Debbie Tam
On July 25, the IRS presented a webinar on the Employee Retention Credit (ERC) to provide information regarding eligibility, compliance, and how to identify and report ERC fraud. The IRS has been systematically educating businesses and tax professionals regarding the ERC due to increased fraud activity related to ERC mills, which have misled taxpayers into believing they are eligible for the ERC. ERC schemes topped the IRS’ Dirty Dozen list of 2023.
Lloyd Kinlaw, Technical Data Analyst/Project Manager of the Office of Fraud Enforcement for the IRS provided an overview of the ERC.
Basics of the ERC.
The ERC is a refundable tax credit for businesses and tax-exempt organizations. The requirements and the amount of the available credit varies depending on the time period for which an employer claims the credit. The credit was available to eligible employers that paid qualified wages to some or all employees after March 12, 2020, and before October 1, 2021 (before January 1, 2022, for recovery start-up businesses).
Generally, businesses and tax-exempt organizations that qualify are those that: (1) were shut down by a government order due to the COVID-19 pandemic during 2020 or the first three calendar quarters of 2021; or (2) experienced the required decline in gross receipts during the eligibility periods during 2020 or the first three calendar quarters of 2021; or (3) qualified as a recovery startup business for the third or fourth quarters of 2021. Eligible employers must have paid qualified wages to claim the credit.
Key areas of ERC compliance.
Lloyd Kinlaw, Technical Data Analyst/Project Manager of the Office Fraud Enforcement for the IRS noted these key areas of ERC compliance:
- Employers who obtained other tax and non-tax benefits are generally not eligible to obtain the ERC. For example, wages used to obtain the Credit for Sick and Family Leave Wages or the Work Opportunity Tax Credit are not eligible for the ERC.
- Employers who obtained Paycheck Protection Program loan forgiveness for wages may not double dip and obtain the ERC.
- Deduction for wages on a business’s income tax return must be reduced by the amount of the ERC claimed on the employer’s employment tax returns for the tax year. If the ERC is claimed through an amended return, the business may need to also amend the income tax return.
- Wages paid to certain family members with relationships to the majority owner of a corporation, partnership, or other entity are ineligible for ERC purposes.
Kinlaw reminded participants that the statute of limitations is extended to five years for claims of the ERC for the third and fourth quarters of 2021. However, there is no time limit for cases of fraud.
Finally, Carolyn A. Schenck, National Fraud Counsel and Assistant Division Counsel from the Office of Chief Counsel reminded practitioners that advance payment of the ERC via Form 7200 (Advance Payment of Employer Credits Due to COVID-19) is no longer available. The last day that Form 7200 could have been filed was January 31, 2022.
Recognizing ERC fraud.
Kinlaw noted there were three types of ERC fraud: fictitious businesses, identity theft, or inflated or falsely claimed ERC. The IRS has multiple teams and units working on combating fraud.
- Fictitious businesses. In these cases, the ERC is claimed by a fake business. The IRS’s Fabricated Entities team specifically works on identifying these fake businesses. Questionable returns are flagged, and refunds are halted. There is also an Emerging Threats Mitigation team that uses data analytics to identify likely fictitious businesses based on patterns or trends and then they take the appropriate action.
- Identity theft. Kinlaw noted that some entities are created under the Social Security numbers of deceased or incarcerated individuals. The Tax Return Monitoring unit screens
- Inflated or falsely claimed ERC. Another scheme involves bona fide businesses that inflate wages or falsely claim the credit. The IRS will identify inconsistencies between wages reported on the W-2 or W-3, employment tax returns, and income tax returns. Sometimes these returns have been filed by an individual or firm that is already currently under civil or criminal investigation. Regardless, the IRS will examine if the taxpayer is complicit in the fraud.
The IRS recently released Tax Tip 2023-93, which provides common signs of an ERC scam and methods used by fraudsters.
Consequences of ERC fraud.
Schenck walked the practitioners through the process of what occurs when the IRS discovers a fraudulent claim. Once a return has been selected for an audit, the IRS will send an information document request requesting documentation to support the ERC claim. This may include a request for bank statements showing wages were paid and records that support the taxpayer is a legitimate business. Once it is determined the ERC was claimed erroneously or falsely, the IRS may assess the ERC refund as underpayment of employment taxes resulting in penalties. Also, the IRS may pursue criminal charges possibly for fraudulent or false statements or assisting in the preparation of a fraudulent document. Schenck warned that the IRS is actively pursuing promoters of the ERC. These promoters may face criminal and/or civil charges.
Kinlaw advised that if a client discovers they have fallen prey to an ERC scheme and has received a refund, the client should take that check to the nearest IRS Taxpayer Assistance Center and explain the details to an IRS employee. Also, the employer will need to submit an amended return. This will document that businesses’ intend to rectify the situation. Alternatively, the business can send the check to the appropriate IRS Service Center. It is best to send it in a traceable method so a record can be retained of the business’s efforts.
While there is no specific voluntary disclosure program for the ERC, Schenck noted that if a business should fall prey to an ERC scheme, the taxpayer should file amended returns to come into compliance. Schenck explained that taxpayers can review the requirements of the voluntary disclosure program which is initiated through Form 14457 (Voluntary Disclosure Practice Preclearance Request and Application).
Reporting ERC fraud.
Kinlaw explained there were many ways to report possible fraud.
- Form 3949-A (Information Referral) can be used to report alleged tax violations by an individual or business. Examples of alleged tax violations include false documents and failure to pay or withhold taxes.
- Form 14242 (Report Suspected Abusive Tax Promotions or Preparers) is used to report suspected abusive tax avoidance schemes and/or tax return preparers who promote such schemes.
- Form 14157 (Return Preparer Complaint) is used by taxpayers to report complaints including those associated with employment taxes as well as preparer misconduct and false documents.
Communicating with clients.
Kinlaw emphasized that tax professionals can help combat ERC fraud by communicating with their clients in a number of ways from sharing information on the company website or social media, issuing warnings about phishing attempts, offering consultations regarding To-Good-To-Be-True tax benefits, and posting the IRS’ Annual Dirty Dozen list.
Client Letter.
There is a Client Letter available to help practitioners educate clients regarding these ERC schemes.
For further information regarding the Employee Retention Credit, see Payroll Guide ¶20,905.
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