April 3 (Bloomberg) -- The Justice Department sued to shut 125 franchises of No. 2 U.S. tax preparer Jackson Hewitt Tax Service Inc. as the IRS accused the outlets of submitting thousands of fraudulent returns that cost the government more than $70 million.

The retail offices -- in Detroit, Atlanta, Chicago and the Raleigh-Durham region of North Carolina -- preyed on people of ``modest means,'' the government said. The stores prepared more than 105,000 returns last year. All of them are partly owned by Farrukh Sohail of Atlanta, who was accused in court papers of creating a ``business environment'' where ``fraudulent tax return preparation is encouraged and flourishes.''

Jackson Hewitt shares plunged $5.87, or 18 percent, to $26.53 as of 4:23 p.m. in composite trading on the New York Stock Exchange. The stock rebounded to $27.25 in after-hours trading.

``This is the largest enforcement action of its kind,'' Internal Revenue Service Commissioner Mark Everson said. ``People of modest means'' who owe the government money may be ``left picking up the pieces,'' he said.

The government said today's action, the third time Jackson Hewitt franchises have been targeted by federal authorities in a year, is part of a crackdown on tax cheaters in anticipation of the April 17 deadline for individuals to file returns. The government has obtained more than 230 court orders to shut tax preparer outlets since 2001.

Jackson Hewitt Responds

In a statement released on PR Newswire tonight, Jackson Hewitt said the complaints were limited to one franchise, or 125 locations of its more than 6,500 total. The company ``takes such matters seriously,'' though it can't comment on franchise litigation, according to the statement. Jackson Hewitt doesn't expect the matter to have a material effect on its financial position, it said.

A woman at a Jackson Hewitt office in Chicago said Sohail no longer works at that location and has left the state.

The government suits identified 24 individuals who work or manage the franchises, including Sohail, one of the largest owners. Jackson Hewitt said it prepared 3.66 million tax returns in fiscal 2006, meaning Sohail's franchises would have prepared about 2.8 percent of the total.

``Sohail's main focus is volume, quotes and profit, all at the expense of preparing honest, accurate tax returns,'' the Justice Department said in court papers.

Sohail and other defendants claimed refunds based on phony W-2 forms, fabricated expenses and fuel tax credits in ``absurd amounts,'' the court documents said. There was also ``massive fraud'' in federal earned income tax credit claims, the government said.

Further Investigation

It may take months to resolve the suits and close all the offices, said Seth Heald, a Justice Department lawyer working on the case. He said the investigation is continuing and there could be more charges.

In the last fiscal year ended April 30, Jackson Hewitt's net income rose 16 percent to $57.9 million on $275 million of revenue. It has been taking market share from rival H&R Block, the No. 1 tax preparer, which has been hurt by regulatory probes, software failures and accounting errors.

Jackson Hewitt's business model relies heavily on selling ``territories'' to franchisees, who use the Jackson Hewitt brand name and sell the company's financial products. The franchises pay royalties to Jackson Hewitt as well as fees for the products used and for advertising the company does to promote the brand name.

As of Jan. 31, Jackson Hewitt had 5,802 franchise offices and 724 company-owned ones. About two-thirds of revenue for the nine months ending in January came from the franchises.

Separately, Jackson Hewitt agreed to pay $5 million in January to resolve California's claims that it used deceptive marketing to push high-interest tax refund anticipation loans to low-income people in California. Refund-anticipation loans are offered to taxpayers expecting a refund who don't want to wait the two weeks to a month the Internal Revenue Service typically takes to send them out.

To contact the reporters on this story: Ryan J. Donmoyer in Washington at rdonmoyer@bloomberg.net; Robert Schmidt in Washington at rschmidt5@bloomberg.net

Last Updated: April 3, 2007 23:55 EDT