IRS to Reject Billions of Dollars in Covid Employer Tax-Credit Claims

irs to reject billions of dollars in covid employer tax-credit claims

The Internal Revenue Service is planning to deny billions of dollars of what it says are improper claims for a popular pandemic-era tax credit, while starting to gradually pay out some claims that have been sitting at the tax agency for more than nine months.

The IRS, following a long review of the employee retention tax credit, plans to maintain a moratorium on processing claims filed since mid-September 2023. The agency, which had said it hoped to resume significant processing of claims in late spring, announced its plans less than an hour before the summer solstice.

The effort represents the government’s latest effort to deal with the twin problems of the credit known as the ERC that Congress created to encourage employers to keep workers on their payrolls during the pandemic.

On one hand, the IRS is trying to stop a wave of fraud. Pop-up firms and marketers created a mini-industry that encouraged a flood of claims long after the pandemic’s emergency-phase ended—many of which the IRS has said are questionable.  The program has cost the government roughly $230 billion, about triple early projections. And although the credit expired in 2021, employers can still file amended tax returns to claim up to $21,000 per employee for tax year 2021.

On the other hand, in the pile of more than one million pending claims, there are legitimate claims mixed in with fraudulent and improper ones, and some employers are counting on that money to survive. In addition, for every day that goes by, the IRS owes those taxpayers more interest along with their refunds.

The IRS has taken several steps already to curb abuse of the program. It has let taxpayers withdraw unpaid claims, increased audits, started criminal investigations and created a voluntary disclosure program so employers can give back money they don’t think they deserve.

Since last September, the IRS has been analyzing its pile of claims and trying to find a way to decide which ones to pay and which to reject.

Meanwhile, the House voted in January to end the ERC for claims filed after Jan. 31, 2024, a move that is estimated to save the government almost $80 billion. But that legislation, which would also revive expired business tax provisions and expand the child tax credit, has stalled in the Senate.

In coming weeks, the IRS plans to deny tens of thousands of claims that had shown the greatest risk of being improper, the agency said. It will continue to analyze an even larger batch of claims that showed an “unacceptable” level of risk. About 60% to 70% of the one million pending claims it reviewed carry unacceptable risk, while 10% to 20% fall into the highest risk category, the agency said.

In some cases, said IRS Commissioner Danny Werfel, claims are obviously ineligible based on the claim itself; in other cases, the IRS may need additional documentation from the taxpayer.

“The IRS remains deeply concerned about how many taxpayers have been misled and deluded by promoters into thinking they’re eligible for a big payday,” Werfel said in a statement. “People may think they are on safe ground, but many are simply not eligible under the law.”

The backlog of unprocessed ERC claims had swelled to 1.4 million by mid-May, including 880,000 filed prior to the moratorium, the government said in a June court filing.  Since the moratorium started, the IRS had processed 28,000 claims totaling $2.2 billion and disallowed more than 14,000 claims worth more than $1 billion, the agency said.

But that would leave more than a million claims still waiting, some legitimate and some not. Some employers say they have waited a year or more for the agency to process what they think are valid claims for refunds. Lawmakers such as Sen. Tommy Tuberville (R., Ala.) have been pressing the IRS to accelerate payouts.

The IRS said it would generally process the oldest claims first and that those payments will start going out this summer, but at a slower pace than the IRS had paid ERC claims earlier in the pandemic. The agency will keep the moratorium in place for claims filed since the September announcement.

Werfel said the IRS can’t safely end the moratorium unless Congress passes the legislation to set the cutoff date for new claims. Otherwise, he said, a new flood of claims might emerge.

“ERC was a runaway train last fall,” Werfel said. “The moratorium gave us time to slow down that train.”

The agency’s enforcement effort is still in its early stages, but the tax credit has already triggered a flurry of investigations and lawsuits. The IRS said it has initiated 450 criminal cases involving nearly $7 billion in potentially fraudulent claims. The agency said it has received hundreds of referrals about unscrupulous promoters and preparers.

In addition to lawsuits filed by the government, these include disputes between tax credit firms and their customers.

The IRS is facing direct challenges too, as taxpayers challenge the agency’s approach or sue for refunds. In May, Stenson Tamaddon, a Phoenix-based tax advisory firm and provider of ERC services, filed a lawsuit in U.S. District Court alleging that the IRS improperly restricted the availability of ERC payments by issuing “guidance” that it has used to deny claims rather than following government rule-making procedures and improperly suspended the program.

As it has stepped up scrutiny of pending claims, the IRS has allowed employers to withdraw pending claims or send back 80% of the money they already received.  More than 2,600 taxpayers have returned tax credits totaling more than $1 billion, the IRS said. In addition, roughly 6,000 small businesses and nonprofits have withdrawn requests for the tax credit totaling $574 million.  The IRS is considering reopening the program for returning tax credits, which ended in late March, but under less-favorable terms.

Write to Richard Rubin at [email protected] and Ruth Simon at [email protected]

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