IRS Shares Five New Warning Signs of Incorrect ERC Claims

The IRS has released five new warning signs to help businesses prepare for upcoming actions against improper Employee Retention Credit (ERC) claims, urging businesses to act proactively to resolve those to avoid penalties, interest, and audit. The agency advises that businesses consult with trusted tax professionals to review and correct any claims initially filed by promoters. No action is necessary for clients who have filed with the guidance of AAFCPAs.

Hundreds of thousands of high-risk ERC claims are being scrutinized while low-risk claims are being processed. Businesses may receive payments for valid periods while other periods are reviewed. ERC eligibility may vary by tax period due to changes in government orders or gross receipts, among other factors. Additional details on compliance efforts, a short-term reopening of the Voluntary Disclosure Program, and updates on processing low-risk payments will be announced soon.

Five New Red Flags

The IRS identified five new warning signs of incorrect ERC claims based on common issues encountered by compliance teams. These new items add to seven previously highlighted problem areas (noted below).

1. Essential Businesses Claiming ERC Without Decline in Gross Receipts

Many essential businesses have been incorrectly advised to claim the ERC despite being able to operate fully during the pandemic. Simply modifying operations, such as requiring handwashing or masks, does not qualify as a partial suspension of business activities. Businesses must review eligibility rules and ensure they meet the criteria set by government orders.

2. Insufficient Proof of Government Order Impact

To qualify for the ERC, a business must show that a government order fully or partially suspended its operations. Many businesses fail to provide adequate evidence to support this claim. Specific details about how the order affected more than a nominal portion of operations are necessary.

3. Reporting Family Members’ Wages as Qualified

Businesses mistakenly claiming ERC on wages paid to family members are at risk. The IRS explicitly excludes wages paid to related individuals, such as spouses, children, siblings, and other close relatives, from qualifying for the ERC.

4. Double Dipping with PPP Loan Forgiveness

Wages used under Paycheck Protection Program (PPP) forgiveness cannot be claimed for the ERC. Businesses must ensure they do not double-count these wages. Any payroll costs covered by a forgiven PPP loan are ineligible for the ERC.

5. Large Employers Including Wages for Employees Providing Services

Special rules applied to large eligible employers, which include employers averaging:

• more than 100 full-time employees in 2019 and claimed ERC for 2020 tax periods, and/or
• more than 500 full-time employees in 2019 and claimed ERC for 2021 tax periods.

Large employers can only claim the ERC for wages paid to employees who were not providing services. Many claims incorrectly include wages for employees actively working during eligible periods.

Previous Warnings and Common Issues

The IRS previously highlighted other common mistakes, including:

1. Claiming the ERC for too many quarters.
2. Misinterpreting government orders as qualifying criteria.
3. Incorrectly calculating qualified wages.
4. Citing supply chain issues as a basis for the ERC.
5. Overstating wages for a tax period.
6. Claiming ERC without paying wages or before the business existed.
7. Following promoters’ advice without professional consultation.

The IRS offers several options for businesses with questionable ERC claims. Ineligible businesses with unprocessed claims are encouraged to use the ERC Withdrawal Program to avoid future compliance issues; the claim will then be treated as if it was never filed, with no interest or penalties. Businesses may also amend their returns to correct overclaimed amounts. The IRS announced that it will be reopening the ERC Voluntary Disclosure Program for a short period, with more details on the horizon.

How We Help

AAFCPAs advises that businesses with pending claims prepared by companies other than a qualified tax professional, e.g., either by themselves or by a mill, carefully review their filing to ensure it complies with eligibility rules. Should you identify any of the above indicators, contact us directly or consider using the special ERC Withdrawal Program and stay informed about the upcoming reopening of the ERC Voluntary Disclosure Program. We also advise that businesses maintain thorough documentation and evidence to support their ERC claim and be wary of aggressive ERC promoters and mills that might offer misleading advice. AAFCPAs can assist organizations that were misled by promoters, helping you reassess eligibility, correct errors, and ensure claims are legitimate.

As the IRS continues to scrutinize ERC claims, businesses must ensure filings are accurate and that they comply with eligibility rules. By addressing identified red flags and seeking professional advice, businesses can avoid significant financial and legal repercussions.

If you have questions, please contact Kaite Noll, CPA, Manager at 774.512.4138 or knoll@nullaafcpa.com, Courtney McFarland, CPA, MSA, 340B Apexus Certified Expert™ at 774.512.4051 or cmcfarland@nullaafcpa.com—or your AAFCPAs Partner.