IRS Creates a Voluntary Disclosure Program for Questionable ERC Claims

By Stanley Rose January 4, 2024

Introduction

In a September article, we explained that the IRS had exhausted its patience with bogus Employee Retention Credit claims and was taking several actions. Among them, the IRS issued a moratorium (through the end of 2023) on processing new ERC claims, promised to continue pursuing civil and potentially criminal action against those who filed erroneous claims, and created a program for filers to “undo” previously filed but unprocessed claims. Finally, it promised to roll out a Voluntary Disclosure Program (VDP) that would allow filers who already had collected their refunds to return them without incurring penalties, and that is the focus of this article.

Specifically, in Announcement 2024-3, released just before Christmas, the IRS explains that it has created a Voluntary Disclosure Program. It will allow qualifying applicants to unwind their erroneous collection of ERC funds by returning most (but not all) of their refunds, in exchange for immunity from penalties and interest. Interestingly, applicants also must share some dirt on the parties who advised them that they should apply for the ERC or assisted them in claiming it.

Background

The Employee Retention Credit (“ERC”) allows businesses to receive funding from the IRS to offset financial damage done by the pandemic. There are very specific rules addressing how to qualify, primarily consisting of:

1. A dramatic (and specific) reduction in revenue during certain parts of 2020 and 2021, or
2. A full or partial suspension of operations directly resulting from a government order, or (less common),
3. By qualifying as a “recovery startup business” during late 2021.

We explained these qualifications in articles published in April 1 of 2020, and on January 5 and January 7 of 2021. We also warned in another piece that we were seeing numerous instances of taxpayers being led to believe by commission-seeking third parties that they qualified for the credit when it was clear that they did not. The IRS saw plenty of the same, resulting in the actions described above that they took in September.

So far, taxpayers have withdrawn previously filed but unprocessed claims that would have yielded around $100 million in refunds. Also, the IRS has issued around 40,000 denial letters to taxpayers whose claims were processed and found to be invalid. Those denial letters relate only to the portion of 2020 filings that have been processed; they exclude unprocessed 2020 filings and all 2021 filings, whether processed or unprocessed. Those letters are just the tip of the iceberg, as more action is forthcoming to allow the IRS to collect payment of the tax, plus interest and penalties. These results are extremely strong evidence that many, many filers improperly took advantage of this program – knowingly or unknowingly.

With that background, we’ll dive into the Voluntary Disclosure Program with a Q&A format.

Questions and Answers

Q1 – What did the IRS do?

A1 – To supplement its moratorium on processing new ERC claims and its continued work on existing audits, in late December 2023, the IRS finalized and rolled out a Voluntary Disclosure Program (“VDP”) that it first alluded to in September.

This new program is distinguished from another one created in September. The older one allows filers to basically “un-file” unprocessed claims that they previously had submitted. In other words, the program created in September is an off-ramp available only to those whose claims have not yet been processed. (That program was created with a sunset date of 12/31/23, and while there is talk of that date possibly being extended, that deadline is intact as of the date this article is published.)

By contrast, the new program can be used only by those whose claims were already processed – generally filers who received their refunds, but now believe they should not have filed.

Q2 – Who can use the new VDP?

A2 – Those who received the benefits of the ERC (claim processed, refund or payroll tax reduction received) but believe they were not truly entitled to it can participate in the VDP if they meet the following criteria:

1. The year of the claim is not the subject of an IRS employment tax exam;
2. The taxpayer has not received IRS correspondence requesting repayment of the ERC (in whole or in part);
3. The taxpayer is not under criminal investigation; and
4. The IRS is not in possession of information leading it to believe that the taxpayer is out of compliance or subject to enforcement action. Presumably this criterion is limited to ERC-related compliance or enforcement, but it doesn’t explicitly say so. (Theoretically someone who ignored all those dire warnings about removing a tag on a newly purchased mattress could be in the IRS crosshairs too.)

Q3 – What’s the benefit of using the new VDP?

A3 – The benefits of using the VDP are best understood by contrasting them with the outcome of an IRS audit or other unfavorable determination handled outside of the VDP setting:

1. With an audit, the full amount of the tax benefit received must be returned. Under the VDP, only 80% of the tax must be repaid to the IRS.

Observation: This 20% discount is offered not only to concede that the IRS would face some litigation and administrative costs if enforcement were pursued, but also because the IRS understands that many innocent taxpayers were led astray by aggressive third parties who marketed their services calculating the ERC in exchange for a commission based on a percentage of the taxpayer’s refund. By requesting that only 80% of the tax be returned by VDP participants, the IRS hopes that taxpayers who step forward will forfeit only a net amount close to what they never should have gained, and not be out of pocket that much plus a commission. (Some of these fly-by-night “credit mills” have disappeared into the ether already, and taxpayers will have better luck picking up a bowling ball while wearing catcher’s mitts than they will clawing back any part of those commissions.)

2. Audit adjustments often include not only tax, but additional assessments of interest and sometimes penalties. However, those using the VDP generally will avoid paying interest or penalties.

Those who cannot repay the full amount of the ERC at once may incur interest by enrolling in an installment plan, but that is “forward-looking” interest. The “backward-looking” interest associated with many IRS audits will not apply to successful VDP applicants.

