As the IRS focuses on increasing enforcement efforts, many taxpayers who filed employee retention credit (ERC) claims are feeling the effects. Many have received inadequate advice about their qualification for ERC refunds, resulting in a tremendous number of questionable ERC claims. This deluge of invalid ERC claims has complicated ERC audit defense for even the most diligent taxpayers. Those who carefully evaluated their ERC eligibility are still having their claims scrutinized heavily by the IRS.
In this article, our tax professionals dive into how we got here, what taxpayers with ERC claims can expect going forward, and steps taxpayers can take to prepare for an IRS audit.
Why is the ERC getting so much attention?
Since being enacted as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, there have been a large number of questionable claims filed. The ERC can be extremely lucrative — small employers may be able to claim ERC credits worth millions of dollars. The ERC was enacted at the beginning of the COVID-19 pandemic amid unprecedented economic and social disruption, and the IRS hasn’t published significant guidance regarding eligibility, opening the door for a cottage industry of ERC evaluation “specialists” advising taxpayers, even on a contingent fee basis. These and other factors have caused the IRS to look at ERC claims with more skepticism. Although Congress intended to help businesses impacted by the COVID-19 pandemic with the ERC, statistics have shown that many claims were not filed until well after the pandemic concluded. Many claims remain unprocessed and unpaid.
IRS warnings about the ERC and updates
The IRS has issued multiple warnings regarding misuse of the ERC, beginning in the fall of 2022, and the ERC was later added to the IRS’s “Dirty Dozen” tax schemes list due to aggressive marketing by promoters and false claims about eligibility. Despite the IRS’s repeated warnings, the volume of improper ERC claims has continued to rise, and in response, the IRS halted the processing of newly received ERC claims through the end of the year. Taxpayers may file ERC claims until April 15, 2024, for 2020 claims (and until April 15, 2025, for 2021 claims), but the IRS has stated that it’s more skeptical of ERC claims filed in 2023 than in prior years because of the continuing increase in claims it considers improper.
The IRS is taking steps to provide taxpayers with amnesty opportunities; for example, it has made a claim withdrawal program available to taxpayers who have filed claims but not yet cashed their refund check, and is also in the process of creating a repayment program for taxpayers who have filed an improper ERC claim and already received the funds. These programs are intended to help unknowing taxpayers who fell victim to false statements by promoters of the credit and wish to avoid harsh consequences, including penalties and interest.
What to do if you’ve already filed an ERC claim
Taxpayers who have already filed an ERC claim should reevaluate their eligibility. Many taxpayers filed ERC claims based on misunderstandings of the eligibility requirements or faulty advice from ERC promoters. Since the enactment of the ERC, the IRS has released several updates to taxpayer guidance, which may help taxpayers better understand if they’re eligible, but that information is still open to interpretation. It’s important to keep in mind that a taxpayer isn’t immune from audit and harsh consequences just because they have received ERC refund checks. In fact, the IRS has confirmed it is currently reviewing already paid ERC claims and may select these claims for audit, just as the IRS is doing for unprocessed and unpaid claims.
Verify ERC credit calculation
In addition to verifying eligibility, taxpayers should ensure that their credit was properly calculated. Since the enactment of the ERC, the rules were updated to allow taxpayers to claim the ERC if they received forgiveness of a Paycheck Protection Program (PPP) loan, but they can’t claim the ERC on the same wages. Other common areas where calculation mistakes arise include correctly determining the employer aggregated group and computing a taxpayer’s decline in gross receipts.
Check ERC exposure during M&A planning
Taxpayers planning for M&A transactions should evaluate their ERC-related exposures as early in the process as possible. Due diligence may identify significant ERC exposures because the ERC can generate very large refunds — even for smaller employers — and the IRS can charge hefty penalties and interest on improperly paid ERC claims. Penalties and interest due on larger ERC refund payments could exceed hundreds of thousands of dollars, depending on the amount of the credit. A taxpayer who delays evaluating their ERC claims may discover mid-sale that they have a significant ERC-related exposure in relation to the sale price of their business, so reevaluating ERC exposure early in the process is recommended.
