Key Points at a Glance:

  • The U.S. Internal Revenue Service (IRS) is intensifying its review of Employee Retention Credit (ERC) claims filed during the pandemic and has sent 28,000 denial notices to businesses in recent weeks. According to the agency, these flawed claims, if approved, could have led to up to $5 billion in improper payments.
  • The IRS paused processing ERC claims submitted after September 14, 2023, in September 2023 to screen out fraudulent or non-compliant claims. The agency has initiated thousands of audits and opened 460 criminal cases. Meanwhile, the IRS has verified 50,000 ERC claims and is "quickly moving them into the payment pipeline."
  • IRS Commissioner Danny Werfel said in a statement Thursday that the ERC "is one of the most complex tax provisions the IRS has ever administered" and that "distinguishing valid claims from invalid ones has taken considerable time."

In-Depth Analysis:

The IRS paused claim reviews after aggressive and predatory marketing related to the credit continued to increase even after the pandemic ended. The IRS noted that some promoters have mischaracterized the credit as a grant, federal relief, or business stimulus funds.

Werfel said such hype has led many ineligible businesses to file claims, further complicating what was already "a resource-intensive review for the IRS."

He added that the administrative challenges "have been exacerbated by misleading marketing — flooding businesses with promotions to claim the credit, creating a perfect storm: increasing the risk of improper payments for taxpayers and the government, complicating IRS processing, and delaying progress for legitimate businesses."

The U.S. Congress established the ERC in March 2020 to encourage businesses to retain employees during widespread pandemic-related shutdowns.

The IRS acknowledged that some of the 28,000 denied claims may have been misjudged, but reviews have shown that over 90% of the denial notices were justified. The agency plans to "maintain communication with the tax community and continue monitoring the situation."

The IRS will begin issuing payments for 50,000 valid claims in September and expects to move another large batch of low-risk claims into processing and payment in the fall.

As of July 1, IRS officials have opened criminal investigations into potentially fraudulent claims involving nearly $7 billion. Of those, 17 investigations have resulted in convictions, and 9 have led to sentencing, with an average prison term of 20 months.

The IRS also said it is investigating fraudulent and abusive promotion practices by tax return preparers and tax professionals based on hundreds of referral leads from external and internal sources.

The ERC applies to employers who were ordered to shut down but continued to pay wages to some or all employees after March 12, 2020, and before January 1, 2022. The credit amount varies depending on how long the business was affected.