IRS Mulls Future of Employee Retention Credit as Enforcement Ramps Up

Aggressive marketing pushing tax assistance with the employee retention credit has the IRS poised to crack down on fraudulent promotors while increasing scrutiny on post-pandemic claims, possibly spelling trouble for some taxpayers selected for audit.

IRS position.

Speaking July 25 at a tax roundtable event in Atlanta, IRS Commissioner Danny Werfel announced the agency has cleared its backlog of legitimate ERC claims and indicated the focus will shift toward increased enforcement against promotors and returns with erroneous ERC claims. “The further we get from the pandemic, we believe the percentage of legitimate claims coming in is declining,” said. “Instead, we continue to see more and more questionable claims coming in following the onslaught of misleading marketing from promoters pushing businesses to apply.”

Werfel added that the IRS and Treasury will work with Congress to “explore legislative solutions” to curtail fraudulent claims, which he hinted may include “potentially putting an earlier ending date for businesses to claim the credit and increase IRS oversight of return preparers.” Currently, the end date for ERC claims is April 15, 2025, which Werfel said “raises future concerns.”

The ERC is among the many temporary tax benefits enacted in response to COVID-19. It was designed to help businesses endure the economic hardships that came with the pandemic. Specifically, the refundable credit was available to qualifying businesses experiencing sharp drops in gross receipts from March 13, 2020, to December 31, 2021, and it was intended to keep on the payroll those employees who could not work due to exposure risk.

While the ERC was amended multiple times following its creation in the CARES Act, generally it is based on a percentage of qualified wages paid to employees with per employee and quarterly caps. For further information on the differences in the ERC for tax years 2020 and 2021, see the IRS’ comparison chart.

Last October, the IRS issued a warning to employers about what are commonly referred to as ERC “mills,” or third-party promotors that use opportunistic marketing ploys to take hefty, upfront contingency fees with the promise of helping businesses compute and claim the credit even if the taxpayer may not be eligible. Repeating its warning, the practice was the first to appear on the agency’s annual “Dirty Dozen” list for 2023.

“The aggressive marketing of these credits is deeply troubling and a major concern for the IRS,” said Werfel in March. “Businesses need to think twice before filing a claim for these credits … There are very specific guidelines around these pandemic-era credits; they are not available to just anyone.”

Attorney analysis.

Speaking with Checkpoint in an interview, Baker Tilly Senior Manager James Creech said that the ERC itself is a “good credit” that only improved over time throughout its different legislative iterations. Nonprofits that “were suffering just as much as for-profit institutions” were added to the regime, and the percentage of qualified eligible wages for credit computation purposes was increased from 50% for 2020 to 70% for 2021 – both welcome changes, Creech said.

“The problem is not the credit,” he explained. “The problem is the greed that comes with people looking at this credit and saying: ‘This is something we can exploit.’ The problem with this credit is the lack of funding at the IRS and the ability to aggressively go after people that they know are abusing the system.”

This begs the question: what exactly is an ERC mill and how can businesses identify a malicious promotor? According to Creech, while there is not a single concrete definition, they share “common themes.” An ERC mill is more likely to prioritize its marketing over its legal work, which involves “proactively reaching out to people” about the credit via TV commercials, billboards, and other advertisements on top of door-to-door visits.

“You don’t find them organically, you don’t find them through word of mouth – they find you,” said Creech. “[M]any of these credit operations … are here because there is a tremendous amount of money to be made” before moving on to the next thing, unlike a legitimate firm that isn’t constructed on a “temporary” basis.

Creech added that mills tend to have a more uniform approach that is “very light on detail” and does not incorporate each taxpayer’s specific facts and circumstances. “[T]here’s no actual individualized effort to determine if you qualify.”

For taxpayers receiving notices that their ERC claim is under review, Creech recommends that businesses put their best foot forward as early in the audit process as possible, as there is a “short window to triage” the information sought by the IRS. “And then you’ve got another hurdle” with an “initial interview.” Creech said the IRS will spend ample time during the interview asking taxpayers “how they learned about the credit and … who did the credit calculations.”

Unfortunately, those who used a mill will already be under heightened scrutiny, but the IRS may be more lenient with real victims as opposed to taxpayers who pursued a sketchy promotor after already being advised elsewhere that they may not qualify. Ultimately, whether the IRS imposes additional penalties “depends,” as there isn’t a clear line in the sand to speak of, according to Creech. But, maintaining books and records and participating during the interview process is encouraged.

The silver lining is that “many of these audits are happening in a pre-payment setting,” he clarified. “So they’re reviewing claims before they pay them out. [W]hen they are denying claims … most of the time it is not as if people are paying money back – the government’s just not going to pay you your refund. They’re denying your refund.”