Seven red flags of a bad ERC claim

February 13, 2024 9:20 PM

Few letters have haunted the post-pandemic business world — and, by association with certain clients, accounting firms — like "ERC."

The Employee Retention Credit was intended as a relief tool to help companies keep people on the payroll even while hammered by COVID shutdowns. Whether through their own greed or the pitches of hucksters, many business clients fudged their ERC applications, pocketed the money and hoped no one would notice.

The Internal Revenue Service did (after temporarily halting the processing of new ERC claims). Last fall, the agency started giving employers a way to withdraw inaccurate ERC claims if they'd fallen for the scams of ERC "mills" that aggressively promoted the credit to businesses. Soon after came the IRS's voluntary disclosure program for businesses that wanted to pay back the money after filing bad ERC claims. The voluntary disclosure program's deadline is March 22.

As the deadline clock ticks, the IRS has highlighted seven warning signs that an ERC claim may be questionable. (The agency also has a FAQ page on the subject.)

2. Government orders that don't qualify

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Some promoters told employers they can claim the ERC if any government order was in place in their area (generally involving restricted public movement), even if their operations weren't affected or if they chose to suspend their business operations voluntarily. This is false: Government orders had to be due to the pandemic and had to fully or partially suspend the employer's operations, among other conditions.

3. Too many employees and wrong calculations

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Employers should be cautious about claiming the ERC for all wages paid to every employee on their payroll. The law changed throughout 2020 and 2021 and there are dollar limits and varying credit amounts. Employers need to meet certain rules for wages to be considered qualified wages, depending on the tax period.

5. Claiming an ERC for too much of a tax period

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It's possible but uncommon for an employer to qualify for the ERC for the entire calendar quarter if their business operations were fully or partially suspended due to a government order during a portion of a calendar quarter. A business in this situation can claim the ERC only for wages paid during the suspension period, not the whole quarter.

6. A business didn't pay wages — or didn't exist

Employers can only claim the ERC for tax periods when they paid wages to employees. Some taxpayers claimed the ERC but records available to the IRS show they didn't have any employees. Others claimed the ERC for tax periods before they even had an EIN, meaning the business didn't exist during the eligibility period. The IRS has started disallowing these claims.

7. "There's nothing to lose."

There is, and your business's clients should be on alert for any ERC promoter who urged them to claim the credit for this reason. Businesses that incorrectly claim the ERC risk being subject to repayment requirements, penalties, interest, audit and the potential expenses of hiring someone to help resolve the incorrect claim, amend previous returns or represent them in an audit.