UPDATE 3-US accuses some Jackson Hewitt outlets of tax fraud

(Adds details in paragraph 6, comment from Sen. Baucus)

By Jonathan Stempel

NEW YORK, April 3 (Reuters) - The U.S. government has sued the operators of more than 125 Jackson Hewitt Tax Service Inc. (JTX.N) tax preparation offices, accusing them of cheating the U.S. Treasury out of more than $70 million through a "pervasive and massive series of tax-fraud schemes."

The complaints target five franchises that operate offices located in the Atlanta, Chicago, Detroit and Raleigh-Durham, North Carolina areas, as well as 24 individuals.

Parsippany, New Jersey-based Jackson Hewitt is the second-largest U.S. tax preparer, with 5,802 franchised and 724 company-owned offices as of Jan. 31. It did not immediately return calls seeking comment.

Jackson Hewitt shares fell 18.1 percent, or $5.87, to close at $26.53 on the New York Stock Exchange.

The company has been winning market share in recent years from larger rival H&R Block Inc. (HRB.N), which has struggled with its own regulatory and legal problems, as well as losses in its Option One Mortgage Corp. subprime lending unit.

Investigators accused defendants in the Jackson Hewitt case of encouraging individuals to file bogus tax returns through such means as claiming fake deductions and fuel tax credits, seeking refunds based on phony earnings statements, and abusing the federal earned income tax credit.

In some cases, managers and employees took kickbacks from customers for helping them file fraudulent tax returns, the government said. The franchises prepared more than 105,000 federal income tax returns last year, the government said.

Mark Everson, commissioner of the Internal Revenue Service, called the case "the largest enforcement action of its kind."

The government is seeking to permanently bar the defendants from the tax preparation business, among other remedies.

"Preparing federal income tax returns based on falsehoods and fabrications is a serious violation of the law," Assistant Attorney General Eileen O'Connor said in a statement.

The government said defendant Farrukh Sohail owns all or part of the five franchises, and comes from the Atlanta area.

A message left at a number listed for Sohail in Marietta, Georgia was not immediately returned. Numbers listed for Sohail's company Smart Tax of Georgia Inc. were disconnected.

Max Baucus, a Montana Democrat who heads the Senate Finance Committee, said the case "underscores the need for closer oversight" of paid tax preparers.

"With a $345 billion total tax gap every year, we have an obligation to close the cracks through which billions of legally owed tax dollars currently fall," Baucus said in a statement.