IRS is stepping up efforts to suppress fraud in the tax credit program

The software was called ‘Tax Bandits’. The scheme, run from a California prison, attempted to fraudulently claim more than half a billion dollars in tax refunds.

The method was known: incorrectly claiming the tax credit.

The IRS said Friday it was stepping up its efforts to root out such cases of fraud as it tries to safeguard taxpayers’ money, but it acknowledged that without congressional intervention, the agency would remain inundated with potentially unjustified claims.

One of the most brazen cases of alleged fraud in the program emerged in February, when federal agents announced charges against the ringleader of an operation led by Kristopher Thomas, a former gang member already in prison for murder. He was charged outside the jail along with seven co-conspirators, including his mother, who helped carry out the scheme, authorities said.

The joint investigation of the FBI and the Internal Revenue Service Criminal Investigation Unit was convened “Operation Fraud Street Mafia.” It involved intercepted calls and text messages exchanging information about fake companies while using the money they earned to live luxuriously – even flying to a party in Las Vegas on a private jet.

The alleged plot is perhaps the most egregious example of the abuse of tax breaks created during the pandemic crisis to keep companies and their workers afloat. Since its inception in 2020, a new sector of tax preparation companies has emerged just to process claims for the Employee Retention Tax Credit, which allows companies to collect up to $26,000 for each employee on the payroll.

But the program is riddled with fraud, with many of those tax preparation companies tricking companies into applying for tax breaks they don’t qualify for. As a result, the program has cost the federal government billions more than originally estimated.

Taxpayers can continue to apply for the tax credit through 2025, but the IRS halted the program last September so it could clear a backlog of claims and ramp up audits. Lawmakers in Congress have negotiated tax legislation that would end the program early, potentially saving the federal government about $80 billion, but an agreement has yet to be reached.

The IRS said Friday that since it temporarily stopped accepting new applications for the credits last fall and offered taxpayers a chance to withdraw their claims, it has safeguarded more than $1 billion in federal tax revenue. However, the agency warned that the program remains a problem and that it still has about a million unprocessed claims.

“We remain deeply concerned about the widespread abuse related to these claims that have harmed small businesses,” Daniel Werfel, the IRS commissioner, said in a statement.

Wally Adeyemo, the deputy finance minister, urged lawmakers on Friday to end the tax credit program.

“Congress must act to protect the interests of American taxpayers and honest small businesses and give the IRS the tools needed to tackle fraud,” he said.

Since last September, 1,800 companies have withdrawn claims totaling $251 million. The IRS said it also caught 12,000 companies in the past six months that filed more than 22,000 claims that were improper, resulting in fines of $572 million.

The pot of seemingly unlimited amounts of pandemic relief money prompted tax firms to launch an advertising campaign to convince companies to apply for the credits, earning them lucrative commissions.

In Mr. Thomas’s case, court documents showed that he and his associates filed approximately 300 payroll tax returns claiming more than $550 million in refunds, much of it tied to the employee retention tax credit.

Officials said the returns were for “fake business entities, real businesses with inflated wages and employee numbers, and businesses that were defunct at the time the payroll tax returns were filed.” Much of the money they requested was not returned because the IRS suspected fraud.

The case showed a striking level of recklessness. At some point in 2023, Mr. Thomas was caught talking to his mother in a recorded prison about her concerns that the federal government would realize what they were doing, officials said.

According to the complaint, Mr. Thomas downplayed these concerns, saying they would likely be told, “You owe us this back and you need to pay it back whenever you can,” which would be the “33rd of Neveruary.”