I.R.S. Stepping Up Efforts to Squash Fraud in Tax Credit Program

The software was called Tax Bandits. The scheme, which was run out of a prison in California, federal officials said, attempted to fraudulently claim more than half a billion dollars in tax refunds.

The method was a familiar one: erroneous claims of the Employee Retention Tax Credit.

The I.R.S. said on Friday that it was intensifying its efforts to root out such cases of fraud and attempted fraud as it tried to safeguard taxpayer money, but it acknowledged that without an intervention by Congress, the agency would continue to be flooded with potentially improper claims.

One of the most brazen cases connected to the program emerged in February, when federal agents announced charges against a man they called the ringleader of a fraud operation, Kristopher Thomas, a former gang member who was already serving prison time for murder. He was charged along with seven co-conspirators outside prison, including his mother, who were helping to carry out the plan, authorities said.

The joint investigation by the F.B.I. and the criminal investigation unit of the Internal Revenue Service was called “Operation Fraud Street Mafia.” It involved intercepted calls and text messages exchanging information about fake businesses while using the money they made to live luxuriously — even flying on a private jet to a party in Las Vegas.

The alleged plot is perhaps the most egregious example of the abuse of a tax benefit that was created during the throes of the pandemic to keep businesses and their workers afloat. Since the program’s inception in 2020, a new industry of tax preparation firms has popped up just to process claims for the Employee Retention Tax Credit, which allows businesses to collect up to $26,000 for each employee on its payroll.

But the program has been rife with fraud, with many of the wrongdoers being tax prep firms luring businesses to apply for tax credits that they are not qualified to receive. 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 I.R.S. paused the program last September so that it could sift through a backlog of claims and step up audits. Lawmakers in Congress have been negotiating over tax legislation that would shut the program down early, potentially saving the federal government approximately $80 billion, but an agreement has yet to be reached.

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

“We remain deeply concerned about widespread abuse involving these claims that have harmed small businesses,” Daniel Werfel, the I.R.S. commissioner, said in a statement.

Wally Adeyemo, the deputy Treasury secretary, urged lawmakers on Friday end the tax credit program.

“Congress must act to protect the interests of U.S. taxpayers and honest small businesses and give the I.R.S. the tools it needs to tackle fraud,” he said.

Since last September, 1,800 businesses withdrew claims totaling $251 million. The I.R.S. said that during the last six months it has also caught 12,000 businesses filing more than 22,000 claims that were improper, resulting in $572 million in penalties.

The pot of a seemingly limitless amount of pandemic relief money led tax preparation firms to embark on a blitz of advertising to persuade businesses to apply for the credits, yielding them lucrative commissions.

In the case of Mr. Thomas, the court documents showed that he and his associates filed approximately 300 payroll tax returns that claimed over $550 million in refunds that were largely associated with the Employee Retention Tax Credit.

Officials said that the returns were for “fake business entities, actual businesses with overstated wages and numbers of employees, and businesses that were defunct at the time the payroll tax returns were filed.” Much of the money that they sought was not refunded because the I.R.S. suspected fraud.

The case demonstrated a striking level of recklessness. At one point in 2023, Mr. Thomas was heard speaking on a recorded jail line with his mother about her concerns that the federal government would catch on to what they were doing, officials have said.

Mr. Thomas, according to the complaint, downplayed those concerns, saying they would likely be told “you owe us this back and you have to pay it back whenever y’all can,” which would be the “33rd of Neveruary.”