5 new warning signs your ERC claim might be wrong

July 29, 2024

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When the COVID-19 pandemic was at its worst in 2020 and 2021, Uncle Sam offered help to businesses who kept workers on payroll. But the Employee Retention Credit (ERC), like many tax benefits, was complicated. That's led to wrong claims, so the IRS is asking companies to review their claims, both filed or about to be submitted.

The Internal Revenue Service says another major announcement about the Employee Retention Credit (ERC), the tax break created to help companies weather the COVID-19 pandemic’s economic challenges, is on the way.

But until then, the agency is urging businesses to re-evaluate their filings. And it has announced five new ERC red flags that could indicated your claim won't pass IRS examiner muster.

5 new wrong ERC warning signs: In March, the IRS listed seven signs that your ERC claim might be wrong. The list now totals 12, as the agency has added five more signs of an incorrect ERC claim.

The additional warnings came from IRS compliance teams that have been working on the claims. They have been recurring on the ERC claims they’ve reviewed.

The five new ERC red flags cover the following areas.

Essential businesses during the pandemic that could fully operate and didn’t have a decline in gross receipts. Promoters convinced many essential businesses to claim the ERC when, in many instances, essential businesses weren’t eligible because their operations weren’t fully or partially suspended by a qualifying government order. Modifications that didn’t affect an employer’s ability to operate, like requiring employees to wash hands or wear masks, doesn’t mean the business operations were suspended. The IRS urges essential businesses to review eligibility rules and examples related to government orders.
Business unable to support how a government order fully or partially suspended business operations. Whether a business was fully or partially suspended depends on its specific situation. When asked for proof on how the government order suspended more than a nominal portion of their business operations, many businesses haven’t provided enough information to confirm eligibility.
Business reporting family members’ wages as qualified wages. If business owners claimed the ERC using wages paid to related individuals, those claims are likely for the wrong amount or ineligible. Wages paid to related individuals aren’t qualified wages for the ERC.
Generally, related individuals are the majority owner and their spouse; child or a descendant of a child; brother, sister, stepbrother or stepsister; father, mother or an ancestor of either; stepfather or stepmother; niece or nephew; aunt or uncle; son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law; household member, meaning an individual who, for the taxable year of the taxpayer, has the same principal place of abode as the taxpayer and is a member of the taxpayer’s household.
Business using wages already used for Paycheck Protection Program loan forgiveness. The U.S. Small Business Administration offered the Paycheck Protection Program (PPP), which provided SBA-backed loans that helped businesses keep their workforce employed during the pandemic. The PPP ended May 31, 2021, but borrowers could still apply for PPP loan forgiveness.
If SBA forgave the loan, businesses can’t claim the ERC on wages that they reported as payroll costs to get PPP loan forgiveness. Participating in the PPP affects the amount of qualified wages used to calculate the ERC. Payroll costs up to the amount SBA forgave aren’t eligible for ERC. Taxpayers can use the rest of their qualified wages to figure their credit.
Large employers claiming wages for employees who provided services. Special rules applied to large eligible employers, which are those that averaged (1) more than 100 full-time employees in 2019 and claimed ERC for 2020 tax periods, and/or (2) more than 500 full-time employees in 2019 and claimed ERC for 2021 tax periods.
Large eligible employers can only claim wages paid to employees who were not providing services. Many large employers’ claims incorrectly included wages for employees who were providing services during these periods. The IRS’ ERC comparison chart provides more details.

7 previous ERC warning signs: None of the above five situations qualify for the ERC under the rules passed by Congress. Neither do ERC claims described in the earlier seven warnings signs announcement. You can get full details in my previous post, but the prior signs are —

Too many quarters being claimed.
Government orders that don’t qualify.
Too many employees and wrong calculations.
Business citing supply chain issues.
Business claiming ERC for too much of a tax period.
Business didn’t pay wages or didn’t exist during eligibility period.
Promoter says there’s nothing to lose.

If any of these dozen warning flags got up when you review your claim, either one you submitted or are in the process of filing, take the appropriate action. Don’t file a bad ERC claim. If you’ve filed it, tell the IRS that you want to recall your questionable ERC claim.

Get help: As you can see, the ERC is a complicated tax break. That’s why the IRS is encouraging companies to review their claims, both those filed and those about to be submitted.

If you haven't filed an ERC claim yet, a review will ensure you don’t submit an improper claim. And if you have filed for the ERC and discover your claim likely will be disallowed, the IRS recommends using its special ERC Withdrawal Program before tax examiners find it.

The IRS also recommends that your review is done with the help of a reputable tax pro. That will help ensure that you are eligible (or not) for coronavirus-created business tax credit.

The tax adviser also can help with any necessary follow-up steps you need to take to clean up after an incorrectly filed ERC.

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