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Eligibility and Tax Impact of ERC Refunds
For many businesses grappling with financial strain in the aftermath of the COVID-19 pandemic, the Employee Retention Credit (ERC) has been a tremendous lifeline. This refundable tax credit aimed to incentivize businesses that either faced government-mandated shutdowns or experienced significant declines in gross receipts during 2020 and 2021 to keep employees on their payrolls.
While the ERC's primary goal was to incentivize businesses to retain employees amid unprecedented challenges, the process of applying for and receiving the credit (which often involves tax refund claims) has not been without its complications and controversies. Fraudulent claims and aggressive marketing tactics by those promoting entitlement to these credits have led to significant scrutiny and enforcement efforts by the IRS pushing back on a sizable number of claims and delaying the refund process for validly filed claims.
Warning Signs for ERC Ineligibility
On July 26, the IRS identified several warning signs that may indicate a business's ineligibility for the ERC. These include:
- Essential Businesses: Businesses classified as essential that could operate fully without a decline in gross receipts may not qualify.
- Government Orders: Businesses must demonstrate how government orders fully or partially suspended their operations. Inadequate documentation of this suspension may lead to disqualification.
- Family Member Wages: Claims involving wages paid to family members may be scrutinized, as these may not meet ERC eligibility criteria.
- PPP Loan Forgiveness: Wages claimed for ERC cannot overlap with those used for Paycheck Protection Program (PPP) loan forgiveness.
- Employee Services: Large employers claiming ERC for employees who continued to provide services during the pandemic may face scrutiny.
Continued Compliance Efforts
The IRS's battle against ERC fraud is far from over. The agency's compliance efforts remain robust, encompassing a variety of initiatives designed to root out improper claims and promote transparency:
- ERC Claim Withdrawal Program: The IRS has facilitated a claim withdrawal process for unprocessed ERC claims. As a result, over 7,300 entities have voluntarily withdrawn claims totaling $677 million.
- ERC Voluntary Disclosure Program: The Voluntary Disclosure Program (VDP) allows ERC recipients to come forward and disclose their claims. The IRS received more than 2,600 applications through this program, revealing credits worth $1.09 billion. Currently, VDP is open through Nov. 22, 2024, for 2021 tax periods.
- Criminal Investigations: As of July 1, IRS Criminal Investigation has initiated 460 criminal cases related to potentially fraudulent ERC claims, with an estimated total value nearing $7 billion. Out of these investigations, 37 have led to federal charges, 17 have resulted in convictions, and nine have concluded with sentences averaging 20 months.
- Promoter Investigations: The IRS is actively investigating abusive tax promoters and preparers who have misrepresented the eligibility criteria for the ERC. The Office of Promoter Investigations has received hundreds of referrals, both internally and externally, and will continue its enforcement actions against those engaged in deceptive practices.
- Audits: Thousands of ERC claims are currently under audit. The IRS's scrutiny aims to ensure that only eligible businesses receive the credit, reinforcing the integrity of the program.
The Recent Moratorium and Its Implications
In response to widespread fraudulent claims and aggressive marketing tactics by some promoters, the IRS placed a temporary moratorium on processing ERC claims filed after Sept. 14, 2023. This pause allowed the IRS to implement additional safeguards to prevent ineligible businesses from receiving refunds and to combat deceptive practices.
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