Employers should be careful before claiming the Employee Retention Credit (ERC).

Over the past several months, the Internal Revenue Service (IRS) has warned taxpayers twice about third parties who advise employers to claim the ERC when they may not qualify. A tax preparation company in Utah and two of its executives also face federal fraud charges relating to the improper claiming of the ERC.

IRS Issues Renewed Warning

The Internal Revenue Service (IRS) issued a renewed warning to taxpayers on March 7, 2023, urging them to carefully review the Employee Retention Credit (ERC) guidelines before claiming the credit. This warning followed an October 19, 2022 IRS news release that warned employers about third parties who advise employers to claim the ERC. The IRS and the tax community continue to see tax credit promoters aggressively advertising too-good-to-be-true ERC claims. Characteristics of ERC promoters include:

• Large upfront or contingent fees
• Opinions that lack legal and factual analysis
• Disclaimers that they are not providing tax advice
• Failure to inform taxpayers that wage deductions on income tax returns must be reduced by the amount of the credit

The ERC is a legitimate, refundable tax credit designed to help businesses who continued to pay employees while they were shut down due to the COVID-19 health crisis or who experienced a significant decline in gross receipts in 2020 and 2021. However, acting IRS Commissioner Doug O’Donnell believes that “there continue to be promoters who aggressively mislead people and businesses into thinking they [qualify] for these credits…The IRS is actively auditing and conducting criminal investigations related to these false claims.” In January, Lia Colbert, the Commissioner of the Small Business and Self-Employed Division of the IRS, told a group of Enrolled Agents that the ERC “unfortunately has been an area very ripe for fraudulent activity.”

Taxpayers are advised to heed the IRS’ advice and to thoroughly review their ERC eligibility as the IRS is actively auditing employers who claimed the credit and conducting criminal investigations of employers and promoters who engaged in ERC fraud.

Promoters Charged with ERC Fraud

On February 1, 2023, a federal grand jury in Salt Lake City, Utah returned an indictment against Zachary Bassett, Mason Warr, and their firm COS Accounting & Tax LLC dba 1099 Tax Pros. The defendants are charged with conspiracy to defraud the United States, wire fraud, and aiding and assisting the filing of false tax returns. This indictment is believed to be the first criminal charge related to the ERC.

The Department of Justice states that the defendants prepared and submitted more than 1,000 Forms 941 (employer’s quarterly federal tax return) and Forms 7200 (advance payment of employer credits due to COVID-19) that claimed more than $11 million in purportedly false and fraudulent employee retention credits over a 16-month period. The defendants allegedly solicited single member LLCs, including independent contractors, rideshare drivers, sole proprietors, and other Form 1099 workers to convert their “businesses” into LLCs taxed as S corporations to claim the ERC. The indictment also states that the defendants claimed the maximum allowable wage per employee, regardless of whether such wage was actually paid to the employee.

Prosecutors also alleged the defendants listed the spouses of married owners of the single member LLCs as employees to increase the amount of ERC, even when the spouse was not actually an employee of the business. Further, they alleged the defendants claimed sick and family leave wages regardless of whether or not an employee had qualifying sick or family leave events. Lastly, the Justice Department accused the defendants of signing their clients’ name on some returns.

Each defendant faces twenty-five criminal counts. Notably, the government is seeking forfeiture of property that was purchased with proceeds from defendant’s alleged scheme to defraud. This means that the government may seize real estate, cars, jewelry, or other valuable items that the defendants purchased with the profits they earned from preparing and filing returns that claimed fraudulent credits.

Given President Joe Biden’s interest in pandemic fraud, the IRS and Justice Department are expected to criminally charge additional tax credit promoters and taxpayers with ERC fraud.

The Takeaway

The IRS is hyper focused on ERC fraud and is using its considerable resources to investigate promoters who pedal the credit to unsuspecting employers.

Employers who claimed the ERC but now doubt their eligibility should consult legal counsel before they are contacted by the IRS. Employers also should beware of ERC promoters and seek a second opinion if they consider claiming the credit.

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