IRS says pandemic tax credit leading to fraud

A federal program intended to be a lifeline for struggling companies during the pandemic instead has become a magnet for fraud, creating a cottage industry of firms that market themselves as tax credit specialists who can help clients — even those who don’t actually qualify for the money — reap huge refunds from the Internal Revenue Service.

The Employee Retention Credit was created as part of the initial $2 trillion pandemic relief legislation. The program offered businesses thousands of dollars per employee if they could show both that COVID-19 was hurting their bottom lines and they were continuing to pay workers.

Although the public health emergency is over, taxpayers can continue to apply for the tax credit until 2025. That has fueled a run for the money and the proliferation of financial service providers, who often charge hefty upfront fees or take cuts of around 25% of any tax refund.

The tax credit has become so popular it is turning out to be far more costly than expected. In 2021, after Congress expanded eligibility for the credit, the Congressional Budget Office projected it would cost the federal government about $85 billion over a decade — up from an earlier estimate of $55 billion. However, even that turned out to be an underestimation: The IRS said it has already paid out $152 billion in refunds associated with the tax credit since it first became available and has a backlog of about 800,000 applications that it is trying to process.

The IRS does not yet know how many of the approved refunds were based on fraudulent applications. But it has begun ramping up efforts to root out scams and focusing additional scrutiny on filings from firms that appear suspicious.

On Thursday, the IRS issued a warning to businesses to be on the lookout for “scams” related to the tax credit, saying it was fueling a flood of “invalid” applications.

“These are Johnny-come-latelies showing up, and they’re pushing this product, pushing this activity, in a way that is unethical,” Douglas O’Donnell, the deputy commissioner of services and enforcement at the IRS, said in an interview. “It is drawing businesses into a trap that they will then be claiming a credit that they are not entitled to.”

O’Donnell warned that those who received refunds but were ineligible for the money would have to repay the funds with penalties. He said the IRS was aggressively auditing taxpayers who collect the refunds and the firms that process them. He estimated hundreds of thousands of tax credit “mills” have popped up across the country in the last three years.

“They seem to be everywhere,” O’Donnell said. Eligible taxpayers could receive a substantial windfall in the form of a tax refund. Businesses, including nonprofit organizations and churches, can seek up to $26,000 for each employee on the payroll if they can show their operations were fully or partially suspended in 2020 or part of 2021 and report a significant decline in their revenues during that time.

However, the fine print that determines if a business is eligible is complicated, and the IRS is concerned firms processing high volumes of applications for the credit are overlooking important restrictions in order to rake in bigger refunds and commissions. For instance, the IRS is concerned about taxpayers dipping into multiple pots of relief money, which isn’t allowed.