How the Employee Retention Tax Credit Became a Magnet for Fraud

In early February, federal prosecutors in Utah charged Zachary Bassett and Mason Warr with defrauding the United States government of millions of dollars. The accounting firm they operated had submitted more than 1,000 fraudulent tax forms to the Internal Revenue Service on behalf of businesses trying to claim pandemic-era stimulus funds, prosecutors said.

COS Accounting and Tax closed later that month, leaving businesses and taxpayers who had paid the firm to help them claim federal money trying to figure out what had happened and why they were suddenly receiving audit notices from the IRS

Amidst the start of the pandemic in 2020, as large parts of the economy shut down, Washington set up various programs to help keep businesses and their workers afloat. Among them was the employee retention credit, a tax benefit that was created as part of the original $2 trillion pandemic relief legislation. The program offered businesses thousands of dollars per employee if they could show that Covid-19 was hurting their bottom lines and that they were continuing to pay workers.

The money was intended to be a lifeline for struggling companies. Instead, it has become a magnet for scams, creating a cottage industry of firms marketing themselves as tax credit specialists who can help clients — even those who don’t qualify for the money — reap tax refunds. Even though the public health emergency is over, taxpayers can continue to apply for tax credits until 2025. This has spurred cash-strapped efforts and the proliferation of financial services providers, who often charge hefty upfront fees or cut about 25 percent of any tax refund.

The tax credit has become so popular that it is turning out to be much 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 understatement: The IRS said it has already paid out $152 billion in refunds related to the tax credit since it first became available, and has a backlog of about 800,000 applications it is trying to process. 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 fraud and focusing extra scrutiny on filings from firms that appear suspicious.

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

“These are Johnny-come-latelys, showing up and they’re pushing this product, pushing this activity in an unethical way,” Douglas O’Donnell, deputy commissioner of services and enforcement at the IRS, said in an interview. . “It’s putting businesses in a trap, so they’re going to ask for a loan they don’t deserve.”

Mr O’Donnell warned that those who received refunds but were not entitled to the money would have to repay the funds with penalties. He said the IRS was aggressively scrutinizing taxpayers who collect refunds and the firms that process them. He estimated that hundreds of thousands of tax credit “mills” have popped up across the country in the past three years.

“They seem to be everywhere,” Mr O’Donnell said.

The tax credits are less popular than the more popular Paycheck Protection Program, which provided forgivable credits to cover payroll, rent and utility costs during the pandemic. But for qualified taxpayers, they have the potential to provide a significant windfall in the form of a tax refund. Businesses, including nonprofits and churches, can claim up to $26,000 for each employee on the payroll if they can show their operations were suspended in whole or in part in 2020 or part of 2021 and report a decline significant portion of their income during that time.

However, the fine print that determines whether a business is eligible is complicated, and the IRS is concerned that firms processing high-volume loan applications are skirting important restrictions in order to collect larger refunds and fees.

For example, the IRS is concerned about taxpayers dipping into multiple pots of cash and says many tax preparation firms are not telling clients they can’t claim payroll tax credits if they also receive cash to cover payroll costs through the Wage Protection Program.

The high cost of the program is exacerbating America’s precarious fiscal situation. The White House and Republican lawmakers are locked in a bitter fight over raising the debt ceiling, which limits how much money the United States can borrow. The Treasury Department has estimated that the government could run out of money on June 1 and has resorted to accounting maneuvers to keep paying its bills.

Treasury officials last month pointed to employee retention credit payments as one reason federal tax revenue is less than expected.

Lawmakers have debated withdrawing some unused pandemic relief funds as part of debt limit and budget negotiations, but the tax credit does not appear to be part of those discussions. Sen. Kirsten Gillibrand, D-New York, sent a letter to the IRS this month asking it to clear its backlog and issue refunds more quickly.

More tax credit applications are coming in every day as firms continue to light up social media sites and television and radio stations with ads touting how easy it is to get federal money. In some cases, firms are cold leads.

Since last October, according to ad-tracking firm Vivvix/CMAG, there have been about 9,000 ads promoting employee retention tax credit application services aired on national cable and broadcast television networks.

About three-quarters of them were sponsored by one of the biggest players in the industry, Innovation Refunds, which advertises on networks such as CNBC and claims it takes just eight minutes for the firm to determine whether an applicant is eligible. The firm says it has helped businesses claim over $1 billion in payroll tax refunds.

“So easy,” says a narrator in one of the ads. “But it’s only available for a limited time.”

Innovation Refunds, which takes a 25 percent cut of any refund a client receives from the IRS, uses a network of tax attorneys to review applications and process forms. It received funding from investment firm Raistone to expand its ability to advertise and process more amended tax returns.

“If you don’t have the knowledge, then you won’t ask for it,” said Mireille Rosselli, a spokeswoman for Innovation Rebates. “We’re on a shot clock.”

Ms. Rosselli added that the Innovation Rebates have a rigorous system of vetting applications: “Our process is designed to deliver what Congress intended to do – ensure that only qualified businesses apply for and receive government incentives and loans.”

Firms that offer employee retention tax credit services use different models. Some don’t have certified public accountants on staff and instead rely on lawyers, offshore workers or software to crunch the numbers. Others rely on customers to “prove” they are eligible for tax credits, leaving those customers more liable in the event of an audit.

Brian Anderson, who has a background in software, co-founded ERTC Express in 2021 after learning that traditional accountants didn’t seem to have the time to help their clients navigate the cumbersome loan application process. His business, which has offices in Atlanta and Tampa, has a team of in-house accountants and a more rigorous monthly process to determine whether a client is eligible to apply. Customers can pay an upfront fee or a percentage of their eventual refund.

“It is complex to find the answer to the question, do you qualify,” said Mr. Anderson, estimating that about a third of his potential customers don’t qualify. “If you don’t qualify, it’s a lot of work for nothing.”

The IRS recognizes that applying for a tax credit is a complicated process, made more difficult by the fact that it must be done by amending previous tax returns using paper forms. The agency warns that firms that say the process can be done quickly and easily are likely to mislead their customers.

Traditional accountants have watched with dismay as applications for the employee withholding tax credit have boomed. Many have since been hired to help taxpayers who suddenly find themselves under IRS surveillance.

“These guys are preying on people, promising the moon,” said Mark C. Wagner, an accountant based near Dallas. “If your sales didn’t meet the criteria for the loan, then you have to pay back the loan, plus penalties, plus interest.”

A lawyer of Mr. Bassett, who pleaded not guilty, said COS Accounting and Tax took seriously its responsibilities to comply with IRS requirements when applying for benefits for its clients. The lawyer, Kathryn Nester, explained that the regulations and guidelines for the loan “were often not clear and were frequently revised”.

This has provided little solace to business customers who have sought answers to their applications or been left to face audits.

Wanchai Chab was working for a Utah-based company that sells pest control supplies in California in 2020. Because he had formed a limited liability company, he was advised that he could apply for the withholding tax credit of employees through COS Accounting and Tax. He paid $500 upfront and was told he would receive a $3,500 loan.

But instead of getting a big refund, Mr Chab, 25, received an audit notice earlier this year and ended up paying extra tax.

Fortunately for Mr. Chab, he was not penalized by the IRS because he never received the loan.

“The auditor said she understood what was going on and knew of many people who were robbed in this way,” Mr Chab said.