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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.
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.
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.
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.
