The federal Employee Retention Credit (ERC) was created by the IRS during the COVID-19 pandemic. It seemed to offer a lifeline to many nonprofits struggling to keep employees on board and their organizations afloat. But for some employers, it may just have been too good to be true. Read on to learn about possible abuses on the part of some employers and the IRS’s response.

Bumpy road

Shady promoters have led many employers astray, promising big payouts if they claimed the ERC (and demanding significant fees for the tax “assistance”). But some of these employers weren’t actually eligible for the credit. Requirements are stringent, despite what some promoters have claimed.

Promoters that told employers they had “nothing to lose” in filing a claim were incorrect, according to the IRS. In reality, organizations could run into repayment requirements, penalties, interest and audits. This has led to dramatic delays in ERC claims processing and the IRS has taken several steps to deal with invalid claims.

Straight and narrow

The ERC is a refundable tax credit targeted at employers that:

1. Continued paying their employees when they were shut down due to the pandemic in 2020 or 2021, or
2. Suffered significant drops in gross receipts from March 13, 2020, to December 31, 2021.

The maximum per-employee credit was $5,000 for 2020. It rose to $7,000 per quarter for the first three quarters of 2021, meaning employers could potentially receive refunds of as much as $26,000 for each retained employee.

In September 2023, after a flood of invalid claims, the IRS halted processing new claims submitted after September 14, 2023. The agency used the hiatus to review about one million ERC claims representing more than $86 million. It found that 10% to 20% of the claims had clear signs of being erroneous, and another 60% to 70% demonstrated an unacceptable level of risk. The IRS announced that tens of thousands of the erroneous claims would be denied and that those with unacceptable risk would undergo further analysis. By August 2024, the agency had sent 28,000 disallowance letters to employers whose claims showed a high risk of being incorrect.

By the numbers

The IRS’s review of 2020 claims revealed more than 22,000 improper claims, resulting in $572 million in assessments against employers. These numbers could climb when the agency reviews 2021 claims, as the maximum per-employee credit that year was $21,000.

As of June 2024, more than 1.4 million ERC claims remained unprocessed, as the IRS closely examined them. In early August 2024, though, the IRS announced that it had identified 50,000 valid ERC claims and was moving them forward for payment processing. Payments were to begin in September, with additional payments going out in subsequent weeks. Another large block of low-risk claims was slated for processing and payment in the fall.

Your road map

Many nonprofits may now wonder if their ERC claims can withstand IRS scrutiny. If you’re among them, you have some options to reduce your risk. For example, if your organization overclaimed the ERC, you can amend your return to correct the amount.

If you haven’t yet received the ERC payout, you also can take advantage of the ERC Withdrawal Program. It’s available to eligible employers that filed a claim but haven’t received, cashed or deposited a refund. Your organization is eligible if it:

• Made the claim on an adjusted employment tax return (Forms 941-X, 943-X, 944-X, CT-1X),
• Filed the adjusted return solely to claim the ERC, with no other adjustment, and
• Seeks to withdraw the entire amount of its ERC claim.

The IRS has stated that it will treat withdrawn claims as if they had never been filed, and no interest or penalties will apply.

Don’t go it alone

While news about the ERC has been coming out at a steady pace over the past 18 months, one thing has remained the same: The IRS continues to encourage employers to work with trusted tax professionals who understand the ERC’s complex rules. We’re here to help you navigate recent developments and chart the right course.

Red flags for invalid ERC claims

The IRS has identified several warning signs it’s seen on incorrect Employee Retention Credit (ERC) claims. For example, employers that could fully operate and didn’t suffer a drop in gross receipts weren’t eligible for the ERC. Note that modifications that didn’t affect an employer’s ability to operate, such as requiring employees to wash hands or wear masks, don’t mean the business operations were suspended.

The IRS has also found invalid claims where employers:

• Can’t support how a government order fully or partially suspended their operations,
• Claim the ERC on wages that they reported as payroll costs to obtain Paycheck Protection Program loan forgiveness,
• Claim the credit for too many quarters or for every employee on their payroll,
• Base their claims on supply chain disruptions, and
• Didn’t pay wages or weren’t in operation during the eligibility periods.

The agency also has reminded employers that they may receive payments for some valid tax periods, while it reviews other periods for eligibility. Remember, ERC eligibility can vary from one tax period to another if, for example, government orders were rolled back.

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