IRS makes progress on backlogged ERC claims

Editor: Mark G. Cook, CPA, CGMA

On June 20, 2024, the IRS announced plans “to deny tens of thousands of improper high-risk Employee Retention Credit [ERC] claims while starting a new round of processing for lower-risk claims to help eligible taxpayers.”

The IRS announcement (IR-2024-169) came after a detailed review process involving digitizing information and analyzing data since September 2023, when the IRS announced a processing moratorium on ERC claims. During this review, the IRS determined “between 10% and 20% of claims fall into what the agency has determined to be the highest-risk group,” while an additional 60% to 70% of the claims showed an “unacceptable level of risk.” The IRS indicated it would soon deny the highest-risk claims while continuing to analyze claims with an unacceptable level of risk.

Despite the percentages of claims with high or unacceptable levels of risk, the IRS determined that 10% to 20% of the claims were low-risk. The Service indicated that, to address concerns about small businesses waiting on legitimate claims, it would begin “judiciously processing more of these claims.”

The ERC and the September 2023 claims moratorium

Congress introduced the ERC during the COVID-19 pandemic as a means to financially assist businesses that retained their employees between 2020 and 2021. First enacted by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136, the ERC was designed to encourage businesses to retain their employees by helping alleviate employee retention costs.

However, the credit soon became the target of aggressive and often improper campaigns, with promoters marketing their services even well after the pandemic ended. Promoters often marketed the ERC by claiming it was a grant, business stimulus payment, or government relief, all in order to entice taxpayers into filing a claim. Promoters would typically receive a percentage of the credit paid out to the taxpayer.

In an effort to quell the flood of claims driven by such promoters, the IRS announced a processing moratorium on ERC claims submitted after Sept. 14, 2023. This allowed the IRS time to digitize the “nearly 1 million” unprocessed claims and evaluate its next steps. The Service announced on Aug. 8, 2024 (IR-2024-203) that it would adjust the moratorium period and “judiciously” process claims filed after Sept. 14, 2023, and before Jan. 31, 2024; the focus of the claims processed during this adjusted period would be on the highest- and lowest-risk claims.

Taxpayer options to withdraw or disclose erroneous claims

Given the number of claims with unacceptable to high levels of risk, the IRS introduced several methods for taxpayers to rectify their mistakes.

First, taxpayers that submitted ERC claims that have not yet been processed can voluntarily withdraw them by using the ERC withdrawal program “to avoid future compliance issues.” As noted in IR-2024-169, the program applies only to taxpayers that submitted ERC claims the IRS has not yet processed. The IRS will treat a withdrawn claim as though it was never filed, and no interest or penalties will apply. In addition, the withdrawal program applies to taxpayers that received an ERC check but have not yet cashed or deposited it.

A second method for rectifying mistakes related to erroneous ERC claims is the voluntary disclosure program (VDP). The initial round of the VDP, which closed on March 22, 2024, allowed taxpayers who believed they had incorrectly filed their ERC claims to voluntarily return to compliance with the IRS by repaying an ERC payment at a 20% discount without being penalized. On Aug. 15, 2024, the Service announced (IR-2024-212) a second round of the VDP, which allows businesses a chance to correct improper ERC payments at a 15% discount and avoid future issues such as audits, full repayment, penalties, and interest. The second round of the VDP is scheduled to end on Nov. 22, 2024, and the IRS makes clear that those who receive “clawback” or “recapture” letters from the Service will be ineligible to participate in this second round.

In an effort to ensure taxpayer compliance with the ERC guidelines, the IRS also announced it intended to work on questionable claims and pursue various courses of action. Such IRS enforcement actions may include:

• Recapture letters for improper 2021 claims: The IRS previously issued letters for tax year 2020.
• Criminal investigations: As of May 31, 2024, the IRS had initiated over 460 criminal cases relating to potentially fraudulent claims worth nearly $7 billion.
• Audits: Currently, thousands of ERC claims are under audit.
• Promoter investigations: The IRS is gathering information about suspected and abusive tax promoters improperly promoting the ability to claim the ERC.

In an update on July 26, 2024 (IR-2024-198), the IRS added five additional warning signs of an incorrect ERC claim to those it had previously identified. The five additional issues are:

1. “Essential businesses” during the pandemic (which must show eligibility based on a qualifying reduction in gross receipts or partial suspension of operations due to an order from an appropriate governmental authority) were able to fully operate and did not have a decline in gross receipts;
2. Businesses were unable to support how a government order fully or partially suspended their business operations;
3. Businesses erroneously reported family members’ wages as qualified;
4. Businesses erroneously based their ERC claim on wages also claimed for forgiveness of their Paycheck Protection Program loan forgiveness; and
5. “Large employers” (those with more than 100 full-time employees in 2019 for ERC claims with respect to 2020 tax periods (500 with respect to 2021 tax periods)) claimed wages for employees who provided services (large employers could claim wages only of employees not providing services).

Previously, the IRS had identified these common errors:

• Claiming the ERC for too many calendar quarters;
• Relying on government orders that do not qualify;
• Claiming nonqualified wages;
• Citing supply-chain issues without meeting further requirements, including showing that the supplier’s operations were also fully or partially suspended due to a governmental order;
• Claiming the ERC for a greater part of a tax period than that in which the employer’s operations were fully or partially suspended due to a governmental order;
• Businesses claiming the ERC when they did not pay wages or did not have an employee identification number during the eligibility period; and
• Promoters claiming that an ERC claim should be filed because the business has “nothing to lose.”

Current state of ERC affairs

Although to date, the processing moratorium is still in place, the adjustment in the moratorium period suggests that the IRS may eventually process ERC claims submitted after Jan. 31, 2024. However, taxpayers should be wary of the schemes and potential missteps surrounding the ERC claims process and should review their application to ensure its accuracy and correctness. If a business believes it received an incorrect amount or submitted an application that may contain incorrect information, the Service recommends that the business look into the available methods to withdraw or disclose such erroneous claims.

For taxpayers that have submitted an ERC claim prior to the moratorium period and are confident that the claim is neither erroneous nor improper, the IRS has indicated that no additional action is necessary and urges such taxpayers to await further notification. In the meantime, the Service recommends that such taxpayers check with their tax advisers or review IRS materials to ensure they do not have a risky ERC claim in the queue.

Editor Notes

Mark G. Cook, CPA, CGMA, MBA, is the lead tax partner with SingerLewak LLP in Irvine, Calif.

For additional information about these items, contact Cook at mcook@singerlewak.com.

Contributors are members of or associated with SingerLewak LLP.