The Internal Revenue Service has allowed itself to be used by embezzlers, vengeance-seekers and others to wreck innocent small businesses and turn their owners' lives upside down, a group of such self-described victims told a Senate panel yesterday.

An Oklahoma tax-return preparer, a Texas oilman and a Virginia restaurateur told lawmakers how raiding parties of armed agents from the IRS Criminal Investigation Division barged into their homes or offices, frightened their employees and families -- and ultimately came up empty-handed.

Two of the men said they later found that former employees had precipitated the raids, and that the IRS had done little or no checking on their informants' credibility. The third witness said he never could determine why he was targeted.

"Wow," said Sen. Daniel Patrick Moynihan (D-N.Y.) after hearing their stories. "We have to be much concerned about the paramilitary performance of the IRS. . . . It's government violence directed against citizens."

IRS Commissioner Charles O. Rossotti, in an unusual outdoor meeting with reporters in front of IRS headquarters on Constitution Avenue NW, said the allegations were serious.

"Should even one of these allegations prove true, it's one too many, and I won't tolerate it," he said.

The testimony came in the second of four days of hearings by the Finance Committee into allegations of IRS abuse of taxpayers and its own employees. The panel created a sensation last fall as taxpayers told of being hounded for taxes they had already paid or did not owe in the first place.

The public outpouring caused by those disclosures caught the Clinton administration and other Democrats by surprise and they have been struggling to defend the agency without suffering too much political damage.

Yesterday produced testimony similar to last fall's, but with an added element of guns and threats of violence.

Richard Gardner, whose company prepares 4,500 to 6,000 tax returns each year, said that one morning in 1995, he was called out of a meeting. He found 15 IRS agents and a half-dozen U.S. marshals in his lobby, "all armed and wearing those jackets that say in bright letters IRS' or U.S. Marshal' on the back."

They seized his client records, computers, personal papers and other files, he said, and held them for two years while the IRS investigation continued. Gardner was able to buy new computers and continue in business, but the damage to his business was extensive. He said IRS agents went to clients and demanded they wear hidden microphones when meeting with Gardner; they hauled his wife before a grand jury; and his employees were told they would be able to buy his business cheaply because he would be out of business soon.

Ultimately, he said, the IRS dropped the case. "It appears the IRS wanted a high-profile guilty even if you're not' victim to use to scare other tax preparers and taxpayers," Gardner said.

W.A. "Tex" Moncrief Jr. testified that he suffered a similar but even more fierce raid on his family-run oil company in Fort Worth in 1994.

Agents "stormed the offices like an army landing on an enemy beachfront," Moncrief said. "My employees heard the agents shout, IRS! This business is under criminal investigation! Remove your hands from the keyboards and back away from the computers. And remember, we're armed!' "

News media had been tipped to the raid and it was broadcast widely, which "sent my business reputation into a tailspin," Moncrief said.

It turned out that a former accountant, fired for incompetence, had gone to the IRS, Moncrief said. The former employee promised to lead them to $300 million in underpaid taxes in exchange for a deal that included a reward of up to $25 million. He in turn promised to share the reward with former government attorneys who helped him, Moncrief said.

Ultimately, the IRS offered to settle the case, first for $300 million, then for $100 million, then for $24 million, then for $23 million. At that point, Moncrief agreed to settle, having already spent $5.5 million on his own defense and seeing his business ruined by the publicity. He also had to agree not to sue the agency or its employees. "I didn't like this arrangement, but it was clear to me that if I didn't agree, the IRS would investigate our family business to its demise and me to my grave," he said.

John Colaprete, owner of the Jewish Mother restaurant in Virginia Beach, told lawmakers he was similarly raided after a bookkeeper, whom he had discovered embezzling, went to the IRS and told agents a lurid tale of drug dealing and gunrunning.

Colaprete, whose story was recounted last week in The Washington Post, said: "The system does not work for the American taxpayer." CAPTION: From left, W.A. "Tex" Moncrief Jr., Richard Gardner and Leroy W. Warren, chairman of the NAACP's criminal justice panel, were among witnesses in the second of four days of testimony before a Senate panel.