Employee Retention Credit: New IRS Guidelines and Relief Options for Businesses

October 29, 2023

Updated January 29, 2024

Recent IRS warnings and announcements regarding the Employee Retention Credit (ERC) have raised some businesses’ concerns about the validity of their claims for this valuable, but complex, pandemic-related credit — and the potential consequences of an invalid claim. In response, the IRS has rolled out a new process that certain employers can use to withdraw their claims.

Fraudsters Jump on the ERC

The ERC is a refundable tax credit intended for businesses that 1) continued paying employees while their operations were suspended due to the pandemic in 2020 and 2021, or 2) suffered significant declines in gross receipts during payroll quarters in 2020 and 2021 as compared to the same payroll quarter in 2019. Eligible employers can file claims until April 15, 2025 (on amended returns), and receive credits worth up to $26,000 per retained employee.

With such potentially large payouts, fraudulent promoters and marketers were quick to rush in with offers to help businesses file claims in exchange for fees in the thousands of dollars or for a percentage of any refunds received. The requirements for the credit are strict, though, and the IRS has found that many of these claims fall short of meeting them.

Invalid claims put taxpayers at risk of liability for credit repayment, penalties and interest, in addition to the promoter’s fees. And promoters may leave out key details, which could lead to what the IRS describes as a “domino effect of tax problems” for unsuspecting employers.

The IRS Responds

The wave of fraudulent claims has produced escalating action from the IRS. In July 2023, the agency announced that it was shifting its ERC review focus to compliance concerns, with intensified audits and criminal investigations of both promoters and businesses filing suspect claims. As of December 2023, it had more than 300 criminal cases underway with claims worth nearly $3 billion, and thousands of ERC claims had been referred for audit.

The IRS also has instituted a moratorium on the processing of new ERC claims. And, in October 2023, the agency began offering a withdrawal option for eligible employers that filed a claim but haven’t yet received, cashed or deposited a refund. Withdrawn claims will be treated as if they were never filed, so taxpayers need not fear repayment, penalties or interest.

The withdrawal option is available if you:

  • Claimed the credit on an adjusted employment return (most commonly, Form 941-X),
  • Filed the adjusted return solely to claim the credit, and
  • Request to withdraw your entire ERC claim.

The exact steps vary depending on your circumstances, including whether you filed your claim yourself or through a payroll provider, have been notified that you’re under audit, or have received a refund check that you haven’t cashed or deposited. Regardless of the applicable procedure, your withdrawal isn’t effective until you receive an acceptance letter from the IRS.

Taxpayers that aren’t eligible for the withdrawal process can reduce or eliminate their ERC claim by filing an amended return. But you may need to amend your income tax return even if your claim is withdrawn.

In late December 2023, the IRS announced another ERC relief initiative, the Voluntary Disclosure Program (VDP). The program is intended for employers that claimed and received credit money but weren’t entitled to it.

VDP Nuts and Bolts

Employers that participate in the VDP may benefit in several ways. For example, they’re required to repay only 80% of the credit received (if repayment in full isn’t possible, the IRS may authorize an installment plan). They also aren’t required to repay any interest received on an ERC refund or amend their income tax returns to reduce wage expense.

These employers won’t be subject to penalties or underpayment interest if the 80% repayment is made before the signed closing agreement is returned to the IRS. The 20% reduction won’t be treated as taxable income, and the IRS won’t audit the ERC on employment tax returns for the tax periods covered by the closing agreement.

An employer can apply for the VDP for each tax period in which:

  • Its ERC claim was 1) processed and paid as a refund that has been cashed or deposited, or 2) paid in the form of a credit applied to that or another tax period,
  • It believes it wasn’t entitled to the ERC,
  • It isn’t under IRS audit for employment taxes,
  • It isn’t under IRS criminal investigation, and
  • The IRS hasn’t reversed, or notified the employer of its intent to reverse, the ERC to zero (for example, with a letter or notice disallowing the credit).

Notably, the IRS is sending up to 20,000 letters with proposed tax adjustments for the 2020 tax year to recover ineligible claims, in addition to 20,000 denial letters it sent earlier. The agency continues to work on the 2021 tax year, with more mailings to come. When an employer is identified through this work as receiving excessive or erroneous ERCs, the IRS will pursue normal tax assessment and collection procedures.

If a third-party payer filed an employment tax return that reported an employer’s ERC-related wages and credits, the employer can participate in the VDP only through the third-party payer. It’ll be rejected if it applies with its own employer identification number.

Act Now

Bear in mind that not every ERC claim was invalid. If you’re at all uncertain about the validity of your claim, regardless of whether you’ve received payment, we can help you navigate this increasingly complex area of your tax liability. The VDP is open only until March 22, 2024, though, so don’t delay.

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