With regular operations back in full force, the IRS and federal government are giving additional attention to tax compliance.
Most urgently, the IRS has made important announcements regarding improperly claimed Employee Retention Credits (ERC) that taxpayers may wish to withdraw or disclose. Two programs offer an opportunity to do so without penalty.
The IRS has also clarified how it will use Inflation Reduction Act funding, including a focus on tax compliance by corporations and high-net-worth individuals. These recent announcements – especially those related to the ERC – may affect a broad range of taxpayers.
ERC – An opportunity to avoid penalties for improper claims
Congress enacted the ERC in March 2020 as part of the Coronavirus Aid, Relief and Economic Security (CARES) Act. The goal was to incentivize employers to retain employees during economic hardship or government-mandated shutdowns related to COVID-19.
After a change to the law allowed taxpayers that received Paycheck Protection Program loans to also claim the ERC, the number of filings exploded – as did the number of fraudulent filings. As of January 31, 2024, the IRS had initiated 374 investigations of potentially fraudulent ERC claims, worth more than $2.95 billion. The IRS has also sent out letters proposing to disallow the credit to more than 20,000 taxpayers, with additional letters forthcoming.
To deal with the volume of claims and potential fraud, the IRS instituted a moratorium on filing new claims as of September 14, 2023. The Tax Relief for American Families and Workers Act, passed by the House on January 31, 2024, and currently awaiting passage in the Senate, would retroactively end the ERC program as of January 31, 2024, as a way of funding expansion of the child and low-income housing credits and business tax benefits. The legislation also cracks down on promoters and extends the statute of limitations for IRS review of ERC claims to six years. Although the IRS continues to review and process ERC claims submitted before the moratorium, some estimates place the number of claims being processed weekly at less than 200.
Meanwhile, the number and scope of ERC examinations continues to expand, with credits of all sizes receiving close scrutiny. To alleviate some of its ERC-related backlog, the IRS announced two programs in late December 2023, both aimed at reducing the volume of questionable claims: the Voluntary Withdrawal Program and the Voluntary Disclosure Program. As of the date of this publication, the deadline for application to the Voluntary Disclosure Program has lapsed and the IRS has not issued any announcements extending the program.
Voluntary Withdrawal Program – For taxpayers that haven't yet received ERC funds
Many employers that have filed ERC claims but not yet cashed or deposited refunds can opt to withdraw their submissions through the Voluntary Withdrawal Program. For an employer that filed a claim but now realizes the claim is not valid, this is an opportunity to avoid future repayment, interest and penalties. To the IRS, it's as if an ERC claim was never filed. There is no deadline for withdrawal, but it's best to withdraw the claim before the IRS processes it.
To participate in the Voluntary Withdrawal Program, an employer must meet all of these criteria:
- The claim was made on an adjusted employment tax return (Forms 941-X, 943-X, 944-X, CT-1X) that was adjusted only to claim the ERC.
- The employer wants to withdraw its entire ERC claim.
- The IRS has not paid the claim, or the IRS has paid the claim, but the employer hasn't cashed or deposited the refund check.
Voluntary Disclosure – For taxpayers that have received ERC funds they're not entitled to
Employers that received ERC refunds and realize they were not entitled to them had until March 22, 2024, to apply for voluntary disclosure. This applies specifically to ERC refunds that were cashed, deposited or applied as a credit to any tax period. Program participants need only to repay 80% of the credit received, as well as cooperate with IRS requests for more information and sign a closing agreement.
There are several benefits to the Voluntary Disclosure Program:
- Employer retains 20% of the credit received.
- No penalties or interest charged on the claimed amount if the 80% is paid back in full by the time the signed closing agreement is returned.
- No need to repay any interest received on the retained 20%.
- Retained 20% credit is not taxable income.
- No need to amend income tax returns to reduce wage expenses.
- The IRS will not examine ERC on employment tax returns for the tax period or periods resolved within the program.
- Employers unable to pay the 80% in full can ask the IRS to consider an installment agreement.
There are a few requirements for this program. The IRS must not have reversed the ERC or notified the taxpayer of an intent to reverse it to $0. The employer must now believe they're entitled to $0 ERC;. and, the taxpayer must not be under employment tax examination (audit) or IRS criminal investigation.
Move quickly to understand ERC eligibility
Given IRS scrutiny of ERC claims and the opportunities offered by these two programs, it's a good idea for any taxpayer that filed for the ERC but might not have properly qualified for it to reconsider their application right away. Whether they're looking at the Voluntary Disclosure Program, with its March 22 application deadline, or the Voluntary Withdrawal Program, with its requirement that funds not have been received, the clock is ticking. Once the IRS sends out a notice of examination or denial of the credit, penalties, interest and other costs come into play.
ERC eligibility hasn't always been clear, and some overly aggressive promoters submitted claims that won't stand up to the scrutiny of the IRS. A qualified tax professional can perform an ERC analysis to understand whether submitted claims should be withdrawn or disclosed and repaid.
The most common issues with the ERC involve claims that an employer was forced to at least partially suspend operations due to a government order. A qualified tax professional will likely look for documentation that the employer was actually subject to a government order related to COVID-19 during the quarter for which a claim was made. Government guidance or recommendations – including from OSHA and the CDC – do not qualify as an appropriate governmental order. The IRS is also requesting employers prove by documentation that employees were actually sent home during this time, and that their work could not be done remotely.
Businesses that willfully filed fraudulent claims, assisted in such conduct or conspired to do so, will not be exempt from potential criminal investigation and prosecution even if they participate in either program. In addition, if a taxpayer has received a letter disallowing an ERC claim, a response is required. Otherwise, the IRS will deny the claim and proceed to collections.
Other IRS tax compliance initiatives
ERC filings aren't the only area where the IRS is ramping up compliance efforts. The Inflation Reduction Act included a significant allocation to the IRS for enforcement, business modernization, technology and improving customer service.
A goal in funding the IRS is to reduce the tax gap (non-filing, underreporting and underpayments), which is largely attributable to dwindling IRS resources. Originally, IRS enforcement efforts were allocated $45.6 billion over 10 years, which would have been a 90% yearly increase in funds for enforcement. However, $1.4 billion has been clawed back by the Fiscal Responsibility Act of 2023, and it looks like another $20 billion will be clawed back through ongoing negotiations. Funding for other IRS initiatives such as modernization and technology have not been reduced.
The IRS has made it clear that it will use additional enforcement funds to expand work focused on complex partnerships, large corporations and high-income/high-wealth individuals. This includes establishing a special area focused on large or complex pass-through entities, expanding the Large Corporate Compliance program and looking more closely at transfer pricing for some U.S. subsidiaries of large foreign companies.
In addition to examinations, the IRS is trying to catch up on collections. Although it is concentrating its efforts on taxpayers with more than $1 million in income and more than $250,000 in recognized tax debt, the agency has resumed normal collection procedures (previously put on hold during the pandemic) for all taxpayers.
IRS updates continue to evolve
These are just a few of the recent IRS updates that taxpayers – especially companies and high-net-worth individuals – should be aware of.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
