Employee Retention Tax Credit Claims Highlight Importance of Compliance with Tax Filing Standards

John E. Rich, Jr.
Director & Chair, Tax Department
Beth L. Fowler
Counsel, Tax Department
Kolbie R. Deamon
Associate, Tax Department
Published: New Hampshire Bar News
February 21, 2024

In tax circles, considerable attention has been focused on employers’ claims for entitlement to the Employee Retention Credit (“ERC”), sometimes called the “Employee Retention Tax Credit” or the “ERTC,” a tax credit created by Congress that provides an economic subsidy to eligible businesses and tax-exempt organizations adversely affected by the COVID-19 pandemic. The Internal Revenue Service (“IRS”) has issued multiple notices questioning the wide-spread claims to the credit by employers often filed with the assistance of third-party promoters who are aggressively marketing in this area. As discussed below, those who advise employers should be aware that frivolous claims to the credit can carry significant consequences to unsuspecting employers and there are options for employers to repay funds and avoid penalties.

What is the Employee Retention Credit?

The ERC is a refundable credit available to certain employers. The dollar amount of the ERC a qualifying employer can claim is based on the qualified wages it paid to its employees between March 13, 2020, and December 31, 2021. In order to be eligible to claim the ERC, an employer must have either sustained a full or partial suspension of operations due to an order from a controlling governmental authority limiting commerce, travel, or group meetings because of the COVID-19 pandemic, experienced a decline in gross receipts meeting the statutory thresholds during the relevant period, or qualified as a recovery start up business during the third or fourth quarters of 2021. Claims for the ERC are made on the employer’s employment tax returns, including amended returns, covering the relevant periods.  It is important for employers to understand that their receipt of an ERC payment following a claim for the credit does not mean that the IRS has approved, or even conducted a review of, the claim. Rather, the IRS can later disallow the claim and require repayment along with interest and penalties.

Internal Revenue Service Guidance and Concerns

Earlier this year, the IRS issued a warning to employers to remain vigilant for misleading claims made by third party ERC promoters about the availability of the ERC. The IRS and our office have observed various ERC promoters engaging in aggressive broadcast advertising, direct mail solicitations, and online promotions involving the ERC. While the credit is real, some ERC promoters are wildly misrepresenting and exaggerating who can qualify for the credits and the extent of the credit available to employers. Our experience has been that ERC promoters are preparing claims for the ERC often with creative interpretations of, or even deliberate disregard for, the requirements to qualify.  Many promoters are offering their services in exchange for a percentage, in some cases in excess of 20%, of the ERC claimed on behalf of an employer and pursuant to service contracts that require the promoter to receive their fee as soon as the ERC is paid and with no obligation on the part of the promoter to repay the fee should the claim later be disallowed. We have also observed employers claiming the ERC without consulting their regular CPA or tax return preparer at the assurance of the promoter that there is no need to obtain a second opinion.

Due to proliferation of fraudulent claims for the credit, the IRS has increased audit and criminal investigation work involving ERC claims. Businesses, tax-exempt organizations, and others considering applying for this credit need to carefully review IRS guidance on the requirements for this limited program before applying. Those who improperly claim the credit, both taxpayers and their advisors, face follow-up action from the IRS.

Intersection of ERC Filings with Tax Code Filing Standards

The Tax Code contains strict rules and standards in connection with filing tax returns.  The IRS imposes penalties on practitioners who prepare or sign a tax return that contains a position, or advises a taxpayer to take a position on a return, that lacks a reasonable basis, is an unreasonable position, or reflects an understatement of tax or a disregard for the rules and regulations. In addition, a preparer could be held liable for advising a client to take a position in any other document submitted to the IRS that is frivolous, intended to delay or impede tax administration, or that intentionally disregards a rule or regulation (and where the position is not a good-faith challenge to the rule or regulation). Other requirements associated with the filing of ERC claims are found in IRS Circular 230 and the Treasury Regulations and include the exercise of due diligence in filing of tax documents.

Aware that some employers who filed potentially abusive ERC claims did so at the behest of aggressive promotors who ignored Circular 230 and other filing requirements, the IRS has created options for employers to self-correct with minimal repercussions.  An employer who has not received a credit in response to an application, or who has received a credit via check and has not yet cashed or deposited the check, can withdraw the claim by following the procedure specified by the IRS.  Note, however, that withdrawal will not protect an employer who submitted a fraudulent claim from potential criminal prosecution.

The IRS has also established a Voluntary Disclosure Program for employers who have received a refund because of a claim for the ERC in an amount that exceeds the amount to which they are eligible.  The Voluntary Disclosure Program allows an employer to self-correct with minimal penalties.  Under the Voluntary Disclosure Program, an employer repays 80% of the credit previously received, retaining 20%.  The IRS will not charge interest or impose penalties on the claimed credit if the employer repays the 80% by the time it returns a signed closing agreement to the IRS. Given the Tax Code requirements, and potential civil and criminal penalties associated with filing a fraudulent ERC claim, those who counsel employers should be aware of heightened IRS scrutiny on ERC claims and the Voluntary Disclosure Program.

In summary, given the IRS’ focus on ERC claims, employers who file or have filed ERC claims should carefully consider whether their claims meet the applicable Tax Code filing standards.  Should there be any doubt as to eligibility, employers are advised to have their claims reviewed by experienced tax professionals.