Background – Employee Retention Credits
The Employee Retention Credit is a refundable tax credit available to certain eligible businesses and tax-exempt organizations which had employees that were affected during the COVID-19 pandemic. The credit is available to eligible employers that paid qualified wages to some or all employees after March 12, 2020, and before January 1, 2022. Subject to limitations, the credit aims to provide financial relief to qualifying businesses that:
- Were fully or partially shut down by a government order due to the COVID-19 pandemic; or
- Experienced the required decline in gross receipts during eligibility periods during 2020 or the first three quarters of 2021; or
- Qualified as a recovery startup business for the third or fourth quarters of 2021.
Increased IRS Scrutiny of ERC Claims
Due to growing concerns of fraudulent filings and deceptive practices in calculating ERC, the IRS has taken several steps to ensure the funds that have been or will be issued under ERC have been properly dispersed to qualifying taxpayers.
Many of these fraudulent ERC claims stem from taxpayers who engaged third-party firms that advertise their expertise in ERC claim preparation and made unscrupulous promises that almost guaranteed a substantial ERC refund regardless of the facts and circumstances involved. Moreover, many of these groups urged taxpayers to ignore advice from their tax professional CPA, Enrolled Agent or attorney. IRS has identified these ERC promoters. IRS can be expected to identify and audit taxpayers who engaged these “ERC mills” as IRS refers to them.
Moratorium on ERC Claims
Since announcing a moratorium on processing new ERC claims in September 2023, the IRS has reviewed claims with more scrutiny and continues to require certain validating documentation be provided by applicants. It is crucial to ensure that all information provided in your claim is truthful and can be substantiated, as the IRS will be taking a closer look at the details of each claim. Businesses should be prepared for potential audits and inquiries into their ERC claims, even if they believe their claims are legitimate.
IRS Voluntary ERC Withdrawal Program
In the fall of 2023, IRS began offering an option for taxpayers to withdraw their unpaid Employee Retention Credit (ERC) claim. Taxpayers concerned about eligibility of ERC claims filed requesting a refund, can withdraw the claim and avoid getting a refund for which they are ineligible. Claims that are successfully withdrawn would be treated as if they were never filed and the IRS will not impose penalties or interest.
Working with the IRS can be daunting, connect with one of our experts to create a plan.
The IRS Voluntary Disclosure Program – Repaying Erroneous ERC Refunds
Finally, on December 1, 2023, IRS announced the Voluntary Disclosure Program, its latest step to protect the integrity of ERC and safeguard the funds allocated for economic relief during the pandemic. By implementing this program, the IRS intends to give these taxpayers the opportunity to disclose ERC claims made in error before an ERC audit occurs to minimize repercussions.
- Deadline to Apply: Eligible businesses have until March 22, 2024, to apply.
- Repayment Terms: Businesses who are accepted are only required to repay 80% of the ERC amount they received.
- Interest Exemption: Businesses are not required to repay any interest received on their ERC refund claims.
- No Requirement to Amend for Wage Expense: Businesses that are accepted into the Voluntary Disclosure Program are not required to amend their income tax returns to reduce their wage expense.
- Installment Agreements: Businesses facing difficulties in repaying the full 80% can seek an installment agreement.
IRS Shares 7 Warning Signs that ERC Claims May Be Incorrect
Recently, IRS issued an Information Release in which it identified seven signs that an ERC claim may be incorrect. This release highlighted the special warning signs that an ERC claim may be questionable to help small businesses that may need to resolve incorrect claims. IRS scrutiny of questionable ERC claims could include audits, demands for repayment of erroneous claims, and significant penalty assessments. These seven suspicious signs an ERC claim could be incorrect are:
- Too many quarters being claimed – some ERC promoters urged employers to file claims for all available Legally, qualifying for all quarters is quite uncommon.
- Government orders that don’t quality – some ERC promoters advised employers to claim the ERC if any government Covid-19 shut-down order was in effect in their area regardless of its impact on the employer. Many ERC promoters advised employers to base their ERC claim on general OSHA guidance which IRS does not accept as a qualifying shut-down order for an ERC claim.
- Too many employees and wrong calculation – employers should be cautious about claiming ERC for all wages paid to every employee on the payroll. The law changed throughout 2020 and 2021. For example, there are limits imposed on how much of each employee’s wages qualify for an ERC claim based the number of full-time employees. Complex single employer aggregation rules for related businesses apply in this determination.
- Business citing supply chain issues – qualifying for ERC based on a supply chain disruption is very uncommon.
- Business claiming ERC for too much of a tax period – its uncommon for an employer to qualify for ERC for the entire calendar quarter if the shut-down order only involved a portion of the quarter.
- Business didn’t pay wages or didn’t exist during eligibility period – employers can only claim ERC for tax periods when wages were paid to employees.
- Promoter says there is nothing to lose – businesses should be on high alert with any ERC promoter who urged them to claim ERC because they “have nothing to lose.” Incorrect claims run the risk of repayments, penalties, interest, audit, and the potential expense of hiring a professional to represent the business in the IRS enforcement action.
We’re Here to Help
Navigating the ERC program and potential IRS audits can be complex and challenging. Bennett Thrasher has expertise in handing IRS Employee Retention Credit tax issues with the IRS. For more information, please contact Tim Watt, Tax Partner, or James Pickett, Director of Tax Controversy.
