03 Oct 2022 IRS Fights Employee Retention Tax Credit Fraud
Fraudulent claims of the Employee Retention Credit (ERC) have the potential to be the largest tax-related scams in U.S. history.
On August 31, 2022, the Treasury Inspector General for Tax Administration (TIGTA) released a significant report that mostly flew under the radar. According to the Treasury Department’s official watchdog, TIGTA, the IRS flagged 11,096 suspicious federal returns that claimed more than $2 trillion in Employee Retention Credits (ERC) as of March 10, 2022.
Making matters worse, the report found that the IRS doesn’t presently have the means to verify whether businesses claiming the credit actually qualify, nor do they have the means to audit employers filing amended returns to claim the credit.
At the same time, there has been a significant rise in businesses and consultants advertising to help companies claim the Employee Retention Tax Credit. Unfortunately, many companies are being told they qualify when in fact, they do not.
Employee Retention Tax Credit availability, the sheer volume of companies claiming the credit, lack of proper IRS oversight, and the rise of ERC consultants has led to significant industry fraud.
This article will provide background information on the ERC and how it has led to fraudulent activity. Then we’ll briefly review the IRS’s response to these findings.
What are Employee Retention Credits
The ERC came about in 2020 as part of the $2.2 trillion federal CARES Act legislation signed into law by President Donald Trump to combat the economic fallout from the pandemic.
The credit program incentivized employers to retain full-time workers on their payroll instead of laying them off. Employers that did so could claim a refundable credit as a form of reimbursement for paying employee salaries during the economic downturn caused by the pandemic. The fact that the credit was refundable means that even businesses that did not owe federal tax could claim the credit and receive a refund from the IRS.
Unfortunately, programs this lucrative, with as much publicity as the CARES Act, can lead to abuse and fraud.
Recently, the IRS implemented an identity theft fraud filter to flag suspicious returns claiming the ERC. However, the full extent of the fraud has yet to be ascertained – because businesses can file amended returns still claiming the credit. Additionally, the IRS currently has a backlog of thousands of amended returns to review and process.
While the publicity of the program and the cash incentives provide plenty of ammunition for fraud, other factors have likely contributed to the problem.
Confusing and changing requirements
There are various changing and complex rules for claiming the benefit – a factor that has likely contributed to the high volume of suspected fraud.
First, the number of businesses that could potentially qualify for the ERC is staggering. To be eligible for the credit, businesses and nonprofits “engaged in a trade or business” with 500 or fewer full-time employees could qualify if they had to be closed due to a government order or suffered “significant economic decline” due to the pandemic. And the ERC program has complicated requirements for determining a business’s decline in income.
Initially, employers could get a maximum credit of $5,000 per employee for the 2020 tax year. In 2021, this figure was boosted to $7,000 per employee per quarter. However, most employers became ineligible for the credit in the fourth quarter of 2021. Only businesses considered “startup recovery businesses” could claim the ERC at that time. To be considered a startup recovery business, the business must have opened its doors after February 15, 2020, and have gross receipts of $1 million or less.
Another factor contributing to the fraud is the proliferation of ERC mills. These firms often employ aggressive marketing tactics that gloss over the credit’s complicated rules. They also failed to inform claimants that the credit could open them to a high likelihood of an audit. Additionally, many ERC promoters were not licensed accountants or credentialed financial advisors. As a result, many did not ensure that claimants had the right qualifications or documentation to claim the credit.
Not only does the IRS take suspected fraud seriously, the Inflation Reduction Act (IRA) recently slated an additional $80 billion over the next decade to fund the IRS and hire more personnel, among other improvements. One stated goal of this funding is to ensure the enforcement of the tax code. Specifically, the IRA intends to raise enforcement funding by 69% relative to current projections (according to the Congressional Research Service). Whether this increased enforcement budget will lead to the identification and prosecution of more ERC fraud is yet to be known.
Also, as early as November 2021, an IRS spokesman reported that the IRS would start training agents to audit ERC. However, considering the backlog of amended returns that have yet to be processed, these audits will likely continue over the next several years.
It’s more important than ever to have an experienced Certified Public Accountant determine if you truly qualify for ERC. If you’d like to ensure you qualify for the ERC and have the appropriate documentation to reduce the risk of audit, please contact our office.
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