With the passage of the 2020 CARES Act, Congress created the Employee Retention Credit (ERC) for eligible employers whose operations were impacted by the COVID-19 pandemic. The IRS, however, stopped processing new ERC claims in September 2023, causing the backlog of unprocessed claims to balloon to more than 1.4 million. Recent guidance from the IRS and a fresh wave of denial notices indicate that the IRS is finally starting to manage this logjam. This update provides a field guide for affected taxpayers on what to expect next and how to protect their claims going forward.

What is the ERC?

The scope of the ERC has evolved significantly since its original enactment. In short, it provides eligible employers a per employee employment tax credit if the employer’s business was significantly affected by the COVID-19 pandemic due to a government order or a significant decline in gross receipts. As amended, employers could claim the ERC on timely filed Forms 941 or amended Forms 941-X for quarters ended June 30, 2020, through December 31, 2021. The deadline for filing all such claims expired on or before April 15, 2024.

What do taxpayers need to do to protect their ERC claims?

In September 2023, the IRS placed a moratorium on processing new ERC claims to combat what it claimed was rampant fraud. While this extraordinary step may have limited the number of erroneous claims that the government paid, it also put hundreds of thousands of valid claims in limbo. It further put taxpayers in an impossible situation, as they suddenly had no path for resolving their claims absent suing the government or simply throwing in the towel and withdrawing their claim.

In a June 20, 2024, update, the IRS indicated that it was beginning to move the ERC logjam. Specifically, it indicated that it would move forward with processing up to 30% to 40% of outstanding claims that it unilaterally determined fell into one of two buckets. First, the IRS stated that it would deny high-risk claims that it determined showed clear signs of abuse (between 10% and 20% of outstanding claims). Second, it stated that it would “judiciously” start granting what it determined to be low-risk claims (between 10% to 20% of outstanding claims), though it recognized that the payments on these claims would go out very slowly starting with the oldest claims. Unfortunately, the update also confirmed that the IRS would keep the moratorium in place for the remaining 60% to 70% of claims, as it determined that such claims “show an unacceptable level of risk.”

Taxpayers and practitioners have started to report the receipt of the promised denial notices. Unfortunately (and perhaps unsurprisingly), some taxpayers have also reported IRS errors in correctly processing their claims, which likely caused or contributed to the denial. In light of these new developments, employers with outstanding ERC claims should address the following questions to determine their best path forward:

• Have I received any correspondence from the IRS regarding my claim? Any correspondence from the IRS regarding an ERC claim will likely require the employer to take action to protect its rights. For example, if the IRS denies a claim, the employer will have two years from the date of disallowance to file a refund suit. Alternatively, if the IRS opens an audit or requests additional information, the employer must timely respond to increase the likelihood that the IRS will approve its claim.
• Should I file a refund suit? Once an employer makes a valid refund claim, it can file a refund suit after the IRS denies the claim or after the claim has been pending for six months. In light of the reported errors in the denial notices, employers who receive a denial notice should closely analyze the IRS’s grounds for rejecting the claim in deciding how to move forward. For employers who remain affected by the moratorium, most likely do not need to proactively file a refund suit, as they can just wait on the IRS to approve or deny the claim. But there are situations where a taxpayer may benefit from filing suit. For example, employers with recently filed, “low risk” claims could still face long waits for approval and payment, as the IRS indicated that it would be paying claims on a first in/first out basis. Filing a refund suit could expedite the approval and processing of the taxpayer’s claim through various procedural mechanisms.
• Should I withdraw my claim? The IRS previously offered the ERC Voluntary Disclosure Program for taxpayers to voluntarily withdraw erroneous ERC claims. While this program expired in March 2024, the IRS is currently considering whether to reopen the program. It is also continuing to offer a special ERC Withdrawal Program that allows an employer to ask the IRS to not process its pending claim. The IRS will treat a withdrawal as though the employer never filed the claim, meaning that there will be no interest or penalties on unprocessed claims. A withdrawal may further reduce the likelihood that the IRS will take further enforcement action related to an erroneous claim, such as a time-consuming audit or a criminal investigation.
• Am I prepared for an IRS audit of my claim? While the IRS’s most recent update indicates that it will be working to resolve pending claims, it also indicates that the IRS has already made the unilateral determination that up to 80% of outstanding claims either show clear signs of abuse or an unacceptable level of risk. As evidenced by the IRS’s aggressive enforcement efforts in other areas, this determination likely means that the vast majority of taxpayers with a pending claim should be ready to defend their claims. Taxpayers can proactively prepare for this invasive scrutiny by starting to compile the evidence necessary to establish their eligibility for the ERC and the amount of their claim now.