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IRS halts Employee Retention Credit processing, identifies “red flags”
September 2023
In brief
The Employee Retention Credit (ERC) under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), enacted on March 27, 2020, was designed to provide funds via payroll tax credits during the second to fourth quarters of 2020 to eligible taxpayers that kept employees on the payroll while impacted by the COVID-19 pandemic. Subsequent legislation further expanded and extended the fully refundable tax credit through the third quarter of 2021, with limited eligibility in the fourth quarter of 2021 for recovery startup businesses.
Effective September 14, 2023, the IRS announced an immediate moratorium on processing new ERC claims. This restriction is expected to last at least until December 31, 2023. The IRS stated that a “substantial share of new claims from the aging program are ineligible and increasingly putting businesses at financial risk by being pressured and scammed by aggressive promoters and marketing.”
In addition to the moratorium on new claims, the IRS noted that processing existing claims will take longer due to an enhanced compliance refund review program and criminal referrals. Supplementing the IRS announcement is an alert to taxpayers warning about asserted predatory practices of ERC claim promoters.
Action Item: Organizations that are evaluating eligibility for the ERC should consider IRS "red flags” (detailed below) when making ERC eligibility determinations and quantifying the credit. While the IRS has stopped processing new claims for now, vetted and appropriate ERC refund claims may be filed on an ongoing basis to preserve taxpayers’ right to the refundable tax credit. Employers that have filed refund claims, whether or not funds have been received, should review the accuracy of the ERC claim and amount. More details on the withdrawal of existing unprocessed claims and the ERC settlement program for ERC refunds already received will be forthcoming from the IRS.
In detail
Background
An eligible employer may claim a credit against applicable employment taxes based on qualified wages, including certain health plan expenses, paid to some or all employees after March 12, 2020 and before October 1, 2021 (with limited exception). To be an eligible employer, one of the following tests must be met during the applicable period:
- A significant decline in gross receipts; or
- A full or partial shutdown due to governmental orders
For the 2020 year, a taxpayer generally experienced a significant decline in gross receipts during an eligible calendar quarter if quarterly gross receipts were below 50% of gross receipts in the same quarter in 2019. For 2021, under a broader rule, a significant decline in gross receipts occurs when the gross receipts for the eligible calendar quarter were below 20% of the comparable quarter in 2019. The significant decline in gross receipts ends with the first calendar quarter that follows the first calendar quarter for which the employer’s 2020 or 2021 gross receipts for the quarter are greater than 80% of its gross receipts for the same calendar quarter during 2019.
While the gross receipts test is quantitative, the government shutdown test is largely qualitative. A taxpayer had fully or partially suspended business operations during any eligible calendar quarter in 2020 or the first three quarters of 2021 (with limited exception) to the extent that orders from an appropriate governmental authority imposed restrictions upon the business operations limiting commerce, travel, or group meetings due to COVID-19.
Additional rules apply regarding aggregation of related entities, quantification of qualified wages eligible for the ERC, and eliminating duplicative credits or benefits counting the same compensation. Under the CARES Act and subsequent legislation, the ERC equals 50% of the qualified wages (including qualified health plan expenses) that an eligible employer paid in an eligible calendar quarter in 2020 and 70% of the qualified wages (including qualified health plan expenses) in the first three quarters of 2021. The maximum credit per employee in 2020 is $5,000; the maximum credit per employee for each of the first three quarters of 2021 is $7,000, for a total of $21,000 for the first three quarters of 2021.
Eligible employers report their total qualified wages for purposes of the ERC and claim the credit (including any refund in excess of the employer portion of social security or Medicare tax) on their federal employment tax returns; for most employers, this is the quarterly Form 941, Employer’s Quarterly Federal Tax Return, or Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return and Claim for Refund.
IRS Announcements
Increasingly since the enactment of the ERC and subsequent IRS guidance formalized in Notices 2021-20, 2021-23, 2021-49, and 2021-65, the volume of ERC refund claims paper-filed with the IRS has resulted in a significant backlog. According to IRS estimates, there are over 600,000 refund claims in the queue for processing. This has drawn IRS attention in light of ongoing ERC-vendor marketing campaigns targeting taxpayers. To that end, IRS Commissioner Danny Werfel stated:
“For those people being pressured by promoters to apply for the Employee Retention Credit, I urge them to immediately pause and review their situation while we look to add new protections and safeguards to stop bad claims from ever coming in. In the meantime, businesses should seek out a trusted tax professional who actually understand the complex ERC rules, not a promoter or marketer hustling to get a hefty contingency fee. Businesses that receive ERC payments improperly face the daunting prospect of paying those back, so we urge the utmost caution. The moratorium will help protect taxpayers by adding a new safety net onto this program to focus on fraudulent claims and scammers taking advantage of honest taxpayers.”
The IRS announcement in News Release 2023-169 on September 14 outlined several initiatives with the following IRS objectives:
- Establish a settlement program designed to help businesses that are victims of aggressive promoters, which includes repayments by those who received an improper ERC payment;
- Implement a special withdrawal option for those who have filed an ERC claim not yet processed. The IRS says that this option – which can be used by taxpayers whose claim has not yet been paid – is intended to allow taxpayers to avoid possible repayment issues and paying promoters’ contingency fees.
- Coordinate with the Justice Department to address ERC claims fraud and promoters who have been “ignoring the rules and pushing businesses to apply.” The IRS Criminal Investigation division is actively working to identify fraud and promoters of fraudulent claims for potential referral for prosecution to the Justice Department. To date, IRS-CI has uncovered suspected pandemic fraud totaling more than $8 billion. As of July 31, 2023, IRS-CI has initiated 252 investigations involving over $2.8 billion of potentially fraudulent ERC claims.
Observation: Taxpayers that are found ineligible for the ERC or claimed credits in excess of qualified wages may be held liable for penalties and interest in addition to being required to repay the credit. While withdrawing a fraudulent claim will not exempt affected taxpayers from potential criminal investigation and prosecution, taking proactive steps to evaluate existing claims at any stage in the refund process may help mitigate risk for tax, penalty, and interest liability.
The IRS also warned taxpayers in News Release 2023-170 of “aggressive marketing by nefarious actors” that claim taxpayers are eligible for the ERC. The IRS expressed increasing alarm about business owners relying on promoters to make ERC determinations and outlined the following “red flag” warning signs to avoid:
- Unsolicited calls or advertisements mentioning an "easy application process."
- Statements that the promoter or company can determine ERC eligibility within minutes.
- Large upfront fees to claim the credit.
- Fees based on a percentage of the refund amount of ERC claimed.
- Preparers seeking anonymity by refusing to sign the ERC return being filed by the business as well as supplying their identifying information and a tax identification number. Similar to "ghost preparers," this is intended to limit the risk to just the taxpayer claiming the credit.
- Aggressive claims from the promoter that the business receiving the solicitation qualifies before any discussion of the group's tax situation. In reality, the ERC is a complex credit that requires careful review before applying.
Additional information
For additional information on the ERC and related legislation, see:
- PwC Tax Insight: Employee retention credit can help financially impacted business
- PwC Tax Insight: Key takeaways from year-end funding bill’s amendments to the employee retention credit
- PwC Tax Insight: Final regulations address recapturing excess COVID-related employment tax credits from employers.
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