On September 14, the IRS announced significant process changes for employee retention credit (ERC) refund claims. These include a temporary pause on the processing of new ERC refund claims and the implementation of procedures to withdraw or settle previously filed refund claims. This follows nearly one year after the first warnings from the IRS about the questionable validity of certain claims being filed, with several interim developments along the way. The full details of the new procedures aren’t yet known, but businesses should anticipate continued examinations and scrutiny of ERC positions moving forward — likely even for refunds that have already been paid by the IRS. Our experts evaluate the announcement and its implications for businesses.
Keep reading for the full discussion. To navigate to individual topics, click one of the links below:
- Initial thoughts on the IRS ERC announcement: What does this mean?
- History of the ERC (so far)
- What happened with the ERC?
- What does this mean for new ERC claims?
- What about filed but unprocessed ERC claims?
- How should prior ERC refunds be viewed?
- What’s next for the ERC?
Initial thoughts on the IRS ERC announcement: What does this mean?
As a starting point, the temporary pause on processing ERC refund claims is a big deal. The significance of the decision is underscored by strong positioning used throughout the announcement, which begins with a reference to the “rising concerns about a flood of improper” refund claims. IRS Commissioner Danny Werfel goes on to note that the “IRS is increasingly alarmed about honest small business owners being scammed by unscrupulous actors, and [the IRS] could no longer tolerate growing evidence of questionable claims pouring in … ” The remainder of the announcement proceeds to describe extraordinary facts in support of the similarly extraordinary procedural changes.
The simple answer to what this means is that it’s a further, but significant, escalation in the scrutiny of ERC tax positions. The most immediate impact will be on refund claims that have not yet been filed, since those are subject to the temporary pause on processing. However, as described in greater detail below, there are also implications for ERC refund claims that have been filed but not yet processed and even those where refunds have already been received. The many businesses that have appropriately claimed the ERC are expected to see limited adverse consequences. However, even those filing valid claims should anticipate additional questions and the need to substantiate positions.
Another key aspect of the announcement is the line drawn between the types of advisors that have been involved with preparation of ERC refund claims. Proper ERC positions may have been supported by a variety of reputable professionals. However, the IRS “urges businesses to talk to a trusted tax professional — not a tax promoter or marketing firm looking to make money generating applications that takes a big chunk out of the ERC claim.” Such language is likely significant and may have implications for the manner in which examinations (current and future) will be conducted. This is particularly true for businesses that use the services of a firm that the IRS concludes isn’t reputable in this area; the IRS has been taking actions to obtain the client lists of those firms to support its enforcement actions.
History of the ERC (so far)
In the early days of the COVID-19 pandemic, Congress was faced with extraordinary challenges as it sought to respond to the pandemic while stabilizing the economy. This resulted in the enactment of a series of legislation beginning in March 2020. An early bill, the Families First Coronavirus Response Act (FFCRA), enacted on March 18, 2020, provided limited support for businesses. Nine days later, the Coronavirus Aid, Relief, and Economic Security (CARES) Act was enacted with broad bipartisan support and provided substantial support for businesses and individuals. Specifically, the ERC and Paycheck Protection Program (PPP) were both established to support businesses that retained their employees despite the economic shutdown. A notable distinction is that the PPP had finite funding that was exhausted during the pandemic, while the ERC would be administered through the payroll tax system. Procedurally, the payroll-based nature of the ERC allows businesses to claim credits in arrears through amended tax filings (Form 941-X), which don’t include documentation relating to eligibility.
As the pandemic evolved, Congress revisited the ERC multiple times. This began in December 2020 with the enactment of the Consolidated Appropriations Act. That bill extended the expiration of the ERC from Dec. 31, 2020 to June 30, 2021, while retroactively creating a PPP coordination rule. Three months later, in March 2021, the enactment of the American Rescue Plan Act further extended the expiration of the ERC (to Dec. 31, 2021) while making additional technical changes. Finally, in November 2021, the Infrastructure Investment and Jobs Act accelerated the expiration of the ERC to Sept. 30, 2021, for the core credit. However, the startup recovery version of the ERC retained the Dec. 31, 2021, expiration. In summary, Congress has passed four separate bills establishing and modifying the ERC, but no legislative activity has been completed since November 2021.
While businesses have continued to file ERC refund claims since its expiration, market developments have resulted in escalating scrutiny of such filings. The initial warnings about ERC claims were publicly announced by the IRS during Fall 2022, including two warnings about third parties promoting improper filings (IRS IR-2022-183 and COVID Tax Tip 2022-170). Such warnings were amplified in March 2023 through a renewed warning and a professional responsibility alert directed to tax professionals. Then, in July 2023, the IRS announced a new phase of scrutiny related to ERC refund claims and outlined what it considers behavioral warning signs. With that backdrop, the September 14 announcement may be viewed as yet another chapter in a growing story about ERC scrutiny.
