WASHINGTON — When IRS Commissioner Danny Werfel recently met privately with senators, the Senate Finance Committee chairman asked for his assessment of a startling report: A whistleblower estimated that 95% of claims now being filed by companies for a COVID tax break era were fraudulent.
“He looked at his shoes and basically said, ‘Yes,’” recalled the lawmaker who asked the question, Sen. Ron Wyden, D-Ore.
The answer explains why Congress is rushing to phase out the so-called employee retention tax credit. Congress created the program during the coronavirus pandemic as an incentive for companies to keep workers on the payroll.
Demand for the credit soared when Congress expanded the tax credit and made it available to more businesses. Aggressive marketers dangled the prospect of huge refunds to business owners if they would just sign up. As a result, what was expected to cost the federal government $55 billion increased to nearly five times that amount as of July. Meanwhile, new claims continue to pour into the IRS every week, adding to a growing price tag that lawmakers are eager to limit.
Lawmakers across the political spectrum who rarely agree on little else — from liberal Sen. Elizabeth Warren, D-Mass., to conservative Sen. Ron Johnson, R-Wis. – agree that it is time to close the program.
“I don’t have the exact number, but it seems like almost universal fraud in the program. It has to end,” Johnson said. “I don’t see how anyone could support this.”
Warren added: “The standards were too loose and the oversight was too thin.”
The Joint Committee on Taxation estimates that faster phasing out of the program and increasing penalties for companies that promote improper claims would raise about $79 billion over 10 years. Lawmakers want to use the savings to offset the cost of three tax breaks for businesses and a more generous child tax credit for many low-income families. Households that take advantage of the changes to the child tax credit would see an average tax cut of $680 in the first year, according to an estimate from the nonpartisan Tax Policy Center.
The package was overwhelmingly approved by a House committee last week, 40 to 3, showing broad bipartisan support.
But passage through Congress is not assured, as many key senators are concerned about aspects of the bill. Wyden said a strong vote in the House of Representatives could spur the Senate to take quicker action. Still, passing major legislation in an election year is generally a daunting task.
Under current law, taxpayers have until April 15, 2025 to claim the employee retention credit. The bill bans new claims after January 31 of this year. It would also impose severe penalties on those who promote the employer tax credit if they know or have reason to know that their advice will lead to underreporting of tax liabilities.
When Congress created the tax credit for employers at the start of the pandemic, it proved so popular that lawmakers expanded and changed the program three times. The credit, worth up to $26,000 per employee, can be claimed on wages paid through 2021.
To qualify, businesses generally must demonstrate that a local or state government order related to the COVID-19 pandemic caused their business to close or partially suspend operations. Or the companies must show that they have experienced a significant decline in turnover.
Larry Gray, a certified public accountant from Rolla, Missouri, said he had early concerns about how the program could be abused.
“There was basically no documentation to talk about” and the IRS simply sent out the checks, Gray said. “They just started printing the checks and I believe Congress wanted them to print the checks.”
His hunch proved correct, judging by the documents he reviewed. He’s even lost customers who didn’t want to be told they didn’t qualify when others told them they did. Generally, he said, the ineligible businesses fail to cite the government order that resulted in their closure or partial suspension. They also routinely cite reasons for reimbursement that do not meet the program’s criteria. For example, one company said it was struggling to find workers and had to increase wages to justify the qualification.
“When I go through the stories of the files I look at, every company in America qualifies,” Gray said.
The IRS suspended acceptance of claims for the tax credit last September until 2024 amid growing concerns that an influx of applications are fraudulent. At that point, it had received 3.6 million claims.
There has been some fraud. For example, in July a New Jersey tax preparer was arrested on charges of fraudulently claiming more than $124 million from the IRS when he filed more than 1,000 tax returns claiming the employment tax credits.
In an update on the program released Thursday, the IRS said it has thousands of audits in the pipeline and has initiated 352 criminal investigations as of Dec. 31 involving more than $2.9 billion in potentially fraudulent claims. In addition, it has opened nine civil investigations against marketers who may have misled employers about eligibility to make claims.
Werfel recently briefed the Senate Finance Committee on steps taken to address the fraud, including developing a special withdrawal program for people with unprocessed claims and a voluntary disclosure program for those who believed they had been paid in error. Since then, the IRS has seen an immediate 40% drop in average weekly claims, he said.
Lawmakers emphasize that reducing fraudulent claims should also help the IRS more quickly resolve legitimate claims that companies have filed and are still awaiting resolution. As of early December, the IRS had a backlog of about 1 million claims.
Congress routinely struggles to find offsets for new spending or tax cuts. But in this case, the employee retention tax credit appears to have few friends left on Capitol Hill.
“Well-intentioned, but boy, boy,” said Sen. Mark Warner, D-Va., in summarizing the program.