You May Have Paid for Someone Else's Phony Refund

Dec. 11, 2006 — -- At Internal Revenue Service headquarters, there are a lot of red faces after they admitted they paid out $200 million in bogus refunds.

Sen. Charles Grassley, an Iowa Republican and longtime critic of the IRS, told ABC News, "They royally screwed up. And it's going to cost the honest taxpayer a lot of money."

Treasury Department investigators said the amount lost actually is more than $300 million.

"It was sort of the worst case scenario," said Michael Phillips, deputy inspector general at the Treasury Department. "What could go wrong did go wrong. And yes, some money is lost and cannot be regained."

All because the IRS paid $20 million for a new computer system that failed -- big time.

"The IRS and computers mix like oil and water," said Pete Sepp of the National Taxpayers Union. "And you can put them together, but eventually everything falls apart."

The IRS hoped the new computers would easily spot tax frauds, such as people who claim suspiciously high deductions for things like gifts to charity and medical expenses. But last year, the company developing the new system warned the IRS it might not be ready come tax season in the spring of 2006.

Sure enough, it wasn't ready. And to make matters worse, the IRS had shut down its backup system.

"They should have ensured that the new system was going to work before they shut the old system down," said Phillips, of the Treasury Department.

The IRS said it's now too late and too difficult to recover most of the fraudulent refunds.

"The management systems of both the IRS and its contractor to improve our automated refund fraud detection system were insufficient and are unacceptable," IRS Commissioner Mark Everson said in a written statement. "We have initiated appropriate action against IRS employees who failed to act responsibly, up to and including dismissal. … The IRS is moving aggressively to fix this problem."