How the Employee Retention Tax Credit Became a Magnet for Fraud

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

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

During the outbreak of the 2020 pandemic, when large parts of the economy went into lockdown, Washington put in place several programs to keep companies and their workers afloat. Among them was the Employee Retention Credit, a tax break created as part of the initial $2 trillion pandemic legislation. The program offered companies thousands of dollars per employee if they could demonstrate that Covid-19 was hurting their bottom line and they continued to pay employees.

The money was meant to be a lifeline for struggling companies. Instead, it has become a magnet for fraud, creating a cottage industry of firms marketing themselves as tax credit specialists who can help clients — even those who don’t actually qualify for the money — getting huge refunds from the IRS. Although the public health emergency has passed, taxpayers can continue to apply for the tax credit until 2025. That has led to a run for the money and the proliferation of financial services firms, which often charge hefty prepayments or receive rebates of about 25 percent on each tax refund.

The tax credit has become so popular that it turns out to be much more expensive than expected. In 2021, after Congress expanded credit eligibility, the Congressional Budget Office projected it would cost the federal government about $85 billion over a ten-year period — up from a previous estimate of $55 billion. But even that turned out to be an underestimate: The IRS said it has already paid $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.

The IRS doesn’t yet know how many of the approved refunds were based on fraudulent applications. But it has started ramping up efforts to root out scams and paying extra attention to reports from companies that appear suspicious.

On Thursday, the IRS warned businesses to be wary of “scams” related to the tax credit, saying it was fueling a deluge of “invalid” applications.

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

Mr. O’Donnell warned that those who received refunds but did not qualify for the money would have to pay back the money with penalties. He said the IRS was aggressively monitoring taxpayers who collect the refunds and the companies 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 well known than the more popular Paycheck Protection Program, which provided forgivable loans to cover labor costs, rent and utilities during the pandemic. But for eligible taxpayers, they have the potential to provide a significant windfall in the form of a tax refund. Businesses, including non-profits and churches, can charge up to $26,000 for each employee on payroll if they can demonstrate that all or part of 2021 ceased operations in 2020 or part of 2021 and report a significant drop in their earnings during that period .

However, the fine print that determines a company’s eligibility is complicated, and the IRS is concerned that companies that process applications for the credit in bulk are overlooking important restrictions to reap larger refunds and commissions.

For example, the IRS is concerned about taxpayers dipping into multiple jars of aid money and says many tax preparation firms fail to tell clients they can’t claim the tax credit on wages if they also receive money to cover payroll costs through the Paycheck Protection Program.

The rising cost of the program exacerbates America’s precarious fiscal situation. The White House and Republican lawmakers have been locked in a bitter battle over raising the debt ceiling, which is the maximum amount of money the United States can borrow. The Treasury Department estimated that the government could run out of money by June 1 and has resorted to accounting maneuvers to keep paying its bills.

Treasury officials last month pointed to the employee retention credit payouts as one reason federal tax revenues are meager than expected.

Lawmakers have debated reclaiming some unused pandemic relief funds as part of the debt limit and budget negotiations, but the tax credit does not appear to be part of those discussions. New York Democrat Senator Kirsten Gillibrand sent the IRS a letter this month urging it to clear the backlog and speed up repayments.

More applications for tax credits come in every day as companies continue to bombard social media sites and TV and radio stations with ads touting the ease of obtaining federal money. In some cases, the companies are making cold calls to potential customers.

According to Vivvix/CMAG, approximately 9,000 ads promoting tax-reduction application services for employee retention have aired on national cable and television networks since last October.

About three quarters of that was sponsored by one of the industry’s biggest players, Innovation Refunds, which advertises on networks like CNBC and claims it only takes eight minutes for the company to determine an applicant’s eligibility. The company says it has helped companies claim more than $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 discount off the refund a client receives from the IRS, uses a network of tax attorneys to review the applications and process the forms. It received funding from investment firm Raistone to advertise and process more custom tax returns.

“If you don’t have the knowledge, you don’t go looking for this,” said Mireille Rosselli, a spokeswoman for Innovation Refunds. “We’re on a shot clock.”

Ms. Rosselli added that Innovation Refunds has a rigorous application vetting system: “Our process is designed to deliver what Congress set out to do – ensure that only eligible companies apply for government incentives and credits and received.”

Companies that offer employee retention tax credits use different models. Some do not employ certified public accountants and instead rely on lawyers, offshore workers or software to crunch the numbers. Others rely on clients to “certify” their eligibility for the tax credits, making those clients more liable in the event of an audit.

Brian Anderson, who has a background in software, co-founded ERTC Express in 2021 after hearing that traditional accountants didn’t seem to have the time to help their clients through the cumbersome process of applying for credits. His company, which has offices in Atlanta and Tampa, has a team of internal accountants and a more rigorous one-month process for determining a client’s eligibility for an application. Customers can pay a prepayment or a percentage of their final refund.

“It’s complicated to find the answer to the question of eligibility,” said Mr. Anderson, who estimated that about a third of his potential customers are ineligible. “If you don’t qualify, it’s a lot of work for nothing.”

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

Traditional accountants are watching with concern as applications for employee retention tax credits soar. Many have since been hired to assist taxpayers who suddenly find themselves under scrutiny by the IRS.

“These guys prey on people and promise the moon,” says Mark C. Wagner, an accountant based near Dallas. “If your sales didn’t meet the criteria for the credit, then you have to pay back the credit, plus penalties, plus interest.”

A lawyer for Mr. Bassett, who pleaded not guilty, said COS Accounting and Tax took seriously its responsibilities to comply with IRS requirements in filing benefits for their clients. The lawyer, Kathryn Nester, explained that the rules and guidelines on the credit “were not often clear and were regularly revised”.

That was of little help to the company’s clients looking for answers to their applications or battling audits.

Wanchai Chab in 2020 worked for a Utah-based company that sold pest control supplies in California. Since he had formed a limited liability company, he was told that he could apply for the employee retention tax credit through COS Accounting and Tax. He paid $500 upfront and was told he would receive a $3,500 credit.

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

Fortunately for Mr. Chab, he was not penalized by the IRS because he never got the credit.

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

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