Employee Retention Credits Being Scrutinized by IRS: Second ERC-Voluntary Disclosure Program Underway

During the pandemic, numerous government programs were created to help businesses stay afloat during those turbulent economic times. Program names reduced to acronyms, such as the PPP (Payroll Protection Program), became common parlance. With these programs came aggressive marketing techniques by promoter groups targeting businesses and urging them to apply for assistance whether they actually qualified for the programs or not.

One such program is the Employee Retention Credit (ERC). The ERC is a fairly complex tax provision aimed at helping businesses (not individuals) who were impacted by the pandemic.

According to the IRS, “Generally, businesses and tax-exempt organizations that qualify [for the ERC] are those that:

• Were suspended by a government order due to the COVID-19 pandemic during 2020 or the first three calendar quarters of 2021, or
• Experienced the required decline in gross receipts during 2020 or the first three calendar quarters of 2021, or
• Qualified as a recovery startup business for the third or fourth quarters of 2021

Eligible employers must have paid qualified wages to claim the credit.

Eligible employers can claim the ERC on an original or adjusted employment tax return for a period within those dates.”¹

As a result, the IRS was flooded with claims, not all of which were valid. Some of these invalid claims were filed as a result of promoters essentially saying, “try it and see what happens.” However, what can happen is a claim being denied, or a claim being improperly paid and then disallowed at a later date, resulting in costly penalties.

The IRS has been actively working on denials for improper ERC claims, as well as stepping up audits and pursuing civil and criminal investigations of potential fraud and abuse. According to the IRS, this summer, “the IRS has sent out 28,000 disallowance letters to businesses whose claims showed a high risk of being incorrect. The IRS estimates that these disallowances will prevent up to $5 billion in improper payments. Thousands of audits are underway, and 460 criminal cases have been initiated. The IRS has also identified 50,000 valid ERC claims and is quickly moving them into the pipeline for payment processing….”²

The IRS is encouraging any businesses that have received the ERC to carefully review their eligibility requirements. If businesses find that they received the ERC in error, the IRS has created a second ERC-Voluntary Disclosure Program for businesses to correct improper payments at a 15 percent discount and avoid future audits, penalties, and interest. The ERC-Voluntary Disclosure Program will run through November 22, 2024.

This allows businesses to withdraw or self-correct and avoid costly penalties. The IRS has outlined a list of new warning signs to help businesses determine if their ERC filings may be made in error:

• Essential businesses during the pandemic that could fully operate and didn’t have a decline in gross receipts.
• Business unable to support how a government order fully or partially suspended business operations.
• Business reporting family members’ wages as qualified wages. 
• Business using wages already used for Paycheck Protection Program loan forgiveness. 
• Large employers claiming wages for employees who provided services. 

The IRS also reminded businesses about these other common issues being seen. The agency has continued to issue warnings involving these seven areas:

• Too many quarters being claimed. Qualifying for all quarters is uncommon, and this could be a sign of an incorrect claim.
• Government orders that don’t qualify. Some promoters have told employers they can claim the ERC if any government order was in place in their area, even if their operations weren’t affected or if they chose to suspend their business operations voluntarily. This is false.
• Too many employees and wrong calculations. Employers should be cautious about claiming the ERC for all wages paid to every employee on their payroll. The law changed throughout 2020 and 2021. There are dollar limits and varying credit amounts, and employers need to meet certain rules for wages to be considered qualified wages, depending on the tax period.
• Business citing supply chain issues. Qualifying for ERC based on a supply chain disruption is very uncommon. A supply chain disruption by itself doesn’t qualify an employer for ERC. An employer needs to ensure that their supplier’s government order meets the requirements.
• Business claiming ERC for too much of a tax period. It's possible, but uncommon, for an employer to qualify for ERC for the entire calendar quarter if their business operations were fully or partially suspended due to a government order during a portion of a calendar quarter. A business in this situation can claim ERC only for wages paid during the suspension period, not the whole quarter.

• Business didn’t pay wages or didn’t exist during eligibility period. Employers can only claim ERC for tax periods when they paid wages to employees.
• Promoter says there’s nothing to lose. Businesses should be on high alert with any ERC promoter who urged them to claim ERC because they “have nothing to lose.” Businesses that incorrectly claim the ERC risk repayment requirements, penalties, interest, audit and potential expenses of hiring someone to help resolve the incorrect claim, amend previous returns or represent them in an audit.

To be eligible to apply for the ERC-Voluntary Disclosure Program, businesses cannot have applied for the first ERC-Voluntary Disclosure Program for the same time period, not be under criminal investigation or an IRS employment tax examination for the same ERC period, have not received an IRS notice and demand for repayment for all or part of its ERC claim, and have not already filed an amended return. Also, the IRS cannot have received information from a third party that the business is not in compliance.³

To apply, employers must fill out Form 15434, Application for Employee Retention Tax Credit Voluntary Disclosure Program, available on the IRS website.

If you received an Employee Retention Credit, we encourage you to speak to your business tax professional.