The Internal Revenue Service announced on September 14 that it was “increasingly alarmed” about potentially abusive submissions for tax credits under the Employee Retention Credit (ERC), which is a tax credit passed in conjunction with relief promulgated under the CARES Act. Citing a backlog in reviewing current claims and warning about aggressive promoters pushing employers to take questionable tax positions, the IRS announced an aggressive crackdown on enforcement under the ERC program. The IRS guidance also provides for a longer processing time for current submissions as well as relief programs for ineligible employers that applied for the credit.

This Q&A summarizes what the announcement means for employers that have already filed an ERC claim as well as for those that are thinking about filing a claim in the future.

What is the basis for filing an ERC claim?

There are two bases for employers to claim the ERC. The first is a “decline in gross receipts,” which is a mathematical calculation that compares income during eligible quarters during 2021 and 2022 to similar quarters during 2019 and 2020. Because the decline in gross receipts test is objectively determinable, the IRS has not scrutinized submissions under this standard to the same degree as those employers that filed under the second eligibility test — the “governmental order test.” Under the governmental order test, an employer has to experience a “suspension of operations” due to a qualifying governmental order. The test is based on relevant facts and circumstances and is intended to apply only if there is a more than nominal suspension of operations. The IRS is concerned that employers are taking aggressive tax positions with respect to the governmental order test, often in reliance on advice of unscrupulous promoters and advisers.

What does the announcement mean for employers that have already filed a claim but not yet received a refund?

For employers that have already filed a claim but not yet received a refund, the guidance has different implications depending on whether the employer wants the IRS to continue processing its submission:

• For those employers that want to continue their submission, the wait to receive a refund will take longer. The IRS stated the standard wait time will expand from 90 days to 180 days. In reality, many employers have waited longer than the standard time to receive a refund, even before the new announcement. In sum, employers can expect to wait at least 180 days to receive an ERC refund, but should plan to wait for up to a year or longer. Employers can also expect more detailed information requests from the IRS when claims are processed.

• For employers that have already filed a claim but do not want to continue pursuing their submission, the IRS unveiled a special withdrawal option. Under this option, employers can withdraw a pending submission even if the employer is currently under an IRS audit. The guidance suggests that this option will allow employers to avoid potential civil penalties as well as avoid the newly announced settlement program intended to recoup payments made to ineligible employers. The IRS will announce new details on the special withdrawal option soon.

How does the announcement affect employers that have already received a refund under the ERC?

It does not affect refunds that were previously paid, although employers that received a refund may want to reconsider their eligibility in light of the enhanced enforcement initiative. The IRS warned that taxpayers were taking overly aggressive positions in applying for the ERC and announced a new initiative to audit employers that previously received refunds, as well as an initiative to pursue criminal investigations against employers and tax preparers that submitted fraudulent claims. The IRS also announced that it would unveil a “settlement program” for employers that received an ineligible refund and repay the amount. Under this program, employers can make repayment of the refund without penalties and without future compliance enforcement.

What should employers do if they have a valid claim but have not yet submitted it to the IRS?

The guidance does not extend the deadlines to submit a claim, which are quickly approaching. For eligible credits for the first quarter of 2020, the deadline to submit an amended tax return is April 15, 2024. Employers that want to submit a claim should consult with a trusted tax professional to ensure the claim is eligible for the ERC.

What should employers do if they already submitted an application but are unsure about their eligibility for the ERC?

Consult a reputable tax professional immediately. The IRS specifically criticized the numerous consulting firms that advised employers to apply for the ERC on the basis of fraudulent or questionable evidence. Accordingly, the IRS described a number of “red flags” that employers should pay attention to when analyzing whether their consultant provided legitimate and reliable advice on the ERC. Some of the red flags include:

• Consultants with aggressive public advertising that promises eligibility for the program without an analysis of a taxpayer’s individual situation, or promises of a “second opinion” on eligibility for the credit.

• Advisers that take a percentage of the credit received rather than work on an hourly or fixed-fee basis.

• Companies that promise an “easy application process” and fail to include key details in determining eligibility, such as the fact that supply chain disruptions will not typically result in eligibility for the ERC.

What are the potential penalties for accepting the credit based on inaccurate or ineligible criteria?

The IRS can impose civil and criminal penalties as well as seek repayment of the amount of the credit previously claimed. Typically, the IRS will seek to impose penalties and repayment through the audit process.