Protecting Your Organization From An Improper ERC Claim


Protecting Your Organization From An Improper ERC Claim

February 23, 2024  |  11 min read

In today’s climate, the Employee Retention Credit (ERC) has become a subject of persistent scrutiny due to the prevalence of fraudulent claims and service providers that use aggressive and predatory tactics (so-called “ERC mills”).

On the accounting side, the ERC legislation includes complex rules on aggregation as well as PPP and ERC interaction, which requires an experienced tax advisor or Certified Public Accountant (CPA). On the legal side, you need seasoned attorneys to pull governmental orders and interpret how they may have applied to your business through a facts and circumstances-based analysis. Given the complex nature of the credit eligibility and accounting required, there are many businesses that may have filed ineligible or incorrect claims. The ramifications of filing an ineligible or incorrect ERC claim, whether knowingly or unknowingly, can be both punitive and formidable. These consequences may include the obligation to repay the credit, incurring interest charges, financial penalties, and in some cases, even criminal liability.

If you think you have worked with an ERC mill or an inexperienced provider, you should consider having an ERC expert take a second look at your claim.

In this regard, our team of licensed, credentialed, and highly experienced tax professionals and attorneys at Sagemont Advisors is available to:

  • Assist in an ongoing ERC audit;
  • Assist in substantiating and documenting your ERC eligibility (providing a “Second Look”), ensuring thorough preparation for a potential audit; and
  • Guide you in determining whether you should reverse all or a portion of your ERC claim in connection with the IRS’s amnesty programs, discussed below.

Expanding on the reasons why you may wish to engage a firm such as Sagemont Advisors to revisit your ERC claim, or defend you in an ERC audit, please see below the February 13, 2024, IRS list of 7 suspicious signs indicating an ERC claim could be incorrect and common red flags they see on ERC claims, as well as an overview of their amnesty programs.

IRS Warning Signs Of An Incorrect Claim

1. Too many quarters being claimed.

Sagemont insight: We often see ERC mills promising the full $26,000 credit per employee, which is only possible if the employer is eligible for all available 2020 quarters (Q2, Q3 and Q4) and all available 2021 quarters (Q1, Q2 and Q3) for the maximum amount per employee in each period.  In practice, however, qualifying for all quarters and for the maximum amount is uncommon and could be a sign of an incorrect claim.

2. Government orders that don’t qualify.

Sagemont insight: Many ERC mills overapply the Partial Suspension Test by claiming that nearly every company in the U.S. is eligible for the ERC because such companies were: (i) restricted by OSHA’s General Duty Clause, or (ii) negatively affected by any disruption to the global supply chain. However, the only companies eligible under the Partial Suspension Test are those that were more than nominally restricted by a domestic COVID-19 governmental order (not by an order that preceded COVID-19 or by a foreign order that affected the global supply chain).

3. Too many employees and wrong calculations

Sagemont insight: Many ERC mills either purposely or unknowingly fail to disqualify their clients for the ERC for calendar years in which such client was too large to qualify (as a small business) for the ERC. A company may be too large to qualify for the ERC as a small business (and therefore, only entitled to a more limited credit for wages paid for employees not performing services) because: (i) the company employed too many full-time employees (FTEs) in 2019, or (ii) the company must be aggregated with another company and the FTE count of the aggregated group of companies causes the aggregated group members to be too large to qualify for the ERC. Eligible small business employers are those that carried on a trade or business in the U.S. during the calendar year for 2020 and/or 2021 and had 100 or fewer full-time W-2 employees in 2019 to qualify for the 2020 credit, or 500 or fewer full-time W-2 employees in 2019 to qualify for the 2021 credit. In addition, employers should ensure that the interaction with any other credits and wages utilized for PPP loan forgiveness have been taken into account / excluded from the calculation as appropriate.

4. Business citing supply chain issues.

Sagemont insight: While not all Supplier-Based Partial Suspension positions are baseless, we often see that these positions are commonly used to stretch eligibility well into 2021, and often well after the respective state or local restrictions have lapsed. The Supplier-Based suspension is a facts-and circumstances-based test with a complex safe harbor that looks at whether restrictions or modifications inhibit a business’s supplier’s ability to provide goods that in turn inhibited their ability to provide goods or perform services by more than 10%. Therefore, not only would a customer need to be aware that this threshold has been met for their supplier outside the shutdown period, but a customer would also need to self-assess that the supplier’s partial suspension was meaningful enough to meet the more-than-nominal-effect threshold for their own business. Suffice it to say that for a significant majority of customers operating in the post-shutdown world, this would be a very hard standard to meet and substantiate in front of the IRS in the case of a challenge.

