Congress created the Employee Retention Credit (ERC) as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020. The CARES Act was one of six pieces of federal legislation enacted between March 2020 and the end of 2021 designed to spend America out of the economic disaster that arose from Covid-19 and, perhaps even more so, the shutdown orders that were issued (with few exceptions) throughout the United States.
The ERC is found in Internal Revenue Code Section 3134. It was designed to provide an incentive for employers to keep their employees on the payroll, even if they were not working. The ERC is a refundable credit against employment taxes owed by employers. The law allows employers to obtain a credit of up to $7,000 per employee per quarter (capped at $21,000).
Recently, the IRS sounded the alarm concerning potentially bogus ERC claims. In July 2023, the IRS issued a news release claiming that it was looking more closely at all ERC claims. The agency is increasingly concerned that marketing by firms overstating ERC eligibility is leading to “businesses filing dubious claims.” In that news release, Commissioner Werfel stated:
The further we get from the pandemic, we believe the percentage of legitimate claims coming in is declining. Instead, we continue to see more and more questionable claims coming in following the onslaught of misleading marketing from promoters pushing businesses to apply. To address this, the IRS continues to intensify our compliance work in this area.
There was always a clear risk that this could happen. Refundable credits have long been the bane of our tax system. People wonder why the IRS targets low-income citizens for audits at a high rate. The reason is that low-income citizens are the ones who claim the earned-income tax credit (EITC). This is also a refundable credit, allowing certain low-income citizens to get more money back from the government than they paid to begin with. The Office of Management and Budget has dubbed the EITC a high-risk program because of the level of fraud associated with it.
Interestingly, the IRS does not specifically identify the nature of the ERC fraud in question. However, later news releases (discussed below) indicate that marketing companies, not tax professionals, are submitting claims for businesses that don’t qualify for the credit. To be sure, after Congress created code Section 3134 in March 2020, the law went through three amendments between then and November of 2021, at which time it was repealed retroactively, except for certain exceptions. This has created what the IRS acknowledges to be a very “complex credit with precise requirements.”
Yet complexity does not excuse the filing of a deliberately false claim, which constitutes a potential felony offense, and at the very least, carries civil penalties and interest on any required payback. It does, however, explain why taxpayers by the millions are driven into the waiting arms of professional hustlers who take advantage of the complexity of the system and the ignorance of citizens.
In September, the IRS announced an immediate moratorium through at least the end of 2023 on processing ERC claims. In issuing the moratorium, Commissioner Werfel stated:
The IRS is increasingly alarmed about honest small business owners being scammed by unscrupulous actors, and we could no longer tolerate growing evidence of questionable claims pouring in. The further we get from the pandemic, the further we see the good intentions of this important program abused. The continued aggressive marketing of these schemes is harming well-meaning businesses and delaying the payment of legitimate claims, which makes it harder to run the rest of the tax system. This harms all taxpayers, not just ERC applicants.
Werfel went on to say that:
businesses should seek out a trusted tax professional who actually understands the complex ERC rules, not a promoter or marketer hustling to get a hefty contingency fee. Businesses that receive ERC payments improperly face the daunting prospect of paying those back, so we urge the utmost caution. The moratorium will help protect taxpayers by adding a new safety net onto this program to focus on fraudulent claims and scammers taking advantage of honest taxpayers.
The IRS will continue to work claims filed prior to September 14, but it is expected that the processing time will at least double, from 90 to 180 days, and perhaps become even longer if the claim faces future review or audit. The September news release also stated that the IRS would provide guidance on how businesses may actually withdraw erroneous ERC claims without facing penalties.
That procedure was just announced. Commissioner Werfel stated:
The IRS is committed to helping small businesses and others caught up in this onslaught of Employee Retention Credit marketing. The aggressive marketing of these schemes has harmed well-meaning businesses and organizations, and some are having second thoughts about their claims. We want to give these taxpayers a way out. The withdrawal option allows employers with pending claims to avoid future problems, and we encourage them to closely review the withdrawal option and the requirements. We continue to urge taxpayers to consult with a trusted tax professional rather than a marketing company about this complex tax credit.
Note that the IRS is clear regarding deliberately bogus claims. In the September news release, the agency claims that “hundreds of criminal cases are being worked and thousands of ERC claims have been referred for audit.” The IRS goes on to say that, “Those who have willfully filed fraudulent claims or conspired to do so should be aware, however, that withdrawing a fraudulent claim will not exempt them from potential criminal investigation and prosecution.” The IRS is currently working with the Justice Department to bring cases against egregious ERC claims and promoters “who have been ignoring the rules and pushing businesses to apply.”
To illustrate that the IRS means business, the agency announced in early December that it was issuing the first round of more than 20,000 letters to businesses denying their ERC claims. The letters are going to businesses that either didn’t exist during the eligibility periods or did not have paid employees during such periods. Such businesses are what the IRS refers to as “a large block of taxpayers” who don’t qualify for the credit. Upon disallowance of the credit, the IRS will seek repayment of all improper refunds.
The key in all this, according to Werfel, is to consult “a trusted tax professional” to address potential issues. If you’re concerned about an ERC claim, consult a tax professional — not a marketing company — with experience in ERC claims as soon as possible.
Author’s note: Nothing in this article should be construed as constituting tax advice, which can be given only by a qualified professional after full and accurate disclosure of all relevant facts.
(For more from the author of “The IRS and the ERC Mess” click HERE)
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