IRS Renews Warnings on Employee Retention Credit Refund Claims

Since the Employee Retention Credit (ERC) first became law as part of COVID-19 pandemic relief legislation, the IRS has made enforcement of the ERC a major focal point.  The IRS is aware that there are unscrupulous firms pushing ERC refund claims which do not meet the requirements for the ERC or taking aggressive interpretations of the law which would not be sustained on audit.  In recent months, the IRS has issued several notices reinforcing their position that ERC claims will be scrutinized closely for fraud and error.  If your business is considering pursuing an ERC refund (or has already done so), here are some things you need to know.

Background and History of the ERC

The ERC first came to be in March 2020, along with the Paycheck Protection Program (PPP), to provide relief to businesses struggling to stay open during the COVID-19 pandemic.  There are very specific eligibility requirements to claim the ERC. To be eligible, employers must have either: (1) Sustained a full or partial suspension of operations due to orders from an appropriate governmental authority limiting commerce, travel or group meetings because of COVID-19 during 2020 or the first three quarters of 2021, (2) experienced a significant decline in gross receipts during 2020 or a decline in gross receipts during the first three quarters of 2021, or (3) Qualified as a recovery startup business for the third or fourth quarters of 2021.  A taxpayer can claim the ERC on an original or amended employment tax return for “qualified wages” paid between March 13, 2020, and Dec. 31, 2021. 

Initially, members of the accounting profession observed that a much higher percentage of the ERC claims appeared to have merit, benefitting taxpayers the way ERC was intended.  But that has all changed in the past couple of years as ERC promoters have gotten increasingly aggressive, with greatly exaggerated assertions of how much a taxpayer may qualify for in ERC refunds.

IRS Steps Up Enforcement Efforts on ERC Refund Claims

The IRS has issued several warnings about ERC claims since it became law.  In a further warning made in March of 2023, the IRS added widely circulating promoter claims involving ERC as a new entry in its annual “Dirty Dozen” list of tax scams and schemes.  The IRS has significantly stepped-up audit and criminal investigation work involving these claims.  The IRS and tax professionals continue to see a barrage of aggressive broadcast advertising, direct mail solicitations, and online solicitations by these ERC “mills” that target unaware taxpayers. 

Third-party promoters of the ERC often don't accurately explain eligibility requirements or how the credit is computed. They may make broad arguments suggesting that all employers are eligible without evaluating an employer's individual circumstances.  ERC promoters may not inform taxpayers that they need to reduce the wage deduction claimed on the federal income tax return of their business by the amount of the ERC, which decreases the benefit.  In addition, many of these promoters don't tell employers that they can't claim the ERC on wages that were reported as payroll costs if they obtained Paycheck Protection Program loan forgiveness.

Due in part to the increase in ERC claims prepared by these promoters, the IRS is dealing with a large inventory of claims to process, many of them questionable.  “It’s along the spectrum of very aggressive to fraudulent,” Douglas O’Donnell, the IRS deputy commissioner for services and enforcement, said of some refund requests.  “We recognize that this is going slowly. We are very worried about the illegitimate claims.”  The IRS would of course prefer to prevent an ineligible claim from being processed, rather than auditing a taxpayer after the claim has been paid - but those audits will occur.  “Just because a refund has been paid, it doesn’t mean you’re free and clear,” O’Donnell said. “You may receive a refund that you’re not entitled to, and you’re going to run into a big cash-flow problem.”

The IRS has trained auditors examining ERC claims that pose the greatest risk, and the IRS Criminal Investigation division is working to identify fraud and promoters of fraudulent claims. The IRS reminds anyone who improperly claims the ERC that they must pay it back, possibly with penalties and interest. A business or tax-exempt group could find itself in a much worse cash position if it has to pay back the credit than if the credit was never claimed in the first place. And it may be difficult to get back the fee paid to the ERC promoter.  So, it's important to avoid getting scammed in the first place.

Warning Signs of Aggressive ERC Promoters

• Unsolicited calls or advertisements mentioning an "easy application process”
• Statements that the promoter or company can determine ERC eligibility within minutes.
• Large upfront fees to claim the credit
• Fees based on a percentage of the refund amount of Employee Retention Credit claimed
• Claims made by a promoter that a business qualifies before any discussion of the business’s tax situation

How Businesses Can Avoid Falling Prey to Aggressive ERC Promoters

• Work with a trusted tax professional. Eligible employers who need help claiming the credit should work with a trusted tax professional; the IRS urges people not to rely on the advice of those soliciting these credits. Promoters who are marketing this ultimately have a vested interest in making money; in many cases they are not looking out for the best interests of those applying.
• Don't apply unless you believe you are legitimately qualified for this credit. Details about the credit are available on IRS.gov, and a trusted tax professional – not someone promoting the credit – can provide critical professional advice on the ERC.
• If you’ve already signed a contract for ERC advice from one of these firms - or if you’ve already submitted an ERC refund claim based on advice provided by one - consider whether action needs to be taken to repair the damage and limit your exposure.  Remember that in addition to having to repay the tax, you may be liable for penalties and interest, as well as even facing possible criminal prosecution in more egregious cases. 

We Can Help

If you have questions or concerns about the Employee Retention Credit or any issues related to an ERC claim, consult your Elliott Davis tax advisor.

The information provided in this communication is of a general nature and should not be considered professional advice. You should not act upon the information provided without obtaining specific professional advice. The information above is subject to change.