IRS Begins Processing ERC Claims, Reopens the Voluntary Disclosure Program

Taxpayers Can Expect Refunds and Disallowance Letters

The summer of 2024 could be dubbed the summer of the IRS Employee Retention Credit (ERC) News Release. In June, the IRS announced that after using new analytics to review 1 million claims, it plans to deny tens of thousands of claims that showed “clear signs of being erroneous.” Then in July, the IRS announced by news release that it had identified additional warning signs of improper ERC claims and that it was in the final stages of issuing a new voluntary disclosure program (“VDP”) for taxpayers seeking a quick settlement with the IRS. On August 8^th, the IRS announced the long-awaited end of the moratorium on processing new claims, though it only partially ended the moratorium. The IRS instituted the moratorium in the fall of 2023, saying that it would not process any claims made after September 14, 2023. After an eventful summer, the IRS announced that it would reopen the VDP for claims relating to 2021 tax periods until November 22, 2024.

The Second VDP

The Second VDP is slightly less advantageous than the first VDP that closed in March. Taxpayers who wish to participate in the program must now repay 85% (as opposed to 80%) of the ERC refund received, excluding any interest paid by the IRS. The Second VDP is only available for ERC claims made on 2021 employment tax returns. To be eligible, taxpayers must have received the ERC as a refund or credit applied to another tax period. The taxpayer must agree they are not entitled to any ERC for the period in which they apply for the ERC. Further, the taxpayer cannot have received a letter of disallowance from the IRS, be under an employment tax examination, or under criminal investigation.

For taxpayers who now believe that they are not entitled to the ERC or who wish to avoid additional defense costs, the Second VDP has its advantages. The Second VDP allows participants to keep 15% of the claim. In exchange for signing a closing agreement, agreeing to extend the statute of limitations for assessment of taxes, and agreeing to comply with requests for information from the IRS, a taxpayer accepted into the Second VDP will be treated as if they never claimed the ERC. The IRS will not assess interest or penalties, provided payment in full is made by the signing of the closing agreement. Additionally, the IRS agrees not to audit the ERC portion of the taxpayer’s employment tax returns. Income tax returns do not need to be amended to reduce wage expense. Taxpayers who cannot pay in full can apply for an installment agreement or an offer in compromise.

Movement with the Moratorium

For those claims that are now being processed, the IRS has said that it will expeditiously process claims that are considered “low risk.” Taxpayers may begin receiving refund checks as early as next month. In its August 8^th news release, the IRS noted that it had identified 50,000 “low risk” ERC claims that it will accelerate through the process.

For those claims considered “high risk,” the IRS has mailed 28,000 disallowance letters and plans to mail up to 30,000 new disallowance letters. The IRS cautioned that claims made for some quarters may be processed more quickly than others. Examination criteria is applied on a quarter-by-quarter basis, which may account for different treatment based on the facts specific to the quarter.

The moratorium will continue to apply to claims filed after January 31, 2024. Claims after this deadline would be barred by the passage of the Tax Relief for American Families and Workers Act of 2024. This bill passed the House of Representatives in January. The Senate brought the bill to a vote in August, but it did not pass. There is a possibility that the bill could find some traction in the Senate after the August recess. If passed, ERC claims after January 31, 2024, would not be allowed.

The IRS provided the following compliance statistics related to the latest ERC initiatives:

• Withdrawal Program – 7,300 entities withdrew $677 million in claims
• Voluntary Disclosure Program – 2,600 applicants disclosed $1.09 billion worth of credits
• Criminal investigations – 460 criminal cases initiated with almost $7 billion in potentially fraudulent claims
• Promoter investigations – the IRS is gathering information based on internal and external referrals and will continue compliance efforts
• Audits – there are currently 1,000s of ongoing ERC claim audits

New Warning Signs

As previously noted, on July 26^th, an IRS news release announced an additional five new “warning signs” of an improper ERC claim. Including these five new warning signs, the IRS has announced twelve warning signs to date. These warning signs include:

• Essential businesses during the pandemic that could fully operate and did not have a decline in gross receipts.
• Businesses unable to support how a government order fully or partially suspended business operations.
• Businesses reporting family members’ wages as qualified wages.
• Businesses using wages already used for Paycheck Protection Program loan forgiveness.
• Large employers claiming wages for employees who provided services.
• Businesses claiming the ERC for too many quarters.
• Businesses relying on Government orders that do not qualify.
• Businesses claiming too many employees and using the wrong calculations.
• Businesses citing supply chain issues.
• Businesses claiming the ERC for too much of a tax period.
• Businesses that did not pay wages or did not exist during eligibility period.
• Businesses influenced by a Promoter who says they have nothing to lose.

The IRS cautioned taxpayers to review their filings to ensure eligibility for the ERC. For potentially erroneous claims, in addition to the Second VDP, the IRS has a withdrawal program. Taxpayers who are eligible and comply with the withdrawal program forfeit the entire claim but are treated as if they never filed the claim.

Problems with Letters and Options for Taxpayers

Many of the warning signs enumerated above could not have been alleviated through the filing of the Form 941 or 941-X, which are the employment tax returns used to claim the ERC by a taxpayer. For example, Government orders were not required to be attached to the employment tax return. Likewise, there is no indication from the face of an employment tax return how an essential business may have been partially shut down due to a qualifying Government order. So, potentially there is a large swath of legitimate ERC claims that will receive a disallowance letter.

As the disallowance letters mailed by the IRS this summer reached taxpayers, tax practitioners immediately noticed certain deficiencies with the letters. The typical ERC disallowance letter contains a generic recitation of the reasons for the disallowance without the specific details one would expect from a fact-intensive analysis. Additionally, around 10% of letters inadvertently failed to include a summary of the taxpayer’s administrative appeal or judicial review rights. The IRS has publicly acknowledged this error and stated that it is working to correct those disallowance letters that did not include language concerning taxpayer rights.

Taxpayers that receive a disallowance typically have 30 days to file a protest that asks for an appeal. Appeals are informal, but the taxpayer may be represented by counsel. The protest should include documentation supporting the ERC claim. Additionally, taxpayers have two years from the issuance of a disallowance letter to file a refund claim in U.S. District Court or the United States Claims Court. The IRS and taxpayer may agree to extend the statute.

Taxpayers receiving disallowance letters should seek the advice of a tax professional to help evaluate next steps.