You Got ERC? Now It’s Time To Protect Yourself

Cassidy Jakovickas

May 15, 2024

The combination of COVID-19’s impact and the lucrativeness of the Employee Retention Credit (ERC) has resulted in many businesses claiming the Employee Retention Credit, whether or not they are eligible to receive it.

To be fair, ERC fraudsters are to blame for many of these inaccurate returns. Greedy for their percentage of their client’s ERC amount, these ERC shysters have misled companies by exaggerating or omitting ERC eligibility information to score big payoffs. The IRS has repeatedly warned businesses about ERC fraud, including this month in IR-2023-105.

The unfortunate consequence of these schemes is that these clients will be held liable for these illegal ERC claims later, as well as penalties related to negligence, underpayment, and other fines. If you’ve received the ERC, it’s in your best interest to confirm that you are actually eligible for it. As stated in IR-2023–40, taxpayers are always responsible for the information reported on their tax returns. This means that improperly claiming the ERC will result in you being required to repay the credit along with penalties and interest.

Extending the statute of limitations on IRS assessments of ERC claims

In general, there is a three-year statute of limitations on IRS tax assessments under IRC Section 6501. This statute of limitations also applies to Social Security, Medicare, and Additional Medicare, and federal income tax withholding that are reported on your Form 941, under IRC Section 6513(c). Under this time frame, the statute of limitations for the ERC would be April 15, 2024, for 2020 quarters and April 2025 for qualifying 2021 quarters.

However, the U.S. Treasury Department’s 2024 “Greenbook” which was released earlier this year includes a proposal to apply the five-year statute of limitations on employee retention credit tax assessments to all the quarters for which the credit was available. Most ERC claims were made on amended returns that were already subject to substantial processing delays. Also, the current three-year statute of limitations provided under the CARES Act for ERC claims does not restart when an amended return is filed. These two factors make it extremely challenging for the IRS to audit and assess amended returns within the current statute of limitations. 

Another route for the IRS to recover erroneous ERC refunds

Under IRC Section 7405(b), the U.S. government can bring a civil action to recover erroneous tax refunds, as long as it can prove that the refund was made to a taxpayer, erroneously issued to the taxpayer, and the government’s lawsuit was timely filed. Under IRC Sections 7405(d) and 6532(b), the statute of limitations for these civil actions is up to five years from the time the refund is processed, particularly in cases where there is evidence of fraud or misrepresentation of a material fact.

How to ensure your ERC claim is valid

When it comes to ERC audits, it’s best to assume it’s a matter of when – not if – it happens to you. When an audit does occur, you want to be ready and able to substantiate both your ERC eligibility and the amounts you received from it. The way in which you validate your ERC claim depends on how you qualified for it. There are three ways to qualify for the ERC, including:

  • Decline in gross receipts: Under the gross receipts test, you are eligible for the ERC if your 2020 gross receipts for any quarter decreased by at least 50% when compared to the same 2019 quarter. In 2021, gross receipts must have decreased by at least 20% when compared to the same 2019 quarter.
  • Suspended operations: If you experienced a full or partial shutdown in 2020 or 2021 due to a COVID-19-related government order, you qualify for the ERC under the suspended operations test
  • Recovery Startup Business (RSB): IRS Notice 2021-49 defines a Recovery Startup Business as one that started carrying on trade after February 15, 2020, has average annual gross receipts under $1 million for three consecutive years preceding 2021, and is not otherwise eligible for the ERC under the gross receipts test or suspended operations test.

To substantiate your ERC claim, I recommend gathering and keeping the following documents along with other paperwork related to your ERC claim:

  • Quarterly gross receipts for 2019, 2020, and 2021
  • Detailed payroll registers/ summary reports from March 2020 through the end of 2021
  • Employer health plan costs by employee for March 2020 through the end of 2021
  • Form 941 or Form 943 and DE-9C for each quarter in 2020 and 2021
  • Copy of PPP1 Application and Forgiveness. Be sure to include loan amounts, laon disbursement dates, and if applicable, PPP forgiveness date and PPP forgiveness amount for both PPP 1 and PPP 2,
  • Copy of government mandate specifically ordering your full or partial closure. If you qualified for the ERC through the suspended operations test, note that OSHA and CDC guidance are not sufficient. The OSHA website states that its guidance about COVID-19 is advisory and informative in nature. Employers closing merely because of CDC recommendations are not described by the IRS in Notice 2021-20 as being eligible for the ERC.

If your ERC isn’t valid, do this

I recommend you don’t play audit roulette and think the IRS will bypass you among the millions of other taxpayers in the United States. The risk could be far greater than you realize for your business.

If an IRS audit reveals that your ERC claim is invalid and you were actually ineligible to receive the ERC, you will be liable for the amount of ERC you received, as well as negligence/accuracy penalties of up to 20% of the amount received if you knowingly disregarded the rules, late payment penalties of 3% to 7% annually, interest and other fines.

For example, let’s say you received $500,000 in Employee Retention Credit. If it’s revealed that you are actually ineligible through an audit, you could be liable for the original $500,000 received, penalties and interest in the tens of thousands, the high fees already paid to an aggressive consultant, and worst of all, a possible negligence/accuracy penalty of $100,000.  

Before being audited, if you discover your ERC claim is not valid, consider filing an amended payroll return (940X) for each quarter you claimed the ERC and return the funds. You should be prepared to pay interest and late payment fines. Considering the substantial figures discussed earlier related to the “audit roulette” option, this option is much more ideal than dealing with the fallout from an IRS audit.

Be safe not sorry with the ERC

Given the IRS’ increased focus on ERC fraud and collections, it is in your best interest to decide sooner rather than later whether your ERC is legitimate. Assuming you’ll fly under the radar could be a costly and unfortunate mistake, especially when it can be avoided with a little prudence and proactive work.