What happened with the ERC?
The IRS announcement includes four key aspects:
- Temporary pause on processing new claims. The most impactful action in the short term is a halt to the processing of all new ERC refund claims at least through the end of 2023. This means that any valid, but unfiled, claims face an elongated process with greater scrutiny. It’s not yet clear what will happen when we enter 2024. However, it is clear that the IRS is focused on stemming the flow of refund claims given the “growing concerns inside the tax agency, from tax professionals as well as media reports that a substantial share of new claims from the aging program are ineligible and increasingly putting businesses at financial risk by being pressured and scammed by aggressive promoters and marketing.”
- Establishment of process to withdraw claims. The IRS announced that a new process will be implemented for taxpayers to withdraw pending ERC refund claims, even those that are currently under exam. Unfortunately, details of this program haven’t yet been announced, so it’s not yet clear what this will entail. Fortunately, the temporary pause on processing of new ERC refund claims doesn’t apply to previously filed claims. Although the IRS notes the application of “stricter compliance reviews” and the possibility that it “may also seek additional documentation from the taxpayer to ensure it is a legitimate claim.”
- Establishment of process to settle claims. The third action is the announcement of a new process for taxpayers to settle previously paid ERC refund claims. This portion of the announcement notes that the program will allow businesses “to avoid penalties and future compliance action.” It goes on to say that the IRS is assessing options for “how to deal with businesses that had a promoter contingency fee paid for out of the ERC payment.” Details of this process haven’t yet been announced, so further clarification will be required.
- Updates to FAQs and related guidance. The IRS also made many edits to its existing FAQs, added a new eligibility checklist, and added further documents to its ERC website. The vast majority of those updates are clarifications of points that have been stated in one form or another by the IRS since 2020. However, consolidating these points, especially related to eligibility determinations and procedural matters, may be helpful to businesses in evaluating their ERC tax positions.
What does this mean for new ERC claims?
The announcement doesn’t preclude businesses from properly claiming the ERC by amending payroll tax returns. In that sense, nothing has changed in the absence of congressional action. From a technical perspective, the rules relating to employer eligibility and the calculation of qualified wages also remain the same. However, the sequence of events leading to September 14 should be read as a progression toward significantly greater scrutiny. Thus, businesses with valid claims may expect an elongated time for the receipt of refunds while being subjected to additional review by the IRS. Conversely, those seeking to pursue ERC filings that contradict guidance about eligibility face extreme headwinds moving forward.
What about filed but unprocessed ERC claims?
Unfortunately, the announcement doesn’t provide greater clarity on the timeline within which businesses might expect to receive ERC refunds. We do anticipate greater scrutiny in the form of additional requests for substantiation of claims. Beyond that, those with valid claims likely face further delays in the receipt of payroll tax refunds.
Those that have taken aggressive or invalid positions may also wish to evaluate the withdrawal of such claims. The process for withdrawal is not yet known, so the full implications of such a decision remains to be seen. However, the creation of this path may be welcomed by those that are feeling uncertain about their positions after reviewing the IRS FAQs in greater detail.
How should prior ERC refunds be viewed?
Businesses that have previously received refunds for valid claims are seemingly unaffected by this news. However, the receipt of a refund isn’t the end of the story given the potential for future IRS exams. This is especially the case for those that took aggressive positions that are viewed as being invalid by the IRS. In those cases, the settlement process is something that might need to be considered given the potential for avoiding penalties. Moreover, prior ERC positions are frequently scrutinized as part of business sale transactions, so a settlement process may provide a solution for parties to such deals. The details of that process will be important, though, especially for those that paid contingent fees to advisors.
What’s next for the ERC?
The IRS announcement is a significant step, but the details of the new procedures will be important as businesses consider their options. The IRS suggested various timelines for the announcement of such procedures. Specifically, details about the withdrawal option are described as being “available soon” while the details of the settlement option will be “available this fall.” Updates related to the processing of ERC refund claims submitted after the announcement will likely follow later this fall. Looking ahead, businesses that haven’t yet filed proper ERC refund claims should also consider the upcoming statute of limitations dates, especially when the first quarter of 2024 arrives. In any event, the September 14 announcement by the IRS is the beginning of a new phase in the ERC, so many more developments are expected over the coming months.
