On Dec. 21, 2023, the IRS announced procedures for a Voluntary Disclosure Program (VDP) for taxpayers to return Employee Retention Credit (ERC) refunds they believe they received improperly. This announcement comes after the IRS suspended the processing of new ERC filings on Sept. 14, 2023, and announced details for an ERC claim withdrawal program on Oct. 19, 2023. Taxpayers must apply for the VDP before the March 22, 2024 deadline.
What happened with the employee retention credit?
The ERC has been fraught with challenges since its enactment during a rapid series of COVID-19 relief legislative packages in early 2020. Legislative changes to the ERC in 2020 and 2021, along with varying opinions regarding ERC qualifications, has created confusion for both taxpayers and the IRS. Since the mechanism for requesting an ERC refund is on the Form 941 Payroll Tax Return, taxpayers are able to submit a claim for refund until the statute of limitation for amending the 941 has elapsed — years after the eligible quarter has passed.
During this time, the IRS has struggled to detect invalid claims among the rising influx of paper 941-X returns, creating an environment ripe for ERC promoters to advise taxpayers to submit claims even when eligibility criteria aren’t actually met. The IRS has issued several warnings throughout the past year about a very high volume of fraudulent and improper ERC claims, and on Sept. 14, 2023, the IRS announced an unprecedented pause on processing ERC claims through at least Dec. 31, 2023. The IRS also announced that it was creating a claim withdrawal program for taxpayers that wanted to withdraw ERC claims in progress, and a voluntary disclosure and settlement program to allow taxpayers to return improper ERC refunds.
On Dec. 21, 2023, the IRS released more details about the voluntary disclosure and settlement program, including program requirements and application procedures. Importantly, the application window is only open for a few short months and will close on March 22, 2024, so taxpayers considering taking advantage of this program will have to act quickly.
How the ERC Voluntary Disclosure Program works
Certain promoters collected fees based on percentages of ERC refunds, in some cases up to 30%. Taxpayers who wish to return an improper ERC refund may be concerned about how to pay back amounts representing such fees. To address this concern, under the VDP, the IRS will allow approved taxpayers to repay only 80% of the refund they received.
Approved taxpayers will be required to enter into a closing agreement with the IRS to resolve improper ERC claims. The IRS won’t charge participants with interest or penalties on the refunds they repay through the program, nor require taxpayers to repay any of the interest the IRS may have paid to the taxpayer on their ERC refund. Taxpayers who can’t repay the full 80% will be required to qualify for an installment agreement and will be responsible for any interest and penalties associated with such installment agreement in the same manner as any other taxpayer.
What are the income tax implications of repaying the ERC?
Under general tax principles, cancellation of debt may result in taxable income. In announcing the VDP, the IRS has taken the view that the forgiven 20% of the ERC claim, interest, and penalties aren’t included within taxable income.
If the taxpayer has already paid income tax on their ERC in the 2020 or 2021 tax year, then there is an opportunity to amend the income tax return upon entering the VDP to request a refund (plus interest). It’s important for taxpayers intending to repay 2020 ERCs to be mindful not to miss the 2020 income tax statute of limitations, which could be as early as March 15, 2024.
Who can participate in the ERC Voluntary Disclosure Program?
Taxpayers who received improper ERC refunds in any quarter can apply to the IRS under the VDP if the following requirements are met:
- The taxpayer isn’t under criminal investigation.
- The IRS hasn’t opened an employment tax audit for the applying taxpayer for the tax period(s) at issue.
- The taxpayer hasn’t received an IRS notice and demand for repayment for any part of the ERC.
- The IRS hasn’t received information from a third party that the taxpayer is noncompliant or received information related to the noncompliance as the result of an enforcement action.
Applying to participate in the ERC Voluntary Disclosure Program
Taxpayers who wish to participate in the VDP must submit an application on Form 15434, Application for Employee Retention Credit Voluntary Disclosure Program. Taxpayers must provide information about their ERC claims, including:
- Identifying taxpayer information, including name, address, and TIN.
- Information regarding all ERC claims for which refunds have been received and the taxpayer is requesting resolution through the ERC VDP program.
- All advisors and preparers who advised the taxpayer to claim, or who assisted the taxpayer in preparing a claim for, the ERC.
- A description of the services provided by any preparers or advisors.
What should taxpayers do if they think they filed an improper ERC claim?
Taxpayers who already received their ERC refunds and are concerned that their ERC claim may have been improper should consult with a trusted tax advisor. Because approved taxpayers will recognize significant benefits from the VDP relative to repaying amounts outside of the VDP, taxpayers who have concerns should weigh their options carefully. The IRS has ramped up efforts to identify taxpayers with invalid claims and have indicated that, upon detection, ineligible taxpayers can anticipate steep penalties and even criminal investigation and prosecution. The window for applying to participate in the ERC VDP will close on March 22, 2024, so taxpayers should take steps now to evaluate any potential ERC liability for improper refunds.
For more information on the ERC VDP, see the Voluntary Disclosure Program landing page or the IRS FAQs.
