ERC Update: IRS says up to 90% of ERC Claims are High Risk or Show an Unacceptable Level of Risk

After months of silence, on June 20, 2024, the IRS issued a news release (IR-2024-169) providing an update on the employee retention credit (“ERC”).  In a nutshell, based on a “detailed review to protect taxpayers” and “analyzing data,” the IRS created three categories of ERC claims based on “risk levels” and explained how it intends to handle claims that fall within those categories. 

While it was nice to receive an update from the IRS, it is unclear what the “detailed review” entailed and what criteria the IRS used to create the categories of claims. Indeed, many ERC practitioners are perplexed by the IRS’s ability to categorize ERC claims because claiming the ERC requires taxpayers to provide very little information. Said another way, how did the IRS place ERC claims into each category when claiming the ERC does not require taxpayers to provide the IRS with detailed information?! 

Below are the categories of ERC claims and an explanation of how the IRS intends to handle the claims.

Category 1:  High-Risk, Denial Letters Forthcoming

 “[T]he IRS identified between 10% and 20% of claims fall into what the agency has determined to be the highest-risk group, which show clear signs of being erroneous claims for the pandemic-era credit.”  The IRS intends to deny “tens of thousands” of claims that fall within this category in the near future. 

While it is unclear the criteria the IRS used to place claims in this category, the IRS could look at certain factors to place claims in this category, including:

• Claiming all periods available for the ERC (Q2 2020 – Q3 2021).
• Claiming the ERC for Q2 and Q3 2021 under the full or partial suspension test (most government orders expired in Q1 2021).
• Claiming the ERC as a recovery startup business for Q3 and Q4 2021.
• Claiming the ERC under full or partial suspension test by a business that was deemed essential, such as daycares, hardware stores, trucking companies, banks, gas stations, etc.
• Claims filed by third-party promoters who started their business specifically to monetize ERC claims. 

If you fall within one of the foregoing categories, it is prudent to reevaluate your ERC claims to ensure you qualify for the ERC.  If after such analysis, you determine you do not qualify for the ERC, you should consider the IRS ERC Withdrawal Program. Additionally, if you have not already done so, you should create an “audit packet” that contains the documents needed to substantiate your ERC claims, including, but not limited to:

• Workpapers showing the ERC calculation, including wages paid and PPP loan allocation.
• If you claimed the ERC based on reduction in gross receipts, documents showing the reduction in gross receipts.
• If you claimed the ERC based on a full or partial suspension of operations:
  • Copies of government orders you relied on in claiming a full or partial suspension
  • Documents demonstrating the government orders caused a full or partial suspension of operations.

Category 2: Unacceptable Level of Risk, Wait Loooooonger

“[T]he IRS analysis also estimates between 60% and 70% of the claims show an unacceptable level of risk. For this category of claims with risk indicators, the IRS will be conducting additional analysis to gather more information with a goal of improving the agency’s compliance review, speeding resolution of valid claims while protecting against improper payments.”

As noted above, it is unclear what factors the IRS used to arrive at this conclusion, but it could be similar factors used in determining the high-risk group. Regardless, if taxpayers have not done so already, taxpayers who claimed the ERC should have an “audit packet” ready to provide the IRS in the event of a request for information. 

Category 3: Low-Risk, Wait Just a Little Bit Longer

“Between 10% and 20% of the ERC claims show a low risk. For those with no eligibility warning signs that were received prior to the last fall’s moratorium, the IRS will begin judiciously processing more of these claims.”

“The IRS anticipates some of the first payments in this group will go out later this summer. But the IRS emphasized these will go out at a dramatically slower pace than payments that went out during the pandemic period given the need for increased scrutiny.”

As noted above, it is unclear what factors the IRS used to arrive at this conclusion, but claims in this group likely include claims based on gross receipts and those industries that were clearly subject to government orders such as bars, restaurants, theatres, music venues, barber shops, and amusement parks, to name a few.

The good news is taxpayers who have claims falling into this category should receive their emergency COVID funding this year and the IRS is paying interest.  The bad news is taxpayers who have claims falling into this category have had to wait to receive their emergency COVID funding until summer 2024. 

Additional Category: Claims Filed After the Processing Moratorium, Wait Even Looooooooonger

While not a new category, the IRS doubled down on the “moratorium” category of claims. “[T]he IRS announced last fall a moratorium on processing claims submitted after Sept. 14, 2023. . . . [T]he IRS will keep the processing moratorium in place on ERC claims submitted after Sept. 14, 2023.”  

Unfortunately, taxpayers who filed ERC claims after September 14, 2023 must continue to wait for an undeterminable time to receive their emergency COVID funding.  As previously noted, a last resort is to file a “suit for refund of taxes paid in the U.S. district court where the taxpayer resides (or where the corporation has its principal place of business), or in the Court of Federal Claims.” IRC § 6532(a).  However, taking such action comes with many unknowns and, obviously, has costs. 

Conclusion

Without providing details on how it arrived at its conclusion, the IRS has concluded that up to 90% of ERC claims are “high risk” or show an “unacceptable level of risk” and, as a result, the IRS will either deny or further analyze claims that fall within these categories. Taxpayers who believe they may fall within these categories should be prepared to substantiate their ERC claims. The IRS has concluded 10%-20% of ERC claims are low risk. Taxpayers who fall in this category should receive their ERC checks “later this summer.”  Finally, taxpayers who filed their ERC claims after September 14, 2023 will, unfortunately, continue to wait to receive their ERC checks unless the taxpayer initiates a refund suit.