Per the notice below, the United States Internal Revenue Service (IRS) has issued additional guidance on the Employee Retention Credit (ERC).

IRS shares more warning signs of incorrect claims for the Employee Retention Credit; urges businesses to proactively resolve erroneous claims to avoid penalties, interest, audits

As the Internal Revenue Service intensifies work on the Employee Retention Credit, the agency today shared five new warning signs being seen on incorrect claims by businesses.  The new list comes from common issues the IRS compliance teams have seen while analyzing and processing ERC claims.  The new items are in addition to seven problem areas the IRS previously highlighted.  The IRS urged businesses with pending claims to carefully review their filings to confirm their eligibility and ensure credits claimed don’t include any of these 12 warning signs or other mistakes.  Businesses with these indicators should talk to a trusted tax professional and consider using special ERC Withdrawal Program that remains available.  Business considering applying for the complex credit also should follow the same steps before submitting a claim.  Businesses with previously approved claims should also review the filings as the IRS intensifies compliance efforts in this area.  Businesses should act soon to resolve incorrect claims and avoid future issues such as audits, repayment, penalties and interest.  The IRS issued today’s five new warning signs to give businesses and tax professionals additional time to prepare for an upcoming announcement involving new steps being taken to counter improper ERC claims.  In coming days, the IRS plans to issue more information on new compliance work involving high-risk ERC claims as well as details about an anticipated short-term reopening of the Voluntary Disclosure Program and an important update about impending processing of low-risk payments to help small business with legitimate claims.  This follows up on last month’s announcement that the IRS was denying more of the highest-risk ERC claims.

“The IRS continues working aggressively to pursue improper claims as well as increase payments going out to businesses with legitimate claims on these complex credits,” said IRS Commissioner Danny Werfel.  “As we prepare for the next major announcement, we want businesses to be aware of common errors our compliance teams are seeing, many of which reflect bad advice coming from promoters.  The IRS continues to urge people with pending claims or previously approved payments to talk to a trusted tax professional rather than a promoter and see if any of these red flags apply to them.”

Aggressive promoters lured many businesses to mistakenly claim this pandemic-era credit when they’re not eligible.  To protect against improper claims, the IRS announced in June that it digitized and analyzed about 1 million ERC claims representing more than $86 billion.  To protect taxpayers from getting an improper refund they’d have to repay, the agency will deny tens of thousands of ERC claims that show clear signs of being erroneous.  The agency is also scrutinizing hundreds of thousands more claims that show risk of being incorrect as well as beginning additional processing of low-risk claims to those with eligible claims.  As the IRS begins to process additional lower-risk claims, the agency reminds businesses that they may receive payments for some valid tax periods – generally quarters – while the IRS reviews other periods for eligibility.  The IRS emphasizes ERC eligibility can vary from one tax period to another if, for example, government orders were no longer in place or a business’s gross receipts increased.  Alternately, qualified wages may vary due to a forgiven PPP loan or because an employer already claimed the maximum amount of qualified wages in an earlier tax period.  Work on ERC compliance efforts around erroneous claims has now topped more than $2 billion since last fall as the agency continues intensifying activity in this area.  The IRS urges taxpayers to work with a trusted tax professional who understands the complex ERC rules.  Tax professionals can help businesses recheck their claims and discuss next steps; this is especially important for those who used a promoter to file claims instead of a tax professional.

Five newly announced signs of an incorrect ERC claim

IRS compliance teams have identified these additional five common signs that have been a recurring theme seen on ERC claims.  None of these qualify under the rules passed by Congress.  The new red flags cover these areas:

• Essential businesses during the pandemic that could fully operate and didn’t have a decline in gross receipts.  Promoters convinced many essential businesses to claim the ERC when, in many instances, essential businesses weren’t eligible because their operations weren’t fully or partially suspended by a qualifying government order.  Modifications that didn’t affect an employer’s ability to operate, like requiring employees to wash hands or wear masks, doesn’t mean the business operations were suspended.  The IRS urges essential businesses to review eligibility rules and examples related to government orders.

• Business unable to support how a government order fully or partially suspended business operations.  Whether a business was fully or partially suspended depends on its specific situation.  When asked for proof on how the government order suspended more than a nominal portion of their business operations, many businesses haven’t provided enough information to confirm eligibility.

• Business reporting family members’ wages as qualified wages.  If business owners claimed the ERC using wages paid to related individuals, those claims are likely for the wrong amount or ineligible.  Wages paid to related individuals aren’t qualified wages for the ERC.  Generally, related individuals are the majority owner and their:

• Spouse.
• Child or a descendant of a child.
• Brother, sister, stepbrother or stepsister.
• Father, mother or an ancestor of either.
• Stepfather or stepmother.
• Niece or nephew.
• Aunt or uncle.
• Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law.
• Household member, meaning an individual who, for the taxable year of the taxpayer, has the same principal place of abode as the taxpayer and is a member of the taxpayer’s household.

