IRS Suspends Processing of New Employee Retention Credit Claims

By Stanley Rose September 15, 2023

Introduction

The IRS yesterday finally became fed up enough with bogus Employee Retention Credit claims that it turned off the spigot, issuing a moratorium through at least the end of this year on processing any new claims. It also is ramping up scrutiny of existing claims and providing some off-ramps for those who previously filed claims, but now believe that perhaps they shouldn’t have. This follows the IRS promise a few weeks ago that it planned to intensify criminal investigations on promoters of aggressive claims that have led taxpayers astray.

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.

However, we also warned in another piece published last year that we were seeing numerous inquiries about the credit, often from clients who did not qualify from the credit, who were being led to believe that they did qualify. This resulted primarily from two things: (1) ads (radio, TV, internet, direct marketing) or (2) direct contact by third parties who promised to help compute the ERC – usually for a hefty percentage of the refund claim.

With the landscape thusly explained, let’s use a Q&A format to look at what happened at IRS headquarters yesterday, and why.

Questions and Answers

Q1 – What did the IRS do?

A1 – The IRS Commissioner ordered an immediate moratorium on processing new ERC claims. He also announced plans for creation of a few programs that previous filers can use to retract their claims. The programs appear to vary based on the status of the claim and who (IRS or taxpayer) pulls the plug on the claim:

1. One of the programs will be available to taxpayers whose claims are not yet processed, who would like to undo what they now suspect is an ill-advised claim.
2. Another is a settlement program for processed claims that are determined to be illegitimate – apparently with features that will allow repayment of previously-received claims, likely with reduced penalties.

This comes on the heels of a previous announcement a few weeks ago that the IRS Criminal Investigation Division was being asked to step in and focus its attention on a number of the third-party firms who were promoting sketchy claims.

Q2 – Why did the IRS do what they did?

A2 – Sometimes the IRS will process claims (ERC or routine income tax refund claims) quickly, and apply some scrutiny later, sometimes with a formal audit. (Congress has encouraged the IRS to process pandemic relief claims very quickly.) But through March of this year, the IRS has paid out over $150 billion in ERC claims, and the WSJ reports that the number could be as high as nearly quarter of a trillion by now. That’s a lot of cash to part with, when much of it should never have been paid. So far, the IRS Criminal Investigation Division has uncovered potential fraud totaling over $8 billion, and they have just started with 252 investigations. This confirms what many have believed all along – that a high percentage of claims are erroneous or downright fraudulent.

The IRS explained that part of the reason they took action this week is because many of the bad actors who tricked taxpayers into illegitimate filings have agreed to delay collection of their fees until the claims are processed and cash is received. The moratorium will help prevent taxpayers from having to chase those actors down later to try to recoup their fees after the fact.

This quote from IRS Commissioner Danny Werfel sums up his rationale:

“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,” 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 ERC applicants.”  “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,” Werfel said. “In the meantime, businesses should seek out a trusted tax professional who actually understands 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.”

Q3 – What is the harm in making a claim, if we believe it could be legitimate?  Couldn’t we be leaving money on the table if we don’t try?

A3 – The harm is the risk of penalties and interest if the claim is denied. Worse (and there seems to be very little mention of this), there is a risk that penalties could be imposed not only on the business entities that file the claims, but also on the employees responsible for the filings. Understanding of the mechanics of the claim is necessary for controllers, CFOs, and others to fully understand how serious this can be.

The claim is filed on a payroll tax form – Form 941. This makes sense because the claim is based on a reduction of payroll taxes. Then, on the taxpayer’s income tax return, the amount of the credit must be added back to income. This is consistent with the treatment of many other credits – to avoid “double-dipping,” you receive a deduction or a credit, but not both. (The employer’s payroll taxes normally create a deduction, but the credit generates a refund of those taxes, so it makes sense to decrease the deduction by the amount of the credit.)

