Risks and Penalties Associated with Incorrect ERTC Claims

Risks and Penalties for Incorrect Employee Retention Credit Claims

Overview of the Employee Retention Credit

The Employee Retention Credit (ERC) was created by the Coronavirus Aid, Relief, and Economic Security (CARES) Act in March 2020 to help businesses retain employees during the COVID-19 pandemic. The ERC provides a refundable tax credit against certain employment taxes equal to 50% of up to $10,000 in qualified wages paid to employees per quarter.

To be eligible for the ERC, an employer must have experienced either:

• A full or partial suspension of operations due to a COVID-19 government order, or
• A significant decline in gross receipts compared to the same quarter in 2019.

The ERC aims to help struggling businesses by subsidizing employee wages and maintaining employment relationships during the pandemic. However, like any tax relief program, some employers or tax preparers may be tempted to claim the ERC incorrectly or fraudulently. This article examines the legal risks and penalties for improper ERC claims.

Penalties for Inaccurate ERC Claims

The IRS treats the ERC like any other federal tax credit. Incorrect or fraudulent claims can lead to civil penalties and criminal prosecution. The main penalties include:

Civil Penalties

• Accuracy Penalties – 20% penalty on the inaccurate or fraudulent ERC amount claimed
• Failure to File Penalty – 5% per month up to 25% for failing to file an accurate and timely tax return
• Failure to Pay Penalty – 0.5% per month up to 25% for failure to pay taxes owed
• Interest – Interest charges applied to unpaid taxes

These civil penalties allow the IRS to recoup unpaid taxes, deter future non-compliance, and promote timely and accurate filing. They can add up to a sizable percentage of any improper ERC claims.

Criminal Penalties

More serious cases of ERC fraud may warrant criminal prosecution. Potential criminal charges include:

• Tax Evasion – Up to 5 years imprisonment and $250,000 fine for willfully evading ERC requirements and taxes owed (26 U.S.C. § 7201)
• False Statements – Up to 3 years imprisonment and $250,000 fine for knowingly making false statements on an ERC application (26 U.S.C. § 7206)
• Identity Theft – Up to 15 years imprisonment and $250,000 fine for using someone else’s identity to claim the ERC (18 U.S.C. § 1028A)
• Wire/Mail Fraud – Up to 20 years imprisonment and $250,000 fine for scheme to defraud the ERC program (18 U.S.C. §§ 1341, 1343)

These charges can lead to serious fines and jail time, especially for larger fraud schemes. The IRS and Department of Justice pursue criminal charges in the most egregious cases as a deterrent.

Common Scenarios for Inaccurate ERC Claims

Some typical scenarios that could trigger penalties for incorrect ERC claims include:

Claiming the ERC Without Experiencing Decline in Gross Receipts

To be eligible based on reduced gross receipts, an employer must demonstrate a decline of at least 50% in quarterly receipts compared to the same quarter in 2019. Claims made without meeting this threshold fail to qualify.

Claiming the ERC for Employees Not Working

The ERC only applies to wages paid to employees who provided services during the quarter. Payments to employees not actually working do not qualify for the credit.

Claiming the ERC After PPP Loan Forgiveness

Employers who had loans forgiven under the Paycheck Protection Program (PPP) cannot claim the ERC on qualifying wages that were already paid for with the PPP loan.

Inflating Employee Wages to Maximize Credit

The ERC caps the credit at $10,000 of eligible wages per employee for the year. Overstating employee wages paid to maximize the $10,000 limit results in an excessive ERC claim.

Failing to Document Eligibility and Wage Expenses

Employers must maintain detailed documentation showing they qualified for the ERC and to substantiate eligible wages paid to employees. Insufficient records increase penalties if the ERC claim is challenged.

Coordinating with Other Improper Credits

Some tax preparers have claimed both the ERC and other COVID credits like the Employee Leave Credit for the same wages. This results in improper “double-dipping” and inflated refunds.

Process for Identifying and Auditing Suspicious ERC Claims

The IRS and state authorities use various processes to detect questionable ERC claims:

Automated Screening

Computer algorithms flag returns with characteristics that suggest excessive or duplicative credits based on past fraud patterns. This allows efficient pre-refund reviews.

Manual Inspection

Examiners manually review flagged returns along with a sample of other highly suspicious claims. This provides closer scrutiny than computers alone.

Employer Audits

The IRS conducts audits of employers who claimed large ERC amounts relative to past payroll tax payments. This verifies whether claimed wage amounts appear reasonable.

Identity Theft Monitoring

Authorities monitor for indicators of identity theft like multiple ERC claims using the same employee SSNs across many firms. This can reveal scheme orchestrators.

Whistleblower Reports

Informants report suspected ERC schemes to the IRS in exchange for whistleblower rewards. Their inside information aids investigations.

Cooperative Enforcement

The IRS partners with other agencies like the Department of Labor to share data, coordinate audits, and pursue joint investigations of ERC fraud.

Options to Self-Report Incorrect ERC Claims

For employers worried they claimed the ERC incorrectly, options to self-report include:

Amended Tax Return

File an amended payroll tax return correcting the amount of ERC claimed. This will reduce penalties and interest compared to waiting for IRS notice.

IRS Voluntary Disclosure Program

The IRS program allows taxpayers to avoid criminal prosecution by self-reporting before an audit. Requires paying back taxes, interest, and certain penalties.

State Voluntary Disclosure Programs

Some states like California and Illinois offer voluntary disclosure to self-report incorrect state tax credits and avoid criminal charges.

Cooperating with IRS/State Audits

If selected for audit, fully cooperating and providing requested records can mitigate penalties, even if the ERC was claimed incorrectly.

Self-reporting through these options allows employers to minimize penalties and reduce chances of criminal prosecution. However, it does not eliminate civil fines or prevent future audits.

Avoiding Issues with ERC Claims

Employers can take the following steps to claim the ERC legally and avoid penalties:

• Thoroughly review eligibility criteria before claiming the ERC
• Maintain detailed support to document suspended operations or gross receipt declines
• Keep accurate payroll records validating wages paid to specific employees providing services
• Consult reputable tax professionals familiar with ERC rules and limits
• Claim conservative ERC amounts and do not inflate wage expenses
• Carefully review returns for accuracy before filing

Following these best practices minimizes exposure to penalties and other legal risks related to improper ERC claims.

Conclusion

The ERC provides vital financial relief allowing employers to retain employees through pandemic challenges. However, improperly claiming the credit can lead to substantial civil fines and criminal prosecution in some cases. Employers should exercise caution, maintain detailed records, and consult tax professionals to ensure they claim the ERC correctly based on eligibility and qualified wage rules. For any employer concerned they may have claimed the ERC improperly, voluntarily disclosing issues to tax authorities can help reduce penalties. With sound compliance practices, businesses can benefit from the ERC while managing legal risks.