5. Business claiming ERC for too much of a tax period.

Sagemont insight: For 2020, the maximum credit is 50% of up to $10,000 of qualified wages annually or $5,000/employee/year. For 2021, the maximum credit per quarter was increased to 70% of up to $10,000 of qualified wages, or $7,000/employee/per quarter for each of Q1, Q2 and Q3 2021. It’s important to note that a business can claim the ERC only for wages paid during an eligible quarter. If the employer is claiming eligibility under a full or partial suspension period, only the portion of the quarter that the employer was full or partially suspended is eligible (i.e., once the applicable COVID-executive orders were lifted, the eligibility for a suspension period would end on that day).

6. Business didn’t pay wages or didn’t exist during eligibility period.

Sagemont insight: In December 2023, the IRS sent out an initial round of more than 20,000 letters to taxpayers notifying them of disallowed ERC claims for entities that either: (i) did not exist; or (ii) did not have paid employees during the period of eligibility (i.e., in 2020-2021). It’s important to remember that the IRS has payroll records of what all taxpayers previously filed and paid-in on their original Forms 941, and also compares the ERC application (941-X) against the Forms W-2 filed with the Social Security Administration. Mathematical inaccuracies or failure to meet this basic criterion of having eligible wages in 2020-2021 will result in an ERC claim being swiftly rejected.

7. ERC mills say there’s nothing to lose.

Sagemont insight: The resulting moral hazard related to engaging an ERC mill is that salespeople working for the ERC mills are strongly incentivized to overinflate their client’s ERC claim and, in some cases, advise a client that they are eligible for the ERC even when they are objectively ineligible. Rather than representing their client’s best interest, the ERC mills are incentivized to overstate ERC claims and misdiagnose a client as ERC-eligible because: (i) the ERC mill gets paid directly in proportion to how many ERC dollars they find, and (ii) the ERC mill may have shut its doors when their clients get hit with nasty ERC audits.

Fortunately, the IRS has provided initiatives to aid victims of unscrupulous and unqualified ERC service providers, as discussed below.

Voluntary Disclosure Program

Businesses that are not eligible for the ERC but have received the funds (i.e., cashed an ERC refund check or received a credit against other tax liabilities) may be able to participate in the IRS’s ERC Voluntary Disclosure Program (VDP). The special program runs through March 22, 2024, and allows eligible participants to repay their incorrect ERC, minus 20%, which is the amount the IRS has deemed is the average cost paid to an external advisor.

Who can apply to the ERC VDP?

Businesses, tax-exempt organizations, and other entities are eligible to apply for the ERC VDP for each tax period that meets all of the below listed requirements.

  • The ERC claimed on an employment tax return has been processed and paid as a refund, which you have cashed or deposited, or paid in the form of a credit applied to the tax period or another tax period;
  • You now think that you were entitled to $0 ERC;
  • You’re not under employment tax examination (audit) by the IRS;
  • You’re not under criminal investigation by the IRS; and
  • The IRS has not reversed or notified you of intent to reverse your ERC to $0 (for example, you received a letter or notice from the IRS disallowing your ERC).

If you used a third-party payroll provider (i.e., a payroll employer organization, or “PEO”) to file your employment tax returns or claim your ERC, you can’t apply to the VDP yourself, but must contact the PEO to apply.

Withdrawal Program

The IRS also is offering employers who filed a claim requesting an ERC refund and now believe they may not be eligible for the ERC a way to withdraw their claim. The method is available only to those who have not yet received a refund and whose claim is currently in process with the IRS. Withdrawing the claim before any refund is issued will allow employers to avoid future repayment of invalid refunds and potential penalties and interest.

Who can withdraw their ERC claim?

Only employers who meet all the following criteria can request withdrawal of an ERC claim via the new option:

  • The employer made the ERC claim on an adjusted employment tax return (i.e., Forms 941-X, 943-X, 944-X);
  • The employer’s sole purpose for filing the adjusted return was to