During the COVID-19 pandemic, the Employee Retention Credit (ERC) became a financial lifeline for businesses. It helped companies continue to pay employees while dealing with a drop in revenue.

Unfortunately, the credit also opened the floodgates to a slew of fraudulent and improper claims. Even after the credit officially ended, “ERC mills” continued aggressively marketing their services to businesses, promising to help them retroactively claim the credit.

This influx of questionable applications overwhelmed the Internal Revenue Service (IRS), prompting them to temporarily halt the processing of new claims in September 2023. With plans to resume acceptance in 2024, businesses looking to apply or those who have previously claimed the credit need to brace themselves for increased scrutiny and potential audits.

If you previously filed an ERC claim or believe you may be eligible for it, this article will cover what the ERC is, who qualifies to claim it, and why partnering with a reputable tax professional is essential.

Understanding the Employee Retention Credit

The Employee Retention Credit was part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020. It incentivized companies to keep employees on payroll through the pandemic by providing a refundable tax credit against the employer’s share of Social Security taxes.

A deep dive into the intricacies of the credit is beyond the scope of this article, but for most businesses, it was available on up to $10,000 of qualified wages and benefits per employee paid between December 31, 2020, and September 30, 2021.

Employers could immediately take advantage of the credit by reducing their employment tax deposits or claiming a refund each quarter using Form 7200.

While the ERC ended for most businesses on September 30, 2021, companies who were eligible to claim the credit but didn’t could retroactively claim it by filing an amended Form 941 for each applicable quarter.

The IRS Crackdown: A Response to Fraud and Improper Claims

The ERC was designed to get money into the hands of businesses quickly to help them weather pandemic-related shutdowns and drops in revenue. However, as ERC claims skyrocketed, so did instances of improper filings, placing the ERC under the IRS microscope.

Many of these claims came from ERC mills—bad actors advising companies to claim the ERC when they didn’t qualify or qualified for a significantly smaller credit than promised, all while charging hefty upfront fees.

The abuse was so rampant that the IRS included ERC mills on its annual Dirty Dozen list of common tax scams taxpayers should be aware of. Despite the public awareness campaign, the agency continued to be inundated with fraudulent or incorrectly filed ERC claims, leading the IRS to temporarily shut down processing new claims in September 2023.

Now, as they gear up to accept claims again in 2024, businesses can expect a heightened level of scrutiny.

Proactively prepare for an IRS audit

Businesses that have previously filed ERC claims may face an IRS audit or at least requests for additional documentation to support their claims.

The IRS will also release additional procedural guidance for businesses that filed ERC claims but shouldn’t have due to ineligibility. The guidance is expected to provide instructions for businesses that want to withdraw claims that have not yet been processed or pay back refunds to avoid an audit and potential penalties.

If you filed a legitimate ERC claim, the first line of defense in an audit is having accurate, complete, and well-organized documentation. Businesses must be able to substantiate their eligibility for the ERC, clearly demonstrating the impact of the economic downturn on their operations. Proactively addressing potential areas of concern and having clear, concise answers backed by documentation will be key.

The role of a trusted tax advisor

There are several things you can do to avoid getting involved in an ERC scam, including working with a trusted tax advisor rather than engaging with people or entities aggressively soliciting the credit.

Some warning signs to watch out for include:

• Statements that the company can determine your eligibility for the credit “within minutes.” In reality, determining eligibility is complex and includes carefully analyzing qualified wages.
• Unsolicited calls, emails, or advertisements touting an easy application process. Applying for the ERC retroactively involves amending your payroll tax filings. Calculating the credit and following the IRS’s rigorous 941-X instructions can be challenging.
• Being asked to pay a sizeable upfront fee or a fee based on a percentage of your anticipated refund. Many ERC mills charge these fees before evaluating a business or calculating an expected refund. You shouldn’t have to pay an upfront fee for an ERC calculation.

On the other hand, a trustworthy tax professional can:

• Ensure your ERC claim complies with the latest IRS regulations, significantly reducing the risk of errors that could trigger an audit.
• Guide you through the IRS audit process, helping you respond to IRS requests for information and presenting your documentation in the best possible light.
• Help prepare a solid, well-documented claim that stands up to IRS scrutiny.

The Employee Retention Credit can be a valuable financial resource for businesses but is fraught with complexities and potential pitfalls. As the IRS ramps up its efforts to weed out fraudulent and improper claims, businesses must be prepared for increased scrutiny and potential audits. Partnering with a reputable and experienced tax professional is no longer just an option—it’s a necessity. If you need help navigating the ERC, preparing for an audit, or ensuring your future claims are rock-solid, contact NewWay Accounting.