Check business tax returns for signs of incorrect Employee Retention Credit claims

Editorial team of TFX

• 31.07.24 • 5 min read

The IRS has raised concerns about some promoters misrepresenting the eligibility criteria for the Employee Retention Credit (ERC), leading businesses to incorrectly claim the credit.

To address this issue, the IRS has identified seven suspicious signs that could indicate an incorrect ERC claim and is urging businesses to consult with trusted tax professionals to rectify any erroneous claims.

...update (July 26)

The IRS has intensified its efforts to ensure the correct application of the ERC and recently released additional warning signs that businesses should be aware of.

This comes as part of the IRS's ongoing compliance work to identify and address improper claims.

Newly identified warning signs

The IRS has outlined five new warning signs that indicate a potential issue with ERC claims:

1. Essential businesses fully operating: Many essential businesses, which did not experience a significant decline in gross receipts or were not fully or partially suspended by a government order, may have been incorrectly advised to claim the ERC. Simple modifications, like requiring employees to wash hands or wear masks, do not qualify as a suspension of business operations.
2. Unsupported government order suspensions: Businesses claiming that their operations were fully or partially suspended by a government order must provide sufficient evidence. Without proper documentation, these claims may be disallowed.
3. Reporting wages for family members: The IRS has identified cases where businesses incorrectly claimed the ERC for wages paid to family members. Generally, wages paid to related individuals are not considered qualified wages for the ERC.
4. Using wages for PPP loan forgiveness: Businesses cannot claim the ERC for wages that were already used to secure forgiveness for a Paycheck Protection Program (PPP) loan. This overlap disqualifies those wages from being used to calculate the ERC.
5. Large employers claiming wages for employees providing services: Large employers, defined as those with more than 100 full-time employees in 2019 (for 2020 claims) or more than 500 full-time employees (for 2021 claims), can only claim the ERC for wages paid to employees who were not providing services during the relevant period.

Upcoming IRS Announcements

In the coming days, the IRS plans to release further details on new compliance measures, including a temporary reopening of the Voluntary Disclosure Program and updates on processing low-risk payments.

This follows a significant push by the IRS to digitize and analyze approximately 1 million ERC claims, with an estimated value exceeding $86 billion.

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Signs an ERC claim could be incorrect

Too many quarters claimed

Promoters may encourage businesses to claim the ERC for all available quarters, but it is uncommon for businesses to qualify for every quarter.

Employers should meticulously review their eligibility for each quarter before making a claim.

Government orders that don’t qualify

Misleading promoters have suggested that any local government order allows a business to claim the ERC, even if the business operations were unaffected or voluntarily suspended.

This is incorrect. 

Claims based on Occupational Safety and Health Administration (OSHA) communications are also generally invalid.

Businesses should refer to the IRS's frequently asked questions about qualifying government orders for accurate guidance.

Too many employees and wrong calculations

Businesses should not claim the ERC for all wages paid to every employee indiscriminately.

Qualified wages must meet specific criteria depending on the tax period. Employers must review all calculations to avoid overclaiming the credit and should not apply the same credit amount across multiple tax periods.

Refer to the IRS's ERC 2020 vs 2021 comparison chart for detailed information on credit amounts.

Supply chain issues

A disruption in the supply chain alone does not qualify a business for the ERC.

Employers must ensure that their supplier’s government order meets the required conditions.

Review the rules on supply chain issues and the examples provided in the 2023 legal memo on supply chain disruptions.

Claims for too much of a tax period

It is unusual for a business to qualify for the ERC for an entire calendar quarter unless their operations were fully or partially suspended due to a government order during that period.

Claims should only cover wages paid during the actual suspension period, not the entire quarter.

Businesses need to verify their claims for overstated wages and maintain supporting payroll records.

Didn’t pay wages or didn’t exist during eligibility period

The ERC can only be claimed for tax periods when wages were actually paid to employees.

Some businesses incorrectly claimed the ERC for periods when they had no employees or for periods before the business was established.

Accurate records must reflect wage payments during the eligibility period.

Promoter says there’s nothing to lose

Be wary of promoters who suggest claiming the ERC because "there’s nothing to lose." Incorrect claims can lead to repayment, penalties, interest, audits, and other expenses.

Businesses should be cautious and ensure claims are legitimate to avoid these risks.

IRS resources for ERC claims

The IRS offers an interactive ERC Eligibility Checklist that both tax professionals and taxpayers can use to assess potential eligibility for the ERC.

This tool helps ensure claims are valid and compliant with IRS guidelines.

For more detailed information, businesses are encouraged to consult the IRS website or seek advice from trusted tax professionals to navigate the complexities of ERC claims correctly.