IRS Warns of New Red Flags for Employee Retention Credit Claims

As the IRS intensifies its scrutiny of Employee Retention Credit (ERC) claims, it has identified five new warning signs of incorrect filings. This is in addition to seven previously highlighted problem areas. Businesses with pending or previously approved ERC claims should review these red flags and consult a trusted tax professional to avoid potential audits, repayments, penalties, and interest.

The IRS recently shared five new warning signs of incorrect business claims for the Employee Retention Credit. The list comes from common issues the IRS has seen while reviewing and processing ERC claims.

New Warning Signs of Incorrect ERC Claims:

1. Essential Businesses: Businesses that were fully operational and didn't experience a significant decline in gross receipts during the pandemic are often not eligible for ERC, even if minor modifications (like mask-wearing) were implemented. Promoters convinced many essential businesses to claim the ERC when, in many instances, essential businesses weren’t eligible because their operations weren’t fully or partially suspended by a qualifying government order.
2. Insufficient Support for Government Orders: Claims must be backed by proof that a government order fully or partially suspended business operations. Whether a business was fully or partially suspended depends on its specific situation. When asked for proof on how the government order suspended more than a nominal portion of their business operations, many businesses haven’t provided enough information to confirm eligibility.
3. Family Members' Wages: Wages paid to related individuals, such as spouses or children, generally do not qualify for the ERC. If business owners claimed the ERC using wages paid to related individuals, those claims are likely for the wrong amount or ineligible.
4. Overlap with Paycheck Protection Program (PPP): Wages used for PPP loan forgiveness cannot also be claimed for ERC. Businesses can’t claim the ERC on wages that they reported as payroll costs to get PPP loan forgiveness.
5. Large Employers Claiming Active Employees: Large employers (over 100 full-time employees in 2019 for 2020 claims, or over 500 for 2021) can only claim ERC for wages paid to employees not providing services. Large eligible employers can only claim wages paid to employees who were not providing services. Many large employers’ claims incorrectly included wages for employees who were providing services during these periods.

Previously Highlighted Issues:

1. Excessive Quarters Claimed: Claims for all available quarters are uncommon and often incorrect. Too many quarters being claimed.
2. Ineligible Government Orders: Only specific COVID-19-related government orders qualify, not general guidance or recommendations.
3. Incorrect Employee Count and Wage Calculations: Ensure accurate employee counts and wage calculations for each period.
4. Supply Chain Disruptions: These rarely qualify unless directly caused by a government order.
5. Overstating Claim Periods: Claims should only cover wages during the suspension period, not the entire quarter.
6. No Wages or Business Activity: ERC can only be claimed if wages were paid during the eligibility period.
7. Promoter Misguidance: Be wary of promoters suggesting there's nothing to lose by claiming ERC.

Resolution Options:

• Claim Withdrawal: Unprocessed claims can be withdrawn through the ERC Withdrawal Program to avoid future issues.
• Amending Returns: Overclaimed ERC amounts can be corrected by amending tax returns.

For details on these warning signs, check new and previously shared signs ERC claims may be incorrect.

Businesses can also use the IRS’s ERC Eligibility Checklist or review Frequently Asked Questions about ERC Eligibility to help identify incorrect claims.

If you have any questions or concerns don't hesitate to get in touch with an Axley & Rode tax advisor for assistance.