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IRS Slows Refund Payments for Pandemic-Era Tax Break

WASHINGTON—The Internal Revenue Service has slowed the payment of tax refunds to employers under a pandemic-era program, as the agency struggles to combat what it says are fraudulent and overstated claims for the employee-retention tax credit.

“We remain deeply concerned about small businesses being scammed and dubious Employee Retention Credit claims being submitted amid aggressive marketing to the business community,” the IRS said Tuesday. “The IRS has slowed our processing of these claims to guard against fraudulent or incorrect submissions as we work to enhance our procedures and controls to best protect small-business owners and taxpayer dollars.”

The announcement marks the government’s biggest step to rein in the cottage industry of employee-retention tax-credit advisers that has emerged in the past few years. The IRS is likely facing years of disputes and litigation because it is expected to try to claw back some refunds it has issued.

Congress created the employee-retention credit, or ERC, in 2020 as part of its response to the coronavirus pandemic. The aim was to reward employers for keeping workers in their jobs. Eligible employers that experienced revenue declines or had their operations suspended by government orders can get up to $26,000 per employee.

The rules for the credit changed several times, and the tax break expired Sept. 30, 2021. But claims have boomed since then. Under the tax code, employers have up to three years to amend their payroll tax returns and claim the credit.

That created an opening for a pop-up industry to bloom. Firms that encourage employers to seek the credit, including many that didn’t exist a few years ago, advertise heavily and persistently contact employers. They often take a percentage of the tax refund as their fee. Many warn that they don’t offer tax or legal advice.

As of early March, the IRS had paid more than $150 billion in ERC refunds, according to the agency. It likely paid $220 billion through July before payments started slowing down in August, according to an analysis of Treasury Department data by the investment bank Piper Sandler. That is roughly triple the original congressional estimates.

IRS officials have been warning for months about fraud and overstated claims for the credit. And many accountants have said that ERC firms are stretching the eligibility criteria. But the government has also been facing pressure in the opposite direction, from business owners and lawmakers concerned about refund backlogs that sometimes stretched for months.

In its statement, the IRS said it worked through a backlog of 800,000 claims and then began intensifying its reviews and compliance work as more refund claims came in.

The IRS discourages employers from using ERC firms that charge large upfront fees or that base fees on a percentage of the tax refund. This summer, it issued a legal memo that warned against an argument some firms were using to claim the ERC based on supply-chain disruptions.

In the past, the IRS has dealt with widespread tax dodging by offering settlements for people who disclose their transactions. That can be particularly efficient for the government, compared with thousands of individual audits that depend on the facts in each situation. An IRS employee told a congressional office late last month that the agency is working on such a program for the ERC, according to a message viewed by The Wall Street Journal.

In addition, IRS Commissioner Danny Werfel said that the IRS might ask Congress to accelerate the deadline for amended tax returns claiming ERC refunds. Under current law, 2020 tax returns can be amended until April 2024, and 2021 returns can be amended until April 2025.

Write to Richard Rubin at richard.rubin@wsj.com