The Internal Revenue Service (IRS) has revealed a series of specific suspicious red flags that could trigger enforcement actions when it comes to mistaken or fraudulent applications for a pandemic-era tax credit.
The IRS indicated in a March 20 notice that there are seven suspicious signs of a bad claim for the employee retention credit (ERC), which is a refundable tax credit designed for businesses that continued paying employees during COVID-19 shutdowns.
The reason the agency is now revealing these telltale signs of incorrect or fraudulent ERC claims is because March 22 is the deadline to apply for a voluntary disclosure program that will let employers who filed bad claims avoid penalties and interest.
Earlier, the IRS found that a large number of improper ERC claims were pushed by predatory promoters on unwitting businesses, with an investigation by the IRS Criminal Investigation (IRS-CI) division uncovering more than $2.8 billion of potentially fraudulent ERC claims.
To fight the wave of dubious ERC claims, the IRS said it had sharply increased compliance action through audits and criminal investigations, with more planned in the future.
However, because of the sheer number of wrongly filed ERC claims and the predatory promotions surrounding them, the IRS developed several ways to get taxpayers who incorrectly claimed the credit to pay it back with minimal penalty.
One of these is the voluntary disclosure program, which lets people who filed bad ERC claims come forward to the IRS and, in exchange for being forthcoming, they only have to pay back 80 percent of what they owe.
Another is a special claim withdrawal process, which lets businesses that filed a questionable claim to withdraw it and avoid the risk of getting an illegal refund that could prove costly.
Generally, anyone who improperly claims the ERC must pay it back, possibly with penalties and interest. The IRS has warned that a business or tax-exempt group could find itself in a much worse cash position if it has to pay back a bad claim than if it had never claimed it in the first place.
The IRS says its latest disclosure of seven warning signs of a bad ERC claim is meant to help businesses review if their claim is questionable and so give them the opportunity to take action by the March 22 deadline.
7 Bad Claim Red Flags
The first warning sign of a potentially bad ERC claim is that it’s claimed for all quarters for which it was available.
Some promoters who pushed employers to file ERC claims advised them to claim the credit for all available quarters, which may not align with eligibility criteria.
“Qualifying for all quarters is uncommon,” the IRS said in the notice, while urging businesses to carefully review their eligibility for each quarter if they want to make sure they don’t fall afoul of the law.
The second red flag that could alert the IRS to a potentially fraudulent or incorrect claim is that it was filed when there was no government order in place that fully or partially suspended the operations of the business claiming the credit.
Some promoters told businesses that they could claim the ERC when any government order was in place in their area, even one that didn’t require the employer to partially or fully suspend its operations.
“This is false,” the IRS said in the notice.
Eligibility for the ERC was limited to periods during which a COVID-19-related order (not guidance or recommendation) was in effect that fully or partially suspended a given employer’s operations.
The third suspicious sign was claiming the ERC for all wages paid to every employee on the payroll.
There were dollar limits and varying ERC amounts, with employers being required to meet certain regulations for wages to be considered qualified wages for a proper claim.
Employers who used the same credit amount across multiple tax periods for each employee is a standout red flag, the IRS says.
The fourth warning sign is claiming a credit solely based on supply chain disruption.
“A supply chain disruption by itself doesn’t qualify an employer for ERC,” the IRS says.
The fifth red flag is employers claiming a credit for the entire calendar quarter when operations were suspended for only part of that quarter.
“It’s possible, but uncommon, for an employer to qualify for ERC for the entire calendar quarter,” the IRS says.
If a pandemic-related government order suspended business operations for part of a given quarter, then the ERC cannot be legitimately claimed for the whole quarter.
The sixth warning sign is that a business that claimed the ERC didn’t employ anyone for part or all of the period for which they’re claiming it.
“Some taxpayers claimed the ERC but records available to the IRS show they didn’t have any employees,” the IRS said. “Others have claimed ERC for tax periods before they even had an employer identification number with the IRS, meaning the business didn’t exist during the eligibility period.”
The seventh red flag for businesses that should alert them that their ERC claim could be bad is if promoters told them that they had “nothing to lose” by filing one.
“Businesses that incorrectly claim the ERC risk repayment, penalties, interest, audit and other expenses,” the IRS says.
The ERC, which is somewhat complex, is available to employers, not individual taxpayers.
Since the program was enacted, over 3.6 million claims have come in, with the IRS saying that ERC-related fraud became worse over time.
Voluntary Disclosure Program
The IRS’s voluntary disclosure program, first unveiled in December 2023, lets employers who wrongly filed for the ERC get right with the tax authorities by admitting to the mistake.
In exchange for volunteering this information, businesses get to keep 20 percent of the incorrectly received credits, and they won’t be charged any interest or penalties on the remaining 80 percent that they repay.
Those that are unable to repay the 80 percent can potentially be approved for an installment agreement, which will let them pay it back over a longer period.
Program applicants must not be under criminal investigation, nor be under an IRS employment tax examination, nor can they have received an IRS notice and demand for repayment of the ERC.
The IRS is also using the program to get at unscrupulous promoters who used aggressive marketing techniques to lure businesses into wrongly claiming the ERC.
In order to qualify for the program, employers must provide the IRS with the names, addresses, and telephone numbers of any advisers or tax preparers who advised or assisted with the claims.
The deadline to apply for the voluntary disclosure program is March 22, 2024.
Interest on money owed to the IRS compounds daily and the failure-to-pay penalty accrues monthly and can rise to as much as 25 percent of the owed amount.
Withdrawal Program
Another program the IRS rolled out in October 2023 was a special withdrawal process that lets businesses that filed a questionable claim withdraw it and avoid the risk of costly penalties and interest.
The withdrawal option lets employers avoid future problems by withdrawing pending ERC claims if they suspect they may have been tricked into filing and have not yet been paid.
Even if a business has received the ERC refund check but hasn’t yet cashed or deposited it, it can still withdraw its claim.
Claims that are withdrawn will be treated by the IRS as if they were never filed, and the agency won’t impose penalties or interest.