Observation: In our September article, we speculated that one of the penalties that seemingly could apply is the so-called “trust fund penalty.” This should be an especially frightening prospect because it is imposed in addition to “regular” penalties, and it is assessed not on the company itself, but directly and personally on the employees of that company who are responsible for payroll tax filings and submitting payroll taxes to the government. The IRS’ VDP FAQ section confirms that this formidable penalty is possible for ERC violations, but can be avoided by participation in the VDP.

Q4 – How and when do I apply for the VDP? What are the mechanics?

A4 – Applicants apply for acceptance into the VDP by submitting Form 15434 via the IRS website, using the Service’s “Document Upload Tool.” Note that whoever filed the original claim must file the Form 15434. In other words, if a third-party files employment tax forms on behalf of the applicant, that third party is tasked with filing the applicant’s Form 15434.

Applications must be filed no later than March 22, 2024. However, applicants are encouraged to begin the process sooner because a number of additional documents may need to accompany Form 15434, and gathering the related information may require some lead time. Additional documentation may include an extension of the statute of limitations (giving the IRS more time to examine related employment tax returns), change of address forms, Powers of Attorney, and excerpts from earlier filings showing identifying information of third-party filers.

After review, the IRS will inform applicants whether their applications were accepted. Successful applicants will be asked at that time to remit funds representing 80% of the ERC.

Q5 – Are there any “tattletale” provisions in the VDP application?

A5 – Why, yes there are!

Obviously, there are plenty of taxpayers and some third-party advisors who simply misinterpreted the rules, inadvertently leading to the desire now to “undo” their filings. But there are some advisors who deserve a bit of scrutiny by the IRS, and Part V of Form 15434 will allow the IRS to compile a list of doors to knock on. Part V requires the filer to disclose information regarding third parties who advised or assisted with the original application of the ERC. Specifically, the IRS requests the name, address, phone number, and details regarding what kinds of services and advice were provided.

Unrelated to Form 15434 (but included with the VDP Q&A), the IRS also has prescribed Form 14242 to, as the name of the form describes, “Report Suspected Abusive Tax Promotions or Preparers.” This can be used by those who were approached by these parties, but didn’t utilize their “services,” to report aggressive ERC hucksters.

Clearly, the IRS is still on the hunt for promoters of abusive tax schemes, and knows there was no shortage of them in the ERC arena.

Q6 – Do I amend my payroll tax return as part of the VDP?

A6 – While a VDP application is outstanding, an applicant should not file an amended payroll tax return, and an amended payroll tax return will not be required at all for successful VDP applicants. The VDP takes the place of an amended payroll tax return. Applicants who are denied entry to the VDP may want to consider an amended return but will have no protection against interest and penalties and no promise of a 20% discount.

Q7 – Do I amend my income tax return as part of the VDP?

A7 – Astute readers will recall that the employer’s share of payroll taxes represents a deductible expense for income tax purposes. Those who claimed the ERC enjoyed a reduction of payroll taxes as reported on their payroll tax filings (Forms 940/941) but suffered a corresponding reduction in deductible expenses on their income tax returns (Forms 1120, 1120S, etc.), because Congress doesn’t allow “double-dipping.” Sometimes this deduction reduction was reported on an original return, and sometimes it required an amended return. However reported, if a company got a break on its payroll taxes via the ERC, it couldn’t pretend it paid the full, unadjusted amount when reporting the payroll taxes as a deduction on its income tax return. Often, payroll taxes are combined with wages on an income tax return, and to properly account for the ERC, companies reduced their wage expense when computing taxable income.

Announcement 2024-3 is a strong candidate for the “Tortured Wording Award” for its failure to point out, in a straightforward manner, that taxpayers who previously lowered the deductible payroll expenses on their income tax returns (to reflect the ERC) are entitled to file amended returns to “undo” the shrinking of the income tax deduction (if they “undo” their claim to an ERC). Yet, the text barely mentions in passing (“nothing to see here . . .”) that the possibility exists that taxpayers might amend a return to regain what for many are very significant deductions.

Presented below are the sentences in Term 3 of Section 3 of Announcement 2024-3, entitled “Income Tax Effects,” with separate columns showing (1) what the IRS wrote (verbatim) and (2) what they could have written if they had chosen to deploy plain English.

Income Tax Effects

A Translation of Announcement 2024-3, Section 3, Term 3

“If they file an amended return . . .” in the third term above is the only reference to reinstating the wage/tax deduction (an action that will benefit taxpayers). This seemingly could have been explained more clearly.

Conclusion

The ERC was a very potent lifeline for qualifying entities that were negatively impacted by the pandemic. Huge dollars were spent on it, in some cases representing the only way companies survived. But it also brought out some of the worst actors, and many innocent taxpayers fell for their twisted interpretations of how to qualify.

The Voluntary Disclosure Program introduced by Announcement 2024-3 provides a very attractive path for those who wish to undo aggressive ERC claims. It is very rare – almost unheard of – to see an IRS program that offers, up front, settlement for only 80% of the tax due, and promises zero interest or penalties. On the flip side, the IRS has warned that a day of reckoning was coming, and its enforcement actions are well underway. Many entities probably will utilize the VDP, and this will leave a smaller pool of ERC recipients for the IRS to audit, increasing the odds that those entities may face adjustments under far less favorable conditions.

These who are interested in the VDP should be sure to act well in advance of the program’s March 22, 2024, application deadline.

For more information, please contact Stanley Rose or your BNN tax advisor at 800.244.7444.