The Internal Revenue Service said on Thursday that it is freezing a pandemic-era employer tax benefit that has been a magnet for fraud and has cost the federal government billions of dollars as the agency looks for ways to stop the program from being abused.
The tax collector also said that it had referred thousands of claims for the so-called Employee Retention Credit for audits and had initiated over 250 criminal investigations involving nearly $3 billion in potentially fraudulent claims.
The moratorium on new claims underscores the high level of alarm within the I.R.S. that the tax credit has been misused and abused. Top I.R.S. officials have warned that the program is being exploited by unscrupulous “tax mills” — accounting firms and other companies that have been aggressively luring taxpayers who are not eligible for refunds to submit applications anyway. Many of these companies receive either commissions for submitting applications or a percentage of the refund and have been relying on faulty interpretations of the rules of the program to convince small business owners that they have a chance to get free money.
Businesses, including nonprofit organizations and churches, have been able to seek up to $26,000 for each employee on their payrolls if they can show that their operations were fully or partly suspended in 2020 or part of 2021, and report a significant decline in their revenues during that time. Before the moratorium was announced, they had until 2025 to file claims.
The I.R.S. is slowing the pace of refunds from applications that have already been submitted and urging taxpayers to consider withdrawing their applications if they believe that they might be ineligible. The program will remain frozen until at least the end of the year.
“We are deeply concerned that this program is not operating in the way it was intended,” Daniel Werfel, the I.R.S. commissioner, said on Thursday. “We believe you should see only a trickle of employee retention claims coming in. Instead, we are seeing a tsunami.”
At the onset of the pandemic in 2020, as large swaths of the economy went into lockdown, 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 initial $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.
In 2021, after Congress expanded eligibility, the Congressional Budget Office projected that the credit would cost the federal government about $85 billion over a decade — up from an earlier estimate of $55 billion. The I.R.S. said on Thursday that it had already paid out about $230 billion in refunds associated with the tax credit and that it had a backlog of 600,000 claims.
Mr. Werfel said that 15 percent of the 3.6 million claims for the credit that the I.R.S. had received since the program began were submitted in the past 90 days. The fact that the pace of applications has been picking up raised concerns within the I.R.S. that their previous warnings about the abuse of the program had gone unheeded.
Interest in the claims has been drummed up by aggressive marketing campaigns on television and radio and through unsolicited phone calls. Most of the improper claims are coming from so-called tax mills that the I.R.S. says have popped up in recent years to capitalize on commissions that they get for processing the credits.
“This great program to help small businesses has been overtaken by aggressive promoters,” Mr. Werfel said. “The program has become the centerpiece for unscrupulous marketing that profits from pushing taxpayers to claim credit that they may not be eligible for.”
The commissioner said that people or businesses who improperly claimed the tax credits could have to repay the money and face additional penalties. He said that the I.R.S. is designing a new settlement program for taxpayers who received credits that they should not have applied for and want to come forward voluntarily.
