ERC Claims and Related Programs Require Taxpayers’ Careful Eye

In its short life, the employee retention credit has gone through multiple iterations, driven by four separate statutes and even more administrative guidance.

The IRS page covering ERC guidance links to over 50 unique resources and pieces of guidance that may pertain to ERC claims. Adding to this already-complex framework, promoters aggressively sold too-good-to-be-true ERC refunds, leading to intense IRS scrutiny and enforcement.

All this has created a complicated framework fraught with potential missteps. Taxpayers with pending or refunded ERC claims should evaluate their claims and weigh potential benefits of participating in the IRS’s withdrawal or voluntary programs—the latter’s deadline is March 22. Those that choose not to participate in either program must ensure they have adequate supporting information to document previously filed claims.

IRS Moratorium

ERC filings have slowed as the pandemic era has given way to a new normal, particularly following the IRS announcement of a moratorium on processing ERC claims last fall. Nonetheless, practitioners continue to see questions from taxpayers.

Currently, employers seek greater certainty regarding the strength of an ERC claim prior to filing. They are also increasingly securing advice from tax attorneys to document second opinions in support of existing claims. Thus, while the IRS moratorium on ERC claims has slowed the submission of ERC claims, meritorious claims continue to be pursued.

That said, advice on tax-related exposure in connection with past ERC claims is more common than advice related to new ones.

Carrot and Stick

Though claim refunds have slowed, employers that believe they have complied with all ERC requirements continue to pursue refunds. Outstanding ERC claims have even inspired employers to sue the IRS to force payment of their claims.

This litigation takes many forms. In Texas, one employer had filed ERC claims covering three quarters of 2021 and received neither its refunds nor a notice of disallowance. In a case still pending, that employer sued the IRS for payment of its claims, penalties, interest, and costs.

In another case, a California employer filed suit to enjoin the IRS from relying on Notice 2021-20 to deny ERC claims, arguing that the notice violates the Administrative Procedure Act.

Employers that have given up on claims, however, may wish to take advantage of the proverbial “carrots” the IRS has offered in conjunction with its enforcement “stick.” These carrots include a withdrawal program announced in October 2023 and the voluntary disclosure program announced in December 2023.

Under the withdrawal program, employers who haven’t yet cashed or deposited refund checks may rescind ERC claims and prevent future exposure, including potential repayment, interest, and penalties.

Under the voluntary disclosure program—through March 22—employers can avoid examination on the ERC claim, as well as penalties and interest, in exchange for paying back 80% of an ineligible ERC and giving information about providers who assisted with the unsubstantiated claim.

What to Expect

The IRS is aggressively pursuing all enforcement avenues, including criminal investigations, to ensure compliance. As a result, there is already an abundance of examination activity surrounding ERC claims. Issues that have appeared on audit include the amount of the credit, substantiation and documentation, reduction of deductible wages by the ERC amount, and inclusion in the proper period.

Taxpayers with non-compliant ERC claims face three categories of potential exposure: payroll and other federal tax penalties, Circular 230 sanctions, and obligations under Notice 2021-20. Potential federal tax penalties include those pertaining to:

• Underpayment of social security and Medicare taxes
• Improper claims for refund
• Persons who are required, and fail, to collect and pay over employment taxes
• Tax return preparers for understatements of tax liability due to unreasonable return positions
• Persons who aid or abet an understatement of tax liability
• Criminal penalties, including potential imprisonment, for willful attempts to evade or failures to pay tax and willful false returns and statements to the IRS

In addition to criminal penalties imposed under the tax code, fraudulent ERC claims may result in criminal liability for knowingly making false claims and statements to the government. Further exposure includes sanctions under Circular 230 for persons who helped make an ineligible ERC claim and potential non-compliance with obligations under Notice 2021-20.

To evaluate an ERC claim, employers should review information that supports their claims. For example, an ERC claim relying on the suspension of business operations may be supported by the government order that suspended operations and records demonstrating the extent to which operations were interrupted, in addition to other substantiating documentation.

An ERC claim relying on a reduction in gross receipts may be supported by records demonstrating gross receipts for the period(s) during which the ERC was claimed and records demonstrating gross receipts for the comparative period(s), in addition to other substantiating documentation.

Other supporting information may include records of employees who received qualifying wages, the amount of wages paid, and the employer’s payroll tax returns. While these are examples of the types of documentation that may support an ERC claim, taxpayers should be prepared with detailed substantiation, as the IRS is requiring a great deal of documentation to support claimed credits.

Considering the substantial enforcement efforts, employers should anticipate IRS exam activity for any ERC claims. Further, given the myriad guidance and misleading information that has been released regarding the ERC, all taxpayers who have submitted claims should review supporting documentation to ensure compliance with all requirements.

Employers with pending or refunded ERC claims should consider a third-party evaluation of their claims to identify potential audit exposure and to aid in determining whether they may benefit from the withdrawal or voluntary disclosure programs.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Ellen McElroy is partner at Eversheds Sutherland and advises on federal tax matters for businesses.

Kristen Martin is an associate at Eversheds Sutherland and advises on federal income tax issues.

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