IRS Unveils Voluntary Disclosure Program for Erroneous ERC Claims
On December 21, 2023, IRS announced a Voluntary Disclosure Program (VDP) through which eligible employers may repay 80 percent of the employee retention credit (ERC) to which they were not entitled and avoid civil litigation, penalties, and interest. IRS initiated this program in response to myriad fraudulent ERC claims, many filed by promoters who aggressively marketed this program to employers. Employers who received improper ERC payments have until March 22, 2024, to submit applications to participate in the VDP.
Who Should Respond?
The IRS has stated that promoters lured ineligible taxpayers to claim the ERC by misrepresenting the eligibility criteria. They marketed their services through radio, email, text messages, phone calls, and social media. Anyone who filed an ERC claim in response to an aggressive marketing campaign should be wary of the validity of that claim. The IRS is advising such employers to meet with a trusted tax advisor who can evaluate the legitimacy of the ERC claim that was filed. Employers who worked with trusted tax advisors to file ERC claims should not generally be concerned about the legitimacy of their previously filed ERC claims. Any employers who filed ERC claims based upon “supply chain issues” (discussed in the ERC Eligibility section below) should ask a trusted tax advisor to review their claims and help them determine whether they should participate in the VDP.
Estimating that at least $3.4 billion of fraudulent claims have been filed and recognizing that taxpayers faced unacceptable risk from aggressive promoters, the IRS halted the processing of new ERC claims on September 14, 2023. At that time, the IRS provided a process for employers to withdraw unpaid ERC claims they now realized were improper. The details of the withdrawal process are outlined at IRS.gov/withdrawmyerc. Pursuant to these instructions, employers who filed improper claims, but have not yet been paid, may generally still withdraw these claims, penalty free, even if an audit has begun.
At the same time, the IRS stated it would be developing a program under which those who had already received the ERC could voluntarily settle their claims with the IRS. The VDP provides employers with that opportunity.
How the Voluntary Disclosure Program Works
Any employer that has claimed the ERC and has received a credit or refund is eligible to participate in the VDP, as long as the following requirements are met:
- The employer is not under criminal investigation and has not been notified that they are under criminal investigation.
- The employer is not under an IRS employment tax examination for the tax period for which they're applying to the VDP.
- The employer has not received an IRS notice and demand for repayment of part or all of the ERC.
- The IRS has not received information from a third party that the taxpayer is not in compliance or has not acquired information directly related to the noncompliance from an enforcement action.
- The employer has not filed an amended return reversing the ERC to 0.
- However, if the amended employment tax return was filed prior to December 21, 2023, the IRS will review applications for possible eligibility to participate in the VDP (which generally requires repayment of only 80 percent of the improper ERC claim).
Terms of the Program
Participants in the VDP will be subject to the following terms:
- The employer must repay 80 percent of the claimed ERC, including both the refundable and non-refundable portions of the credit.
- The IRS is requiring only an 80 percent repayment of the claim, recognizing that many promoters claimed a large percentage of the proceeds as a fee.
- The employer will not be eligible for any ERC—refundable and/or nonrefundable—for the tax period(s) at issue.
- The participant will not be required to repay any overpayment interest received. Additionally, if the full 80 percent is repaid at the time of closing, no underpayment interest will apply. Interest will only be due if the IRS authorizes an installment agreement for the repayment.
- For those employers who have not yet reduced their wage deduction to correspond to the amount of the claimed ERC, they are not required to amend a return to do so, even with respect to the 20 percent that is not repaid.
- Pursuant to the settlement terms, a participant has no income with respect to the resolution of the tax obligation once the 80 percent obligation has been paid.
- For those employers who have already reduced their wage deduction to correspond to the amount of the claimed ERC, they may file an amended return to eliminate the wage expense reduction.
- If a return preparer or advisor assisted or advised the participant with any part of the claim for credit or refund, the employer must provide the name, address, and phone number of the preparer and/or advisor and a description of the services provided by that advisor.
- The IRS will not assert civil penalties related to the underpayment of employment tax attributable to the claimed ERC against a participant in the VDP, as long as they remit 80 percent of the claimed ERC prior to executing the closing agreement.
- The employer must execute a closing agreement.
Applying for the Voluntary Disclosure Program
Eligible employers much submit a complete application package by 11:59 pm local time on March 22, 2024, by following the instructions on Form 15434, Application for Employee Retention Credit Voluntary Disclosure Program. An authorized person must sign and date the application. Some applicants may need to submit additional forms. The application package must be submitted using the IRS Document Upload Tool. Instructions for filling out Form 15434 and submitting it are located here. The IRS urges employers to submit their payment using Electronic Federal Tax Payment System (EFTPS) at the time they submit their application. Separate payments are required for each tax period. Paying at the time of the application “can help speed up processing and resolve your case more quickly,” according to the IRS.
The IRS will initially send a letter to applicants informing them that their application was received and whether it is in process or rejected. If the application is not rejected, the IRS will review the application and mail a second letter providing next steps. If the application is accepted, the IRS will automatically adjust the employment tax account. No amended employment tax returns will be required. An examiner will mail an ERC-VDP closing agreement package that must be signed and returned, along with any balance due, within 10 days of receipt of the package. Employers may seek an installment agreement for the payment due, but the IRS must approve it.
If the application is rejected, the employer may still be able to correct errors in the application or amend employment tax returns to eliminate the invalid ERC.
ERC Eligibility Background
The ERC is a refundable payroll tax credit that was available to many employers for quarters in 2020 and 2021. Although Congress created the ERC to compensate businesses for wages paid to employees during the COVID-19 pandemic, many bad actors began misleading business owners about the requirements for the credit. Some promoted near universal eligibility, collected large commissions, and encouraged the filing of fraudulent payroll tax claims. Relying on the advice of these promoters, many employers unknowingly filed illegitimate claims.
