Over the past year, the Internal Revenue Service (IRS) has discovered billions of dollars in potentially fraudulent Employee Retention Credit (ERC) claims. Due to the high number of claims from ineligible employers, the IRS put an immediate hold on processing new claims for the ERC in September 2023. The moratorium, which the IRS says may be lifted later this spring, was put in place to protect small business owners from aggressive promoters and scams that put businesses at financial risk. While the IRS has new ERC claims on pause and works to investigate possible fraud, business owners still have the opportunity to protect themselves from potential civil and criminal penalties.

ERC Background and Rise of Scams

The ERC was signed into law in 2020 as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act to help employers struggling during the COVID-19 pandemic. Eligible businesses affected by COVID-19 could receive a refundable tax credit of up to 70% of the wages they paid to employees in 2021. To be eligible, a business’s operations must have been fully or partially suspended due to the pandemic, and the business must have experienced a corresponding significant decline in its gross receipts in 2021. The IRS has issued an ERC eligibility checklist to help businesses understand eligibility requirements.

The IRS began warning the public about potential scams designed to trap business owners in fall 2022, and by March 2023, the ERC scams landed the top spot on the IRS’ annual “Dirty Dozen” list of tax scams to be aware of in the coming year. The bogus advertisements flooded TV, radio and social media, promoting false information about eligibility, and scammers either charged exorbitant fees to “help” business owners who did not qualify or stole valuable personal information to commit fraud.

Businesses Beware

While the IRS is not currently accepting new ERC applications, businesses should continue to be aware and watch for ERC scams and red-flag behavior, such as messages from unfamiliar individuals or organizations promising quick refunds, requests for large up-front payments or ERC percentages, and failure to include information about applicable laws and limitations. If the application period opens again, business owners should talk to a tax professional prior to filing an ERC claim.

Penalties for Ineligible ERC Claims

By July 2023, the IRS had discovered more than $2.8 billion in ERC claims from potentially ineligible businesses. The IRS is empowered to begin criminal investigations in these cases. Felony convictions are punishable by up to $100,000 for individuals or $500,000 for corporations, and up to five years’ jail time. Businesses that received ERC funds without meeting the qualifications may be required to reimburse the IRS for the value of the credits, along with interest and possible additional penalties. Fines can be steep: The IRS can impose a 20% penalty against those who negligently underpay their taxes and a penalty of up to 75% for those who underpay fraudulently. The first lawsuits related to ERC claims are beginning to appear in courts across the country, and this number will likely increase as the IRS continues its investigation. (Finland Financial v. United States, No. 23-1707, 2023 WL 8717480 (C.D. Cal. Dec. 18, 2023)). According to recent reports, the IRS has initiated almost 400 criminal actions, with damages totaling nearly $3 billion, and these actions have led to 12 convictions so far.

What Can Businesses Do to Protect Themselves Against Penalties?

Updates from the IRS and extensive coverage of this topic indicate that the agency will continue to pursue increased legal action based on improper ERC claims. The good news for employers is that businesses in the process of filing for and obtaining ERC can still act to avoid penalties.

While the IRS continues to process ERC claims submitted before the moratorium, it is doing so with higher scrutiny and at a much slower rate. Businesses that have submitted an ERC claim should verify their eligibility and keep paperwork that reflects the required decline in gross receipts, as well as records of employee wages.

Businesses whose claims haven’t yet been paid have the chance to withdraw pending claims. In March, the IRS reported that there are more than one million unprocessed ERC claims, making the claim withdrawal process an important option for businesses that may have submitted an improper or fraudulent claim. In the same update, the agency shared that the claim withdrawal process has allowed more than 1,800 businesses to withdraw their claims so far, accounting for $251 million in recovered revenue for the IRS. This process essentially allows businesses to take back their claims as though they were never filed—and the IRS will not impose any penalties or interest on the claim. Even businesses that have already received an ERC check can withdraw their claim as long as they have not cashed the check and can return it. Businesses should work closely with a tax professional and follow the IRS’s guidance regarding claim withdrawal.

For those businesses that received claims, the IRS ERC voluntary disclosure program allowed ineligible businesses to pay back 80% of the credits they received, which generated $225 million from more than 500 taxpayers. While the program closed on March 22, the IRS stated it may choose to reopen the program in the future as a way to counter questionable claims, particularly those made due to aggressive marketing schemes in the 2021 tax year.

Final Thoughts

While the ERC was intended to provide much-needed support for businesses, unsuspecting business owners have fallen victim to misinformation and scams. Many can still protect themselves against increased potential civil and criminal penalties by observing the warnings from the IRS and consulting with experienced tax professionals.

Reprinted with permission from the May 13, 2024 edition of Daily Business Review © 2024 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or reprints@alm.com.