The Employee Retention Credit (ERC) was established to support businesses during the COVID-19 pandemic by providing refundable tax credits for maintaining employee payrolls. However, the Internal Revenue Service (IRS) has identified a significant number of improper ERC claims, leading to intensified audits and enforcement actions.
Surge in Improper Claims
In recent months, the IRS has observed a substantial increase in ERC claims that do not meet eligibility requirements.
Aggressive marketing by some promoters has contributed to businesses submitting erroneous claims, often without a thorough understanding of the program's complexities. This surge has prompted the IRS to take decisive action to protect the integrity of the tax system.
IRS Enforcement Actions
To address the issue of improper ERC claims, the IRS has implemented several measures:
- A processing moratorium on new ERC claims filed after September 14, 2023, giving the agency time to build better fraud-detection filters before paying out more claims.
- An ERC claim withdrawal process allowing businesses with an unpaid or uncashed claim to withdraw it entirely and avoid penalties, interest, or examination, provided the claim was the only adjustment on the return.
- Two rounds of a Voluntary Disclosure Program letting businesses that already received an improper payment repay a reduced amount without penalties; the second round closed to new applications on November 22, 2024, so it's no longer an option for claims filed after that date.
- IRS Criminal Investigation has opened hundreds of ERC fraud cases covering billions of dollars in disputed credits, working alongside the civil audit function reviewing already-filed claims.
Warning Signs of Incorrect Claims
The IRS has identified seven warning signs of incorrect ERC claims:
- Claiming the credit for too many quarters. Qualifying for every quarter the ERC was available is uncommon.
- Relying on a government order that didn't actually suspend or limit the business's operations, or that the business voluntarily chose to comply with beyond what was required.
- Claiming the credit on wages paid to every employee on payroll, rather than only the wages that meet the specific ERC calculation rules.
- Citing supply chain disruptions as the basis for the claim. A supply chain issue alone doesn't qualify a business; it must have been subject to a qualifying government order that caused the disruption.
- Claiming the credit for more of a tax period than actually qualifies. A partial-quarter suspension of operations doesn't support claiming the credit for the entire quarter.
- Claiming the credit for a period when the business paid no wages, or before the business existed.
- Following a promoter who says there's "nothing to lose" by claiming. Incorrect claims can mean repayment, penalties, interest, and audit exposure.
Businesses are urged to review their ERC claims for these warning signs and consult with trusted tax professionals to ensure compliance.
Steps for Businesses
To navigate the IRS's intensified scrutiny of ERC claims, businesses should:
- Run their claim against the IRS's Employee Retention Credit Eligibility Checklist (Publication 5887) and the seven warning signs above.
- Gather and retain the documentation that supports eligibility: the gross-receipts decline calculation or the specific government order that suspended operations, plus the wage calculations used.
- If a claim looks wrong and hasn't been paid, or the refund check hasn't been cashed, use the claim withdrawal process rather than waiting for an IRS notice.
- If a claim was already paid and looks wrong, work with a tax professional on the correct path to repay or amend, since the Voluntary Disclosure Program's second round is now closed.
- Be skeptical of any ERC promoter who is not a CPA, attorney, or enrolled agent, or who is paid a contingency fee based on the credit amount.
By taking these proactive steps, businesses can ensure compliance with ERC regulations and avoid the risks associated with improper claims.
