The IRS has announced that it is sending more than 20,000 letters to taxpayers notifying them that their Employee Retention Credit, or ERC, claims have been disallowed. These letters are targeted to taxpayers the IRS believes are not eligible and who have applied for, but have not yet received the credit.
This initial round of letters is being sent as the IRS continues increased scrutiny of ERC claims. In September of this year, citing “rising concerns about a flood of improper Employee Retention Credit claims,” the IRS announced an immediate moratorium on processing new ERC claims. The pause will run through through at least the end of the year—no new claims will be reviewed or processed until early 2024.
In October, the IRS introduced a new withdrawal option, allowing certain employers that have filed an ERC claim but have not received a refund to withdraw their submission and avoid future repayment, interest, and penalties. Employers that have submitted an ERC claim that’s still being processed can withdraw their claim and avoid the possibility of getting a refund for which they’re ineligible.
Later this month, the IRS intends to unveil a separate voluntary disclosure program which will allow those taxpayers who received questionable payments to make a disclosure and avoid future IRS action.
Taxpayers who are ineligible for the credit will receive Letter 105 C, Claim Disallowed. Taxpayers who receive this letter fall into two categories: their entity did not exist during the ERC timeframe or they did not have employees for the time period when the credit was claimed.
“With the aggressive marketing we saw with this credit, it’s not surprising that we’re seeing claims that clearly fall outside of the legal requirements,” said IRS Commissioner Danny Werfel. “The action we are taking today is part of an initial set of steps in our compliance work in this area, and more letters will be going out in the near future, including both disallowance letters and letters seeking the return of funds erroneously claimed and received.”
The mailing reflects just part of the ongoing IRS review of these claims.
What To Do
If you receive a letter, read it carefully. The letter will explain that if you disagree with the disallowance, you can respond with documentation that supports you eligibility or claim amount, or you can file an administrative appeal.
The IRS says that sending out the letters will help ineligible taxpayers avoid audits, repayment, penalties and interest, as well as protect taxpayers by preventing an incorrect refund from going to an ERC promoter. The letters will also save IRS resources by disallowing incorrect credits before they enter the audit process.
What Comes Next
These are the first round of letters. The IRS plans additional letters beyond the disallowance letters.
The IRS is also continuing to review ERC claims and may request more information from taxpayers to support their ERC claim.
And, the IRS will accept and process requests to withdraw a full ERC claim under the special withdrawal process. Taxpayers have until at least the end of the year to request a withdrawal.
Here’s how the ERC works. Eligible employers are those that paid qualified wages to some or all employees after March 12, 2020, and before Jan. 1, 2022. Typically, to qualify, you must demonstrate that your business was shut down by a government order due to the pandemic during 2020 or the first three calendar quarters of 2021, or that you experienced a specific decline in gross receipts during the eligibility periods during 2020 or the first three calendar quarters of 2021. Some businesses may also qualify as recovery startup businesses for the third or fourth quarters of 2021 (otherwise, the ERC relief was phased out by Congress for businesses for that period).
The credit is 50% of up to $10,000 in wages, meaning that it can be as high as $5,000 per employee in 2020 and as high as $21,000 per employee in 2021 (totaling the $26,000 per employee that is regularly touted).
The ERC is available to most kinds of businesses, including tax-exempt businesses. It is not available to individuals, including freelancers and independent contractors.
Some additional restrictions apply. For example, businesses may not include wages funded by a Payroll Protection Program (PPP) forgivable loan (another Covid relief program) when calculating wages eligible for the ERC.
The IRS has created a chart to help a business or other organization quickly decide if they qualify for the ERC. While the IRS acknowledges that this is a very technical area of the law, they note that the chart includes the main eligibility factors. Taxpayers are encouraged to review IRS guidance and tools for helping determine ERC eligibility, including frequently asked questions and a new question-and-answer guide to help businesses understand if they are eligible for the credit.
More information is available on IRS.gov/erc.
If you realize that you should not have filed an ERC claim, you can participate in an ERC claim withdrawal process. You can participate if all of the following apply:
- You claimed the ERC on an adjusted employment return (Forms 941-X, 943-X, 944-X, CT-1X);
- You filed the adjusted return only to claim the ERC and made no other adjustments;
- You want to withdraw the entire amount of their ERC claim; and
- The IRS has not paid the claim, or the IRS has paid the claim, but you haven’t cashed or deposited the refund check.
If you made any other changes on the adjusted employment tax return or only need to reduce your ERC claim (not withdraw it entirely), you can’t use the withdrawal process—you need to amend your return. For more information, check out my previous article or “Amending a return” (Q1 and Q2) on the ERC frequently asked questions page on the IRS website.
The IRS reminds those being approached by these promoters that there are simple steps that can be taken to protect themselves from making an improper ERC. Many of these are simply common sense. Their number one tip—and mine? Work with a trusted tax professional.
According to Werfel, “As we continue our audit and criminal investigation work involving the Employee Retention Credits, we continue to urge people who submitted a claim to review the rules with a trusted tax professional. If they filed an inaccurate claim, we urge them to consider withdrawing their pending claim or use the upcoming disclosure program to repay improper refunds to avoid future action.”
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