How the employee retention tax credit became a fraud magnet

How the employee retention tax credit became a fraud magnet

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 run had filed more than 1,000 fraudulent tax forms with the Internal Revenue Service on behalf of companies 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 company to apply for federal money now having to figure out what happened and why they were suddenly receiving audit notices from the IRS

At the start of the 2020 pandemic, with much of the economy under lockdown, Washington launched various programs to keep businesses and their workers afloat. Among them was the Employee Retention Credit, a tax credit created under the first $2 trillion pandemic relief legislation. The program offered companies thousands of dollars per employee if they could show that Covid-19 was affecting their bottom line and they continued to pay their workers.

The money was to serve as a lifeline for struggling businesses. Instead, it has become a magnet for fraud and has created a cottage industry of companies that market themselves as tax credit specialists who can help their clients — even those who aren’t actually entitled to the money — to get huge refunds from the IRS , although the public health emergency is over, taxpayers can still claim the tax credit until 2025. That has led to a race for the money and the proliferation of financial services firms, which often charge high upfront fees or take cuts of around 25 percent in tax returns.

The tax credit is so popular that it is far more expensive than expected. In 2021, after Congress expanded eligibility for the loan, the Congressional Budget Office projected it would cost the federal government about $85 billion over a decade — up from a previous estimate of $55 billion. But even that turned out to be an underestimate: The IRS said it has already paid out $152 billion in tax credit-related refunds since its inception and has a backlog of about 800,000 claims it is trying to process.

The IRS does not yet know how many of the approved refunds were based on fraudulent claims. However, the company has begun to step up its efforts to combat scams, adding additional scrutiny to reports from companies that appear suspicious.

On Thursday, the IRS warned companies to look out for “scams” related to the tax credit, saying they would fuel a spate of “invalid” applications.

“These are Johnny-come-ladies who come out and push this product, push this activity in a way that’s unethical,” Douglas O’Donnell, the IRS’s assistant services and enforcement officer, said in an interview. “It traps companies into taking out a loan they’re not entitled to.”

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

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

The tax credits are less well known than the more popular Paycheck Protection Program, which provided forgivable credit to cover wages, rent and utilities during the pandemic. However, for eligible taxpayers, there is the potential for a significant windfall in the form of a tax refund. Businesses, including nonprofits and churches, can ask for up to $26,000 for each employee on payroll if they can show they ceased all or part of their operations in 2020 or part of 2021 and they were employed during that period report a significant drop in sales.

However, the fine print that determines whether a company is eligible is complicated, and the IRS fears companies that process loan applications at scale are overlooking important limitations in order to reap higher refunds and commissions.

For example, the IRS is concerned that taxpayers are grabbing multiple pots of relief money, and says many tax-prep firms don’t tell their clients they can’t claim the wage tax credit if they’re also paying for it through the Paycheck Protection Program received wage cost coverage.

The program’s skyrocketing costs are exacerbating America’s precarious budgetary situation. The White House and Republican lawmakers are at loggerheads over raising the debt ceiling, which limits US borrowing. The Treasury Department believes the government could run out of cash as early as June 1 and has resorted to accounting maneuvers to keep paying its bills.

Treasury Department officials pointed out last month that the employee retention loan payout was one reason federal tax revenues were lower than expected.

Lawmakers have been debating recovering some unused pandemic funds as part of the debt ceiling and budget negotiations, but the tax credit doesn’t appear to be part of those discussions. Senator Kirsten Gillibrand, a Democrat from New York, sent the IRS a letter this month urging it to clear its backlog and issue refunds more quickly.

Applications for tax credits are increasing every day as companies continue to bombard social media sites, TV and radio stations with ads promoting how easy it is to get federal funds. In some cases, companies do cold calling of potential customers.

According to advertising-tracking firm Vivvix/CMAG, since last October, about 9,000 ads have aired on nationwide cable and broadcast networks promoting recruitment tax credit application services.

About three-quarters of those were sponsored by one of the industry’s biggest players, Innovation Refunds, which advertises on networks like CNBC and claims it takes the company just eight minutes to determine if an applicant is eligible. The company claims to have helped businesses claim over $1 billion in payroll tax refunds.

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

Innovation Refunds, which cuts the refund a client receives from the IRS by 25 percent, uses a network of tax attorneys to review applications and process forms. The company received funding from investment firm Raistone to expand its ability to advertise and process additional amended tax returns.

“If you don’t have the knowledge, you won’t seek it,” said Mireille Rosselli, spokeswoman for Innovation Funds. “We’re in full swing.”

Ms. Rosselli added that Innovation Refunds has a rigorous system for reviewing applications: “Our process is designed to achieve what Congress intended – to ensure that only eligible companies apply for and receive government incentives and loans.”

Companies that offer tax credits for employee retention use different models. Some don’t have certified public accountants and instead rely on lawyers, offshore workers, or software to get the numbers. Others rely on customers to “certify” that they are entitled to the tax credits, making those customers more liable in the event of an audit.

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

“Finding the answer to whether you qualify is complex,” Mr. Anderson said, estimating that about a third of his potential clients are not qualified. “If you’re not authorized, that’s a lot of work for nothing.”

The IRS recognizes that applying for the tax credit is a complicated process complicated by the need to amend previous tax returns using paper forms. The agency warns that companies claiming the process can be done quickly and easily are likely to mislead their customers.

Traditional accountants have watched with concern as the number of applications for the employee retention tax credit is booming. Many have since been hired to help taxpayers suddenly find themselves under IRS scrutiny.

“These guys prey on people and promise them the moon,” said Mark C. Wagner, an accountant based near Dallas. “If your sales did not meet the criteria for credit, you must repay the credit plus penalties and interest.”

An attorney for Mr. Bassett, who pleaded not guilty, said COS Accounting and Tax takes seriously its responsibility to comply with IRS requirements when claiming benefits for its clients. Attorney Kathryn Nester explained that the regulations and guidance on the loan “were often not clear and were frequently revised.”

That was little consolation to the company’s customers, who were looking for answers to their requests or grappling with audits.

In 2020, Wanchai Chab was working for a Utah-based company that sold pesticides in California. As he had incorporated a limited liability company, he was advised 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 receiving a large refund, Mr Chab, 25, received an audit notice earlier in the year and ended up paying additional taxes.

Luckily for Mr. Chab, he was not penalized by the IRS as he never received the credit.

“The investigator said she understood what was going on and knew of many people who had been scammed in this way,” Mr Chab said.