In its most recent effort to fight fraudulent and improper Employee Retention Tax Credit (ERC) claims, the Internal Revenue Service (IRS) is notifying an initial 20,000 taxpayers that it is rejecting their claims. The IRS, which made the announcement on Dec. 6, 2023, is issuing disallowance letters to taxpayers who did not exist or who did not have employees during the eligibility period but still claimed the ERC.
The ERC is a refundable tax credit for businesses that paid employees while shut down due to the COVID-19 pandemic or for those that had significant declines in gross receipts from March 13, 2020 to Dec. 31, 2021. Previously, the Tax Inspector General for Tax Administration (TIGTA) has criticized the IRS for mishandling ERC claims, for instance noting that that IRS did not have a process to verify whether a taxpayer claiming the ERC in the fourth quarter of 2021 was an “eligible business” otherwise entitled to the ERC.
IRS Commissioner Danny Werfel stated that due to “the aggressive ERC marketing we saw with this credit [the ERC], it’s not surprising that we’re seeing claims that clearly fall outside of the legal requirements. The action we are taking today is part of an initial set of steps in our compliance work area, and more letters will be going out in the near future, including both disallowance letters and letters seeking the return of funds erroneously claimed and received.”
The IRS will send Letter 105 C, Claim Disallowed, the initial disallowance letter, to two types of taxpayers not eligible for the ERC:
- Taxpayers who did not exist during the ERC eligibility period. To qualify for the ERC, a taxpayer must be established no later than Dec. 31, 2021.
- Taxpayers who did not pay employees during the eligibility period. Since taxpayers are entitled to an ERC in an amount based on eligible wages paid to employees during the eligibility period, if a taxpayer did not pay any employees during the eligibility period then it does not qualify for the ERC.
Taxpayers who disagree with a disallowance letter can respond by providing the IRS with documentation supporting their eligibility or file an administrative appeal with the IRS Independent Office of Appeals.
Specialized ERC Voluntary Disclosure Program
In the Dec. 6, 2023 announcement, the IRS also foreshadowed a new voluntary disclosure program (VDP), designed for taxpayers who received improper ERC payments. The IRS expects to announce the new VDP this month. The VDP will operate side by side with the ERC withdrawal program the IRS recently announced for taxpayers who claimed the ERC but either had not received payment or had not cashed or deposited the refund check. The withdrawal program, however, did not provide any process for taxpayers who had already deposited ERC refunds outside of the IRS’ notoriously slow voluntary disclosure programs otherwise available to taxpayers. This specialized VDP should shift claims away from the general IRS voluntary disclosure programs to resolve voluntarily disclosed ERC claims more efficiently.
The IRS urges taxpayers who submitted an ERC claim to review their eligibility with a trusted tax professional, especially if they hired a tax credit promoter to file their claim. The ERC withdrawal and specialized VDP offer taxpayers a limited time opportunity to resolve their ERC claims on favorable terms.
Previous IRS Efforts
For almost two years, the Internal Revenue Service (IRS) has engaged in a concentrated compliance effort to stamp out improper Employee Retention Tax Credit (ERC) claims.
While the ERC was designed with the noble intent of helping businesses during the COVID-19 pandemic by encouraging businesses to keep employees on their payroll, ERC fraud has run rampant and unscrupulous promoters have pushed businesses that do not qualify for the credit to file fraudulent ERC claims.
As of Sept. 30, 2023, the IRS Criminal Investigations Division has initiated 301 investigations involving over $3.4 billion of potentially fraudulent ERC claims for tax years 2020 through 2023, the IRS has referred thousands of cases involving ERC clams for audit, on Sept. 14, 2023 the IRS issued a moratorium on processing new ERC claims through at least the end of this year, and on Oct. 19, 2023 the IRS announced a withdrawal program for certain taxpayers to withdraw their ERC claims.
The Takeaway
The ERC is a legitimate, refundable tax credit designed to help businesses that continued to pay employees while they were shut down due to the COVID-19 pandemic or that experienced a significant decline in gross receipts in 2020 and 2021 during the pandemic. In response to rampant ERC fraud and aggressive ERC promoters, however, the IRS is cracking down on taxpayers who made ERC claims for which they were not eligible.
Businesses that are considering filing an ERC claim should heed the IRS’ advice, thoroughly review their ERC eligibility, and consult with a trusted tax professional before claiming the ERC. Businesses that already claimed the ERC but now doubt their eligibility should consult legal counsel about their options, before they are contacted by the IRS.
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