Background

The Employee Retention Credit (ERC) was enacted and modified in a number of COVID relief pieces of legislation¹ as a means of helping employers impacted by the COVID pandemic retain and continue to pay employees. The ERC was designed as a refundable payroll tax credit that applied to "qualified wages" paid to employees from 13 March 2020 through 30 September 2021 (or, in the case of a recovery startup business, through 31 December 2021).² For large employers, meaning employers with 100 or more employees (500 or more for calendar quarters commencing after 31 December 2020), qualified wages generally were wages paid to employees when the employees were not providing services due to COVID-19-related circumstances. The credit was not only refundable, but it could be received in a number of ways: (i) in advance of filing the employment tax return for a quarter by filing a Form 7200 "Advance Payment of Employer Credits Due to COVID-19," (ii) on the original employment tax return (e.g., Form 941) for the quarter at issue, or (iii) after the fact by amending the employment tax return.

Potentially fraudulent ERC claims are an issue of great concern to both Congress and the IRS. There are concerns that fraudulent claims are being promoted by unscrupulous third-party vendors, dubbed "ERC mills." These ERC mills generally are paid a percentage of the ERC claim out of the credit or refund received, and then employers who made the claims are frequently left on their own to defend the claim. If the claim does not truly qualify for the ERC, after paying the ERC mill its percentage of the ERC claim, the employer can be left with no ERC refund in the first place, or an IRS notice seeking a return of the refund, plus interest and penalties. The IRS has instituted civil and criminal investigations of certain ERC mill promoters. Larger employers have seen these kinds of claims arise in due diligence when looking to purchase a smaller company. This fall, the IRS has taken a number of steps, described below, to combat potentially fraudulent claims. While these steps are aimed primarily at small employers that have been victimized by unscrupulous ERC mill promoters, they have impacted all employers, both large and small, with pending ERC claims.

IRS actions

First, the IRS announced in September 2023 (IR-2023-169, 14 September 2023) that it was placing a moratorium on the processing of new ERC claims through at least the end of 2023 due to concerns that an increasing number of claims being received were ineligible for the credit. According to the announcement, previously filed claims (those filed before the September 14th announcement) will also take longer to be reviewed and processed (180 days or more up from 90 days) because the IRS is scrutinizing them more carefully, including referring them for audit and/or criminal investigation. In practice, the processing of these previously filed claims effectively ground to a halt. Numerous taxpayers have sought assistance from the Taxpayer Advocate Service, which has in its inventory more than 2,000 such cases in which the failure to process an ERC claim has resulted in significant hardship to a taxpayer (contrary to Congress’ original intent to help taxpayers adversely impacted by the pandemic).

Second, the IRS announced in October 2023 (IR-2023-193, 19 October 2023) that it had put in place a special process for employers to withdraw an ERC claim they had already filed. The withdrawal is possible under the following circumstances:

• The claim was made on an adjusted employment tax return (e.g., Form 941-X).
• The adjustment addressed only the ERC (and no other issues).
• The employer would like to withdraw the entire ERC claim (not just a part of the ERC claim).
• The IRS has not yet paid the ERC claim or has paid, but the check has not yet been cashed or deposited.

For taxpayers who have not received a check or been notified that the claim is under audit, the withdrawal involves simply faxing to a dedicated fax line at the IRS a copy of the claim, marked as withdrawn and signed by an authorized person. Additional details are set forth in FS-2023-24. If the taxpayer has not received a check, but has been notified that the claim is being audited, the taxpayer should instead respond to the audit letter or contact the assigned auditor to withdraw. If the taxpayer has received a check, but has not cashed or deposited it, the taxpayer will need to void the check and then mail back the withdrawal and voided check to the Cincinnati Refund Inquiry Unit at a specified P.O. Box.

Finally, the IRS has been promising that a voluntary disclosure program will be available soon for taxpayers that have received and cashed or deposited refunds and are not eligible for the withdrawal process. In the meantime, to the extent these taxpayers would like to mitigate their exposures to penalties associated with a potential audit of their prior ERC claims, they may still reduce or eliminate their ERC claim by filing an amended return.

Key takeaways

While we anticipate that most Baker McKenzie clients and other large taxpayers will rely on reputable advisors in assessing and submitting their ERC claims, the existence of aggressive and fraudulent claims can still impact employers with valid claims. First, all claims that have not yet been processed will likely experience continued delays as the IRS implements procedures to review and assure the validity of claims. For taxpayers still waiting on a pre-14 September 2023 claim that technically should not be impacted by the moratorium, it may be possible to obtain relief by elevating the issue, such as by contacting either the Taxpayer Advocate's Office or the constituent services function of one of the taxpayer's elected officials. If legitimate claims are not processed by the end of January 2024, there is a real concern that their processing will be delayed even further as the IRS focuses its resources on the upcoming tax return filing season.

Another area where larger taxpayers may need to be aware of the withdrawal and voluntary disclosure processes is when acquiring smaller taxpayers. In that case, if a questionable ERC claim is discovered in due diligence, the acquirer might consider requiring, as a closing condition, that the ERC claim be withdrawn or addressed through the upcoming voluntary disclosure process.

1 The ERC was first enacted in section 2301 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, Pub. L. No. 116-136 (27 March 2020), and amended and extended by section 206 of the Taxpayer Certainty and Disaster Tax Relief Act of 2020, Pub. L. No. 116-260 (December 26, 2020) and section 9651 of the American Rescue Plan Act, Pub. L. No. 117-2 (11 March 2021).
2  For businesses other than recovery startup businesses, the Infrastructure Investment and Jobs Act retroactively terminated the ERC with respect to wages paid after 30 September 2021. See Notice 2021-65, 2021-51 IRB.