An employer was generally eligible for the ERC with respect to a calendar quarter if:
- the operation of the employer’s trade or business was fully or partially suspended due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to COVID-19, OR
- the employer experienced a certain decline in gross receipts.
Full or Partial Shutdown Test
Generally, otherwise eligible businesses that were instructed by their governors or other official to shut down or limit capacity because of COVID-19 were eligible for the ERC for the days during which those mandatory governmental orders were in effect.
Promoters, however, told many employers that they qualified for the ERC under the full or partial shutdown test for all available quarters because of “supply chain issues.” The IRS has explained that a supply chain disruption itself did not qualify an employer for the ERC. Instead, only those employers whose operations were partially or fully suspended because of a mandatory governmental order qualified for the credit, absent a significant decline in gross receipts (see gross receipts test explanation below). In a September Q&A, the IRS warned employers about supply chain claims.
IRS AM-2023-005 explained the very narrow opportunity for employers to claim the ERC based upon a supplier shutdown:
The employer [may] “step into the shoes” of its supplier for purposes of the suspension test. To meet the terms of this exception, … the supplier must have been subject to a governmental order that cause[d] the supplier to suspend its operations. In addition to having a governmental order, the employer must substantiate its eligibility for the credit by providing records or documentation demonstrating that (i) the governmental order caused the supplier to suspend operations, (ii) the inability to obtain the supplier’s goods or materials caused a full or partial suspension of the employer’s business operations, and (iii) the employer was not able to obtain these critical goods or materials from an alternate supplier.
The memo goes on to explain that an employer does not qualify under this test if critical goods were available from an alternate supplier, even if those goods cost much more than the employer was used to paying. Additionally, if an employer did qualify under this very strict test, they were only eligible for the ERC for the days the shutdown occurred, not for an entire quarter or multiple quarters.
Employers who claimed the credit for “supply chain disruptions” should immediately consult with a trusted tax advisor to ensure their claim was legitimate. The IRS will disallow the claim if the file does not contain a mandatory and specific governmental order that caused the suspension. The IRS will also disallow the claim for any periods of time after the governmental order was lifted, even if residual delays continued.
Gross Receipts Test
The other way employers could qualify for the ERC in 2020 and 2021 was by meeting the gross receipts test. The gross receipts test provided a basic mathematical test under which employers could qualify. Credits claimed under the gross receipts test are generally legitimate if the gross receipts and wages calculations were properly performed.
For the 2020 ERC, an employer was an “eligible employer” during the first calendar quarter for which gross receipts for that quarter were less than 50 percent of gross receipts for the same calendar quarter in 2019. The eligibility period ended with the earlier of January 1, 2021, or the calendar quarter following the first calendar quarter in which gross receipts were greater than 80 percent of gross receipts for the same calendar quarter in 2019.
Becoming an “eligible employer” under the gross receipts test was easier in 2021. Employers could generally qualify for the ERC if their gross receipts for a calendar quarter in 2021 were less than 80% of the gross receipts (>20 percent decline) for the same calendar quarter in calendar year 2019. Also in 2021, an employer could elect to use an alternative quarter to calculate gross receipts. Under this election, an employer may generally determine if the decline in gross receipts test is met for a calendar quarter in 2021 by comparing its gross receipts for the immediately preceding calendar quarter with that for the corresponding calendar quarter in 2019. The election to use an alternative quarter calculation was made on a quarter-by-quarter basis and could be changed.
Calculating the ERC
If an employer met the full or partial suspension test or the gross receipts tests, they likely qualified for the ERC. For 2020, “qualified wages” (including allocable health plan expenses) were those paid by an eligible employer after March 12, 2020, and before January 1, 2021. The maximum amount of qualified wages which could be taken into account for the 2020 ERC was $10,000 per employee for all quarters. As such, the maximum 2020 ERC was $5,000 per employee.
From January 1, 2021, through September 30, 2021, the ERC percentage increased from 50 percent to 70 percent of qualified wages. Additionally, for 2021, employers could count qualified wages in an amount up to $10,000 per employee per quarter (instead of across all quarters) in calculating the credit. This meant that an eligible employer could claim up to $21,000 per employee ($7,000 per quarter) in credits in 2021.
Congress also provided “startup recovery businesses” with a different opportunity to qualify for a credit in the amount of up to $50,000 in both the third and fourth quarters of 2021. The qualification rules for startup recovery businesses were different. Only recovery startup businesses were eligible for the ERC in the fourth quarter of 2021.
In addition to meeting the above requirements, employers had to ensure that they met other requirements, such as not calculating the ERC using wages connected to a forgiven PPP loan or wages that were used to calculate another tax credit. Furthermore, the wages of related parties, which in most cases included the wages of owners and their spouses, could not be used to calculate the credit. Employers who claimed the ERC were also required to amend their federal income tax return for the year the credit was claimed to reduce their wage deduction in the amount of the credit.
In conjunction with unveiling the VDP, the IRS stated that it “continues to identify new methods of analyzing ERC claims to identify ineligible taxpayers. If you claimed and received ERC you're not entitled to, and you don't participate in ERC-VDP to correct it, you risk detection by the IRS, which could lead to substantial interest and penalties and increase your risk of criminal investigation and prosecution.” The IRS then published this chart, which specifies the civil interest and penalties that could apply to invalid ERC claims that are not resolved pursuant to the Program.
New VDP Hotline: Employers may contact the ERC-VDP hotline at 414-231-2222 and leave a voicemail for a return call. Calls will generally be returned within 3 business days.
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