Consult with a tax professional
Now is a great time for taxpayers to consult with trusted tax professionals regarding ERC claims. Taxpayers should review their documentation and discuss with such professionals how best to address any deficiencies in their claims. Taxpayers should ensure that they have a file complete with all source documents and workpapers used to substantiate their eligibility and calculate their credits. Unlike the experience many taxpayers have had with income tax audits, the IRS is moving ERC audits along very quickly, and taxpayers won’t want to be pressed for time to locate documentation once an audit begins.
Consider the possibility of amended returns
Taxpayers must also address issues other than IRS audits; those who file ERC claims must consider amending income tax returns to ensure wages aren’t deducted for income tax purposes when such wages are used for calculating their ERC in order to comply with existing tax rules. Taxpayers should ensure they have complied with this requirement before any audit begins, as this is a common issue IRS agents will verify during an audit.
Taxpayers who are reconsidering their decision to file ERC claims may benefit from settling or withdrawing their claims to increase their chances of obtaining penalty protection, and they should discuss any questions they have about these programs with their trusted tax professional.
What to do if you’re considering filing an ERC claim
Taxpayers still have time to file ERC claims, but the IRS moratorium on processing new ERC claims, as well as increased enforcement efforts, should cause them to carefully consider the benefits and risks of pursuing an ERC claim. Taxpayers who engage a professional to consult on their ERC should choose carefully. The IRS has warned taxpayers repeatedly about predatory practices and misleading advice by third-party preparers, such as contingent fee structures, aggressive advertising, and guarantees that sound “too good to be true.” It has repeatedly encouraged taxpayers to consult with a “trusted tax professional.”
One of the factors that the IRS considers during an ERC audit is the taxpayer’s history with their ERC preparer. IRS representatives have stated that they look more favorably at ERC claims prepared by an accountant that has a prior professional relationship with the taxpayer, as opposed to a third party whose only work for the taxpayer has been the preparation of their ERC claim.
Taxpayers should also consider the timeline to receiving payment and the cost and effort involved in going through an IRS audit. Many taxpayers have waited years for payment of their ERC claims, and the IRS has increased the expected processing time for ERC claims due to the sheer volume of claims being filed, so taxpayers filing claims now could still be a long time away from receiving a refund check.
The ERC is unique because taxpayers claim it on employment tax returns, instead of income tax returns. As a result, the ERC is claimed on a quarterly basis, with eligibility determined for each quarter. For this reason, ERC audits can be more burdensome than other types of audits, as such audits must often be opened for several tax periods. IRS ERC audits can move quickly, but these audits can also expand beyond the ERC and take a significant amount of time to resolve. A taxpayer’s experience going through the IRS audit process can vary widely depending on the region in which the taxpayer’s case is assigned and the IRS agent working on their audit, so taxpayers should prepare for the possibility that they may be subject to a burdensome IRS audit if they file a claim.
Managing your ERC audit risk
Given the IRS’s warnings and announcements about their views of ERC misuse, it’s increasingly likely that ERC claims — especially claims for large amounts — will be selected for an IRS audit. A simple ERC audit could lead to substantial administrative and financial burdens for taxpayers who are not able to satisfactorily respond to the IRS’s questions and requests for information.
Taxpayers who are contacted by the IRS regarding their ERC claims will benefit from working with seasoned tax professionals who have experience evaluating ERC eligibility, calculating the credit, and defending IRS audits. If not deftly handled by a professional, an ERC-related audit could expand into other issues, so taxpayers should consider the potential cost of attempting to resolve their IRS audit without the assistance of tax professionals.
If you have questions about your ERC claim or are undergoing an IRS audit, reach out to the tax professionals at Plante Moran to discuss your options.
