Federal legislation relating to the employee retention tax credit (“ERTC”), passed to alleviate the financial burdens of businesses shut down due to governmental orders during COVID, is discussed in a prior Client Advisory. These credits are for taxes that an employer pays on employee compensation earned during a business shutdown. Shutdowns that put employees on unpaid leave do not qualify for the credit.

Taxpayer claims for the ERTC have been subject to detailed and extensive IRS scrutiny that has substantially slowed taxpayers’ receipt of the credit. In reviewing claims for credit, IRS has found a great deal of error and fraud.

IRS recently created the Office of Fraud Enforcement and National Fraud Counsel, which scrutinize, investigate, and prosecute tax fraud using data analytics. Schemes involving the ERTC are now top of the IRS Dirty Dozen Fraud List.

In a webinar on July 25, 2023, the IRS Office of Fraud Enforcement and National Counsel revealed the factors scrutinized when looking for fraud regarding ERTC applications. These factors revolve around the following issues:

1. Whether the entity filing for the ERTC is a real, active business.
2. Whether the entity filing for the ERTC existed during the period for which the ERTC is claimed.
3. Whether any stolen tax identification numbers are used on the return.
4. Whether the Social Security Number of any individual is of a deceased person or a prisoner.
5. Whether the credit being claimed seems inflated or false, given the other tax filings of the entity. Facts that IRS may cross-check include employment tax returns and compensation deductions on entity income tax returns. Another factor that IRS may use is the number of employees reported participating in the benefit plans of the entity.
6.   Whether the entity filing the return is already under investigation by the IRS.
7. Whether there has been a significant increase in payroll during the period for which the ERTC is claimed.
8. Whether the taxpayer files for an address change shortly before IRS issues a check for the credit.

IRS has already instituted criminal investigations against certain entities that have filed ERTC claims. Because of taxpayer privacy rules, however, the names of these individuals are confidential. The IRS has warned the public that certain consultants heavily advertising their ERTC services have prepared ERTC claims improperly and possibly fraudulently.

Taxpayers are advised to use trusted tax advisors in filing ERTC claims and to have patience for what has proved a long processing time for ERTC claims by the IRS.