Certain payroll taxes are deemed to be “trust funds,” in that they consist not only of entity tax, but also of those businesses’ employees’ Social Security and Medicare tax. In other words, even in a routine, pre-ERC setting, an employer is holding an employee’s money, and is charged with remitting it to the government on the employee’s behalf. For that reason, failure to remit those funds is viewed differently than failure of a business to turn over its own tax to the authorities, and penalties can be assessed not only on the business, but on the person responsible for the underpayment – generally the party who signs the payroll tax return or is responsible for the process (those in a company’s finance department, like controllers, CFOs, finance managers, treasurers, etc.). This is often referred to as a trust fund penalty.

Technically, the ERC is a reduction of the employer’s share of payroll tax. But because it can produce a refund that exceeds that amount, logically it can be viewed as dipping into the employee’s share of payroll taxes reported on the same form. For this reason, it seems possible that the trust fund penalty could be imposed.

So the risk of an aggressive ERC claim is that the money will have to be returned to the IRS, in addition to possible penalties and interest imposed on the company, and possibly (again, I haven’t seen this, but it seems plausible) penalties and charges levied against the individual employees of that company who were responsible.

Q4 – Why is there so much scrutiny on this? Why so many false claims?

A4 – The path to qualifying for an ERC claim is very, very narrow. Other than for new businesses, it involves one of two alternative paths, both of which are very objective determinations. One is a somewhat complex, but relatively straightforward math computation. The other is through suspension of operations due to orders from an appropriate governmental agency. This, too, is objective, but is where many interpreters miss the mark.

During the pandemic, a number of suggested guidelines were issued by the federal CDC. But enforceable orders generally were issued only by the states – generally through executive orders of the governors. Some ERC claims were erroneously based on voluntary shutdowns that followed CDC recommendations. That is not enough. In other cases, employees were not showing up to work, or customers were not visiting, or suppliers were failing to deliver. As a result, businesses shut down or greatly curbed their hours of operation. This, too, is not enough to qualify. It may have “felt” like suspended operations resulted from a government order, and indirectly an order may have played a part. But filing a claim based on the impression (regardless of how true it is) that the pandemic hampered your business is really applying a subjective measure to what is supposed to be an objective one. Voluntarily shutting down because there was no point in staying open is not the same as being ordered to shut down.

If those changes, however, resulted in decreased revenues, that may have provided a path under the other objective measure, and for many, it did.

It is rather difficult to qualify for the credit, in spite of well-known actors appealing to us in TV ads making us believe that it is easy.

Q5 – You are coming down awfully hard on these third-party firms who offer to help compute ERC claims. Why? What’s up with that . . . are CPAs threatened by them?

A5 – We are so busy that we welcome firms that legitimately help compute the ERC credit. After all, this really is a payroll-related filing, and our focus is on income taxes. We have worked with a number of legitimate firms that know and adhere to the rules, and we welcome their involvement.

But we are the ones who have a long-standing relationship with our clients, and plan to be here for the long haul, and we have seen some absurd proposals coming from some of these places, often after we or others helped determine that the criteria for a claim are not met. Also, note that of all the “players” in the payroll and income tax return filing mix, these third parties are the only ones not signing a tax return – a signature that you may recall is affixed “under penalties of perjury.” The taxpayer and its payroll service provider must sign the Form 941 initiating the claim. And then the taxpayer and its CPA sign the income tax return that reports net income – a number that is indirectly impacted by the credit, as explained above. These third-party promoters don’t sign anything that is being filed with the government. You may have legal recourse against them if they have led you astray, but they are not making direct assertions to the U.S. Treasury Department that all of the other parties involved with the ERC claim make when they sign a tax return.

Conclusion

Those who have filed ERC claims that, after a bit of reflection, seem like they may not qualify, should be on the lookout for one of the settlement programs that Commissioner Werfel announced yesterday. Those who are still considering filing should pay close attention to the qualification rules and understand that tremendous scrutiny is being applied to these filings, and to allow for that, processing of new claims will be delayed for months. Those who legitimately filed will need to be patient while the IRS looks harder at these filings, and diverts resources to auditing aggressive claims. The full text of the IRS announcement explaining the moratorium and new programs is found in IR-2023-169.

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