ERTC Update: IRS Red Flags the Employee Retention Tax Credit

Over the last three years, much talk has been about qualification for the Employee Retention Tax Credit (ERTC). The Internal Revenue Service (IRS) released guidance multiple times over this period, and millions of businesses have properly filed and received the ERTC refunds.

Unfortunately, while there are qualified and honest filings, many who filed were not eligible. Over the last year, the IRS has put the ERTC on its top scam alerts because many companies were misled regarding eligibility and filed inappropriate claims.

In response, the IRS created an Employee Retention Credit Eligibility Checklist: Help understanding this complex credit | Internal Revenue Service and reminds taxpayers to take “precautionary steps to independently verify their eligibility to receive the credit before applying through a promoter.” These “promoter firms” charge a % of the ERTC ranging from 10% to 25%. So, the more ERTCs you get, the higher their fee. If audited, most of these promoters, but not all, will repay the ERTC fee they charged. However, penalties, interest, and repayment of the ENTIRE ERTC are not covered.

The Red Flags

The IRS released Red flags for Employee Retention Credit claims; IRS reminds businesses to watch out for warning signs of aggressive promotion that can mislead people into making improper ERC claims | Internal Revenue Service and warns “businesses should be cautious of advertised schemes and direct solicitations promising tax savings that are too good to be true. Taxpayers are always responsible for the information reported on their tax returns. Improperly claiming the ERTC could result in taxpayers being required to repay the credit along with penalties and interest.”

Red flags include ploys that say you can “qualify in minutes,” offers of “risk-free claims” or an “advanced payment” on the ERTC, and many claim qualifications based on improper positions taking great liberties in the interpretation of the IRS guidance. Additionally, many promoters also did not consider or share with employers the impact on Paycheck Protection Program (PPP) loans, overhead rates calculated under the Federal Acquisition Regulations (FAR), and requirements to amend business income tax returns to reduce wage expense by the ERTC which creates taxable income for the claiming company.

On September 14, 2023, the IRS announced they were halting processing any claims received after this date until at least January 2024. This deferral period gives the IRS time to process the claims already in hand, scrutinize claims more carefully, and apply additional review and audit techniques. The ERTC claims only required filing an amended payroll tax return and did not require documentation to prove qualification, which attributed to the ease of fraud. As a result, the IRS is “increasingly shifting its focus to review these claims for compliance concerns, including intensifying audit work and criminal investigations on promoters and businesses filing dubious claims.” The IRS also announced that “hundreds of criminal cases are being worked, and thousands of ERTC claims have been referred for audit.” The IRS feels that most legitimate claims have already been filed and that the claims coming in at this point are more likely to be based on aggressive marketing campaigns and more apt to be ineligible or fraudulent. The notice stated, “The IRS is increasingly alarmed about honest small business owners being scammed by unscrupulous actors, and we could no longer tolerate growing evidence of questionable claims pouring in,” IRS Commissioner Danny Werfel said. “The further we get from the pandemic, the further we see the good intentions of this important program abused. The continued aggressive marketing of these schemes is harming well-meaning businesses and delaying the payment of legitimate claims, which makes it harder to run the rest of the tax system. This harms all taxpayers, not just ERTC applicants.” Werfel urged businesses with legitimate claims to continue filing and work with a trusted tax professional who understands the complex ERTC rules, not a promoter after easy money.

ERTC Claim Withdrawal Service

On October 19, 2023, the IRS issued details on a special Withdraw an Employee Retention Credit (ERC) claim | Internal Revenue Service. This service was created to allow any business that filed a claim in error and who had not received the refund to withdraw the claim without any penalty, interest, or criminal charges. At that time, the IRS noted, “if you willfully filed a fraudulent ERTC claim, or if you assisted or conspired in such conduct, withdrawing a fraudulent claim will not exempt you from potential criminal investigation and prosecution.”

To qualify for withdrawal, you must meet all of the following:

• You made the claim on an adjusted employment tax return (Forms 941-X, 943-X, 944-X, CT-1X).
• You filed your adjusted return only to claim the ERTC and made no other adjustments.
• You want to withdraw the entire amount of your ERTC claim.
• The IRS has not paid your claim, or the IRS has paid your claim, but you have not cashed or deposited the refund check.

Since the withdrawal process didn’t assist those who had already received their refunds, on December 21, 2023, the IRS released information on Employee Retention Credit – Voluntary Disclosure Program | Internal Revenue Service. (ERC-VDP). The ERC-VDP allows you to notify the IRS that you want to return the ERTC funds you received in error without penalty and at 80% of the credit you received. The IRS is offering this “discount” to help offset the fees businesses may have paid to one of these boutique firms so that there is as little financial harm as possible. This program is only available through March 22, 2024, and you can only apply if:

• Your ERTC claimed on an employment tax return has been processed and paid as a refund, which you have cashed, deposited, or paid in the form of a credit applied to the tax period or another tax period.
• You now think that you were entitled to $0 ERTC.
• You are not under employment tax examination (audit) by the IRS.
• You are not under criminal investigation by the IRS.
• The IRS has not reversed or notified you of intent to reverse your ERTC to $0. For example, you received a letter or notice from the IRS disallowing your ERTC.
• You did NOT use a third-party payer (such as a section 3504 agent, professional employer organization (PEO), or a Certified Professional Employer Organization using the third-party payer’s own Employer Identification Number (EIN) rather than your EIN) to file your employment tax returns.

If approved, the benefits of the ERC-VDP not only allows you to keep 20% of the ERTC, but it also allows you to keep any interest you received with the ERTC refund. The IRS will not charge penalties or interest on the claimed ERTC amount if you pay it in full (minus 20%) by the time you return your signed closing agreement to the IRS. The IRS will not examine ERTC on your employment tax return for tax period(s) resolved within the terms of ERC-VDP. You do not have to amend income tax to pay tax on the 20% – the reduction will not be considered taxable as income. A side note – you would still want to amend your business income tax return to claim the additional wages on the 100% of the ERC originally claimed, as you had to reduce wages by this when you filed your ERC claim. The IRS is also offering a repayment plan for those not able to pay all at once, however, that would come at a cost of some interest expense.

While the ERC-VDP is a wonderful opportunity to repay the ERTC filed in error and avoid penalties & interest, it does come with a requirement to “Cooperate with any requests from the IRS for more information and sign a closing agreement”. The terms of the ERC-VDP closing agreement cannot be appealed. One main component of this program is the employer must provide the IRS with the names, addresses, and telephone numbers of any advisors or tax preparers who advised or assisted them with their claim and details about the services provided.

This request may set the stage for the IRS to evaluate whether the claims were indeed in error or if the promoters have a history of filing dubious claims; the IRS could then go after these “bad actors” at a criminal level.

Next Steps

If you have a concern over your already filed ERTC and would like a second opinion on qualification or if you would like an analysis of qualification for an unfiled current legitimate ERC claim, please reach out to Kelly A. Chambers, CPA.