WASHINGTON – When IRS Commissioner Danny Werfel met privately with senators recently, the chairman of the Senate Finance Committee asked for his assessment of a startling report: A whistleblower estimated that 95% of claims now being made by businesses for a COVID-era tax break were fraudulent.
“He looked at his shoes and he basically said, ‘Yeah,’” recalled the lawmaker who posed that question, Sen. Ron Wyden, D-Ore.
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The answer explains why Congress is racing to wind down what is known as the employee retention tax credit. Congress established the program during the coronavirus pandemic as an incentive for businesses to keep workers on the payroll.
Demand for the credit soared as Congress extended the tax break and made it available to more companies. Aggressive marketers dangled the prospect of enormous refunds to business owners if they would just apply. As a result, what was expected to cost the federal government $55 billion has instead ballooned to nearly five times that amount as of July. Meanwhile, new claims are still pouring into the IRS each week, ensuring a growing price tag that lawmakers are anxious to cap.
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 it's time to close down the program.
“I don’t have the exact number, but it’s like almost universal fraud in the program. It should be ended,” Johnson said. “I don’t see how anybody could support it.”
Warren added: “The standards were too loose and the oversight was too thin."
The Joint Committee on Taxation estimates that winding down the program more quickly and increasing penalties for those companies promoting improper claims would generate about $79 billion over 10 years.
Lawmakers aim to use the savings to offset the cost of three business tax breaks and a more generous child tax credit for many low-income families. Households benefiting from the changes in 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.
That tax credit is $2,000 per child, but only $1,600 is refundable, which makes it available to parents who owe little to nothing in federal income taxes. An agreement reached earlier this month by congressional tax-writers would increase the maximum refundable child tax credit to $1,800 for 2023 tax returns, $1,900 for the following year and $2,000 for 2025 tax returns. The Center on Budget and Policy Priorities, a liberal think tank and advocacy group, projected that about 16 million children in low-income families would benefit from the child tax credit expansion.
The package was overwhelmingly approved by a House committee last week, 40-3, showing it has broad, bipartisan support.
But passage through Congress is not assured because many key senators have concerns about aspects of the bill. Wyden said a strong vote in the House could spur the Senate into quicker action. Still, passing major legislation in an election year is generally a heavy lift.
Under current law, taxpayers have until April 15, 2025, to claim the employee retention credit. The bill would bars new claims after Jan. 31 of this year. It also would impose stiff penalties on those who are promoting the employer retention tax credit if they know or have reason to know their advice will lead to an underreporting of tax liabilities.
When Congress created the tax break for employers at the pandemic’s onset, it proved so popular that lawmakers extended and amended the program three times. The credit, worth up to $26,000 per employee, can be claimed on wages paid through 2021.
To qualify, generally businesses must show that a local or state government order related to the COVID-19 pandemic resulted in their business having to close or partially suspend operations. Or the businesses must show they experienced a significant decline in revenues.
Larry Gray, a certified public accountant from Rolla, Missouri, said he had concerns early on about how the program could be abused.
“There was no documentation really to speak" and the IRS just sent out the checks, Gray said. ”They just started printing the checks and I believe Congress was wanting them to print the checks.”
His hunch has proven correct, judging by the filings that he has reviewed. He has even lost clients who didn’t want to hear that they did not qualify when others were telling them they did. Generally, he said, the businesses that don’t qualify are failing to cite the government order that resulted in their closure or partial suspension. They are also routinely citing reasons for reimbursement that don’t meet the program’s criteria. For example, one company said it was struggling to find employees and had to raise wages as a justification for qualifying.
“If I go through the narratives on the filings that I’m looking at, every business in America qualifies,” Gray said.
The IRS paused accepting claims for the tax credit in September last year, until 2024 due to rising concerns that an influx of applications are fraudulent. At that point, it had received 3.6 million claims.
Some fraud has been prolific. For instance, a New Jersey tax preparer was arrested in July on charges related to fraudulently seeking over $124 million from the IRS when he filed more than 1,000 tax returns claiming the employment tax credits.
In an update issued Thursday about the program, the IRS said that it has thousands of audit in the pipeline and that as of Dec. 31, it has initiated 352 criminal investigations involving more than $2.9 billion in potentially fraudulent claims. Separately, it has opened nine civil investigations of marketers that potentially misled employers on eligibility to file claims.
Werfel briefed the Senate Finance Committee recently on the measures that have been put into place to address the fraud, including developing a special withdrawal program for those with unprocessed claims and a voluntary disclosure program for those who believed they were improperly paid. Since then, the IRS has seen an immediate 40% decline in average weekly claims, he said.
Lawmakers emphasize that cutting down on the fraudulent claims should also help the IRS more quickly resolve the legitimate claims that businesses have filed and are still awaiting resolution. In early December, the IRS had a backlog of about 1 million claims.
Congress routinely has difficulty finding offsets to pay 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 oh boy,” said Sen. Mark Warner, D-Va., in summing up the program.