The Internal Revenue Service (IRS) announced on Thursday that it is implementing a freeze on a pandemic-era employer tax benefit to prevent further abuse and fraudulent claims. This tax credit program has cost the federal government billions of dollars, prompting the IRS to take action.
In addition to the freeze, the IRS has referred numerous claims for audits and initiated over 250 criminal investigations related to potentially fraudulent claims totaling nearly $3 billion.
The decision to halt new claims highlights the alarm within the IRS regarding the misuse and abuse of this tax credit. Senior IRS officials have raised concerns that unscrupulous “tax mills” – accounting firms and other companies – have been enticing ineligible taxpayers to submit applications by offering commissions and misleading interpretations of the program’s rules. These companies prey on small business owners, convincing them they have a chance to receive free money.
Under the program, businesses, including nonprofits and churches, could claim up to $26,000 per employee if they demonstrated a complete or partial suspension of operations in 2020 or part of 2021, along with a significant decline in revenue. Initially, businesses had until 2025 to file claims.
To handle the existing applications, the IRS is reducing the pace of processing refunds and advising taxpayers to consider withdrawing their applications if they suspect they may not be eligible. The freeze will remain in effect until at least the end of the year.
Daniel Werfel, the IRS commissioner, expressed deep concerns about the program’s misuse, stating that the number of employee retention claims being submitted is far beyond expectations. He referred to it as a “tsunami” rather than a trickle.
When the pandemic hit in 2020 and forced widespread lockdowns, the government implemented several programs to support businesses and workers. One such program was the Employee Retention Credit, a tax benefit created as part of the initial $2 trillion relief legislation. This program aimed to provide financial assistance to businesses by offering thousands of dollars per employee if they could prove that COVID-19 had impacted their revenue but they continued paying their workers.
Following the expansion of eligibility in 2021, the Congressional Budget Office projected the credit’s cost to the federal government to be around $85 billion over a decade, up from the initial estimate of $55 billion. The IRS revealed that it has already paid out approximately $230 billion in refunds related to the tax credit and has a backlog of 600,000 claims.
Mr. Werfel disclosed that within the past 90 days, 15% of the 3.6 million claims received by the IRS were submitted, indicating an alarming increase in applications. This raised concerns among IRS officials that their prior warnings about program abuse had been disregarded.
The aggressive marketing campaigns through television, radio, and unsolicited phone calls have fueled interest in these claims. Most of the fraudulent claims originate from “tax mills,” entities identified by the IRS that have recently emerged to capitalize on the commissions earned from processing these credits.
Mr. Werfel expressed concerns that this beneficial program for small businesses has been distorted by aggressive promoters, turning it into a platform for unscrupulous marketing that encourages taxpayers to claim credits they are not eligible for.
Taxpayers or businesses found to have improperly claimed these tax credits may be required to repay the funds and face additional penalties. The IRS is also developing a settlement program for taxpayers who want to voluntarily come forward and rectify their improper claims.
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