• Business using wages already used for Paycheck Protection Program loan forgiveness.  The U.S. Small Business Administration offered the Paycheck Protection Program, which provided SBA-backed loans that helped businesses keep their workforce employed during the pandemic.  The PPP ended May 31, 2021, but borrowers could still apply for PPP loan forgiveness.  If SBA forgave the loan, businesses can’t claim the ERC on wages that they reported as payroll costs to get PPP loan forgiveness.  Participating in the PPP affects the amount of qualified wages used to calculate the ERC.  Payroll costs up to the amount SBA forgave aren’t eligible for ERC.  Taxpayers can use the rest of their qualified wages to figure their credit.

• Large employers claiming wages for employees who provided services.  Special rules applied to large eligible employers, which are those that averaged:

• more than 100 full-time employees in 2019 and claimed ERC for 2020 tax periods, and/or
• more than 500 full-time employees in 2019 and claimed ERC for 2021 tax periods.

Large eligible employers can only claim wages paid to employees who were not providing services.  Many large employers’ claims incorrectly included wages for employees who were providing services during these periods.  The ERC comparison chart provides more details.

Previously shared signs of an incorrect ERC claim

The IRS also reminded businesses about these other common issues being seen.  The agency has continued to issue warnings involving these seven areas:

• Too many quarters being claimed.  Some promoters have urged employers to claim the ERC for all quarters that the credit was available.  Qualifying for all quarters is uncommon, and this could be a sign of an incorrect claim.  Employers should carefully review their eligibility for each quarter.

• Government orders that don’t qualify.  Some promoters have told employers they can claim the ERC if any government order was in place in their area, even if their operations weren’t affected or if they chose to suspend their business operations voluntarily.  This is false.  To claim the ERC under government order rules:

• Government orders must have been in effect and the employer’s operations must have been fully or partially suspended by the government order during the period for which they’re claiming the credit.
• The government order must be due to the COVID-19 pandemic.
• The order must be a government order, not guidance, a recommendation or a statement.  Some promoters suggest that an employer qualifies based on communications from the Occupational Safety and Health Administration (OSHA).  This is generally not true.  See the ERC FAQ about OSHA communications and the 2023 legal memo on OSHA communications for details and examples.  The frequently asked questions about ERC – Qualifying Government Orders section of IRS.gov has helpful examples.  Employers should make sure they have documentation of the government order related to COVID-19 and how and when it suspended their operations.  Employers should avoid a promoter that supplies a generic narrative about a government order.

• Too many employees and wrong calculations.  Employers should be cautious about claiming the ERC for all wages paid to every employee on their payroll.  The law changed throughout 2020 and 2021.  There are dollar limits and varying credit amounts, and employers need to meet certain rules for wages to be considered qualified wages, depending on the tax period.  The IRS urges employers to carefully review all calculations and to avoid overclaiming the credit, which can happen if an employer erroneously uses the same credit amount across multiple tax periods for each employee.  For details about credit amounts, see the Employee Retention Credit - 2020 vs 2021 Comparison Chart.
• Business citing supply chain issues.  Qualifying for ERC based on a supply chain disruption is very uncommon.  A supply chain disruption by itself doesn’t qualify an employer for ERC.  An employer needs to ensure that their supplier’s government order meets the requirements.  Employers should carefully review the rules on supply chain issues and examples in the 2023 legal memo on supply chain disruptions.

• Business claiming ERC for too much of a tax period.  It's possible, but uncommon, for an employer to qualify for ERC for the entire calendar quarter if their business operations were fully or partially suspended due to a government order during a portion of a calendar quarter.  A business in this situation can claim ERC only for wages paid during the suspension period, not the whole quarter.  Businesses should check their claim for overstated qualifying wages and should keep payroll records that support their claim.

• Business didn’t pay wages or didn’t exist during eligibility period.  Employers can only claim ERC for tax periods when they paid wages to employees.  Some taxpayers claimed the ERC but records available to the IRS show they didn’t have any employees.  Others have claimed ERC for tax periods before they even had an employer identification number with the IRS, meaning the business didn’t exist during the eligibility period.  The IRS has started disallowing these claims, and more work continues in this area as well as other aspects of ERC.

• Promoter says there’s nothing to lose.  Businesses should be on high alert with any ERC promoter who urged them to claim ERC because they “have nothing to lose.”  Businesses that incorrectly claim the ERC risk repayment requirements, penalties, interest, audit and potential expenses of hiring someone to help resolve the incorrect claim, amend previous returns or represent them in an audit.

Options for resolving incorrect ERC claims

The IRS has several options to help businesses who have discovered they have questionable ERC claims.

• Claim withdrawal: Given the large number of questionable claims identified in the recent review, the IRS continues to urge ineligible businesses with unprocessed claims to consider the ERC Withdrawal Program to avoid future compliance issues.  The IRS will treat the claim as though the taxpayer never filed it.  No interest or penalties will apply.

• Amending a return: Businesses that overclaimed the ERC can amend their returns to correct the amount of their claim.