of the New Jersey Division of Consumer Affairs gives him unique insight into consumer privacy, legislation and financial advocacy. He is a nationally recognized expert on identity theft and credit.