Safeguard Against Uncertainty When Claiming Employee Retention Credits

The following article first appeared in the Insights section of CliftonLarsonAllen’s website. It is reposted here with permission.

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Many employers unknowingly made false employee retention credit claims after falling prey to companies engaging in aggressive schemes.

Now, for the second time, the IRS is offering a way to repay improper credits.

The IRS has been closely monitoring ERC activities and cracking down on fraudulent practices.

To address this issue, the IRS has again opened a voluntary disclosure program as a way for employers to repay ERC funds that were improperly claimed. 

Explore what the VDP could mean for employers who received the credit but were not entitled to it.

Evolution of ERC claims

The IRS issued multiple warnings, generic legal advice memorandums, and the “dirty dozen” article warning taxpayers against aggressive schemes for claiming COVID-related relief with the employee retention credit program. 

September 2023: The IRS announced a moratorium on processing new refund claims through the end of the year to get a better handle on fraudulent claims and to slow the process to identify claims that may be less than reputable. 

October 2023: It issued instructions on how to withdraw improper ERC claims. 

November 2023: The IRS clarified an area of grey many promoters used to seduce employers into believing they were eligible for the credit. It issued a general legal advice memorandum discussing in depth why OSHA guidelines alone are not sufficient to support an ERC claim.  

While a GLAM does not officially bind the IRS, taxpayers, or the judiciary, it provides a clear perspective on how IRS agents will treat claims based on OSHA directives.

December 2023: The IRS initiated a voluntary disclosure program for employers who received their funds and wanted to return them. 

August 2024: The IRS opened the VDP for a second time with slightly less generous terms for employers. This program is available until Nov. 22, 2024.

The IRS also lifted its moratorium and is in the process of issuing close to 50,000 payments to employers awaiting refunds—and simultaneously is issuing 30,000 rejection letters for “high-risk” claims.  

VDP Helps Employers Who Paid Exorbitant Fees

The IRS is sympathetic to the fact that many employers are unable to repay the credit because of their agreement with the vendor who assisted in the preparation of the refund claim.  

In many instances, the fees aren’t refundable unless the IRS audits and disallows the credit. IR-2024-213 requires the employer to repay only 85% of the refund as part of the agreement. 

Employers unable to repay the required percentage may be considered for an installment agreement.

If the IRS paid interest on the employer’s ERC refund claim, the employer doesn’t need to repay that interest.

Employers unable to repay the required percentage may be considered for an installment agreement on a case-by-case basis.

Interested employers must apply to the VDP by Nov. 22, 2024. 

Who Is Eligible?

Any employer who already received the ERC for a 2021 period but isn’t entitled to it can apply if the following are also true:

• The employer is not under criminal investigation and has not been notified they are under criminal investigation.
• The employer is not under an IRS employment tax examination for the tax period for which they’re applying to the VDP.
• The employer has not received an IRS notice and demand for repayment of part or all of the ERC.
• The IRS has not received information from a third party that the taxpayer is not in compliance or has not acquired information directly related to the noncompliance from an enforcement action.

What Do Employers Need to Apply?

To apply, the employer must first file Form 15434, Application for Employee Retention Credit Voluntary Disclosure Program, available on IRS.gov. Submit the form using the IRS Document Upload Tool. 

Employers will be expected to repay their full ERC, minus the 15% reduction allowed through the VDP.

Employers will be expected to repay their full ERC, minus the allowed 15% reduction.

Employers not able to pay the amount in full will have the option to set up an installment agreement under certain conditions.  

If the employer outsources their payroll to a third party, the third party is required to file the form on behalf of the employer.

Should You File a Protective Claim?

Many employers have filed income tax returns reflecting lower wage expenses due to their ERC claims—without having received their ERC refunds.

With the three-year statute of limitations for 2020 income tax returns either closing soon or having closed already, taxpayers and practitioners are concerned they’ll run out of time to potentially reclaim those lost wage deductions if the ERC claims are denied. 

Claiming the ERC causes the employees’ wages generating the ERC to be not deductible for income tax purposes.

Consequently, employers who claim the ERC on amended payroll tax returns after they have filed their original income tax return are generally required to file amended income tax returns or administrative adjustment requests to reflect the ERC claims.

Filing the amended income tax returns has been complicated by the IRS’s delays in processing ERC claims and general rhetoric about the high percentage of improper or high-risk claims (estimated by the IRS to be as high as 90% of total claims). 

The taxpayer could pay additional income tax only to have their ERC claims ultimately denied by the IRS.

The extended five-year statute of limitations for assessment of Q3 2021 ERC claims further increases the risk of employers facing contradictory outcomes.

The taxpayer could pay additional income tax only to have their ERC claims ultimately denied by the IRS after the three-year statute of limitation has closed on the 2021 income tax return.

Generally, if your right to a refund is contingent on future events and may not be determinable until after the time period for filing an amended return expires, you can file a protective claim for refund.

However, it’s uncertain whether the agency will recognize a protective claim for refund related to ERC refunds and related wage expenses as effective.

Consult a qualified tax professional to determine a specific course of action.