‘Tsunami’ of ERC claims required IRS action to halt fraud, experts say

“You could receive up to $26,000 per employee.”

“Did your CPA say you’re not eligible? You should get a second opinion from us because we’re the experts.”

“Act before it’s too late. Don’t miss out.”

This is the type of language used on websites and in TV ads to get small businesses to apply for the employee retention credit (ERC), a pandemic-era program that applied in 2020 and 2021. The IRS believes the program is so rife with abuse by ERC mills that the Service imposed an immediate moratorium on the processing of new claims, at least through the end of 2023.

Some described the IRS actions as unprecedented. And several in the finance and accounting world say it was about time that the IRS acted forcefully.

“The IRS doesn’t just sit back and get scammed and do nothing about it,” said attorney Steve Klitzner, whose practice specializes in resolving disputes with the IRS and who is a member of the IRS Advisory Council. “These companies that are advertising if you can’t get it from someone else, come to us, and we’ll get it for you … There are so many obvious scams, and [the IRS is] just paying out. When they pay out, [clients] pay their 10% or 20% referral fee. Then they get audited and guess who’s gone? They eat the whole thing.”

So far, the Service has paid $230 billion in ERC claims, an IRS representative said last week.  

The ERC was a refundable tax credit for businesses that paid workers during the COVID-19 pandemic while their operations were fully or partially suspended because of a government order or for those that had a significant decline in gross receipts during the eligibility period. It was available from March 31, 2020, to Sept. 30, 2021, with a deadline of Dec. 31, 2021, for recovery startup businesses.

The IRS has received 3.6 million ERC claims, and of the 600,000 (15%) currently unprocessed by the IRS, virtually all were filed in the past 90 days, IRS Commissioner Danny Werfel said Thursday, when he announced the actions. At a time when the filing of new claims should be a trickle, they are instead a tsunami, he said.

As of July 31, the IRS Criminal Investigation Division has initiated 252 investigations involving more than $2.8 billion of potentially fraudulent ERC claims, with 15 of those investigations resulting in federal charges, Werfel said. Six of those 15 have resulted in convictions. In addition, the IRS has referred thousands of ERC claims for examination.

The IRS offered two ways to help small businesses. First, those with claims among the 600,000 still awaiting IRS review will be offered a process to withdraw them. This withdrawal option will allow taxpayers to avoid possible repayment issues and keep them from having to pay contingency fees to promoters, the IRS said.

The IRS also is working out details of the settlement initiative that will allow taxpayers to repay a claim that they erroneously received and avoid penalties and future compliance action. The Service promised more details on how this program will work in the fall.

Possibly lost in the focus on abuse and fraud is that the ERC was a good benefit, said James Creech, senior manager with the tax advocacy and controversy group at Baker Tilly.

“It’s easy to look back at this now and say, ‘Oh, the fraud,’ but in 2020, 2021, this kept a lot of people employed when there was no work, when the business would have folded otherwise, and they would have been out trying to find jobs that didn’t exist,” Creech said. “And they’ve still got to eat, they’ve still got to put gas in the car. You’ve still got to make a mortgage payment or pay rent. I think that the credit itself is not a bad credit. I think the problem lies with a bigger systemic problem in terms of the IRS hasn’t been funded in over a decade.”

Former IRS commissioner Mark Everson, who called the IRS actions “a sound step in the interest of tax administration,” agreed that the ERC started as a legitimate benefit.

“But what has happened, and particularly in recent months, there’s been an acceleration — really the flimsiest of claims, some of them outright fraud, and really, it’s been predatory behavior by pop-up outfits that have convinced people they can qualify for this when they don’t,” said Everson, who served as IRS commissioner from 2003 to 2007 and now is a vice chairman of alliantgroup, a tax and business consulting group.

“The ERC is still a very legitimate benefit and worth businesses researching with an expert firm,” Everson said. “The IRS pause is beneficial in weeding out the scams so the agency can get to the legitimate claims.”

In some cases, small business owners got a “no” from their tax preparer but a “yes” from a promoter. Those taxpayers are now coming to firms such as Baker Tilly or alliantgroup with buyers’ remorse, dubious about their own claims.

“The heartbreaking thing here is it’s going to put people out of business,” Creech said because they will, at a minimum, have to repay the credit and are out whatever contingency fee they paid to the ERC company. “And there’s people that are going to lose their jobs because the credit mills were too aggressive.”

Everson said alliantgroup screened out some small businesses, “and then someone else got in touch, and they filed a claim. And they come back to us and say, ‘You guys didn’t help us the way the other guy did.’ Sometimes they regret that later.”

Klitzner lays the blame for ERC fraud almost solely on the mills, saying he does not think most small business owners intended to commit fraud.

“They really believe that if there’s a company that tells them they can get it and fills out the forms and the IRS gives them the money, that it must be legit. I don’t think these taxpayers think they’re pulling a fast one,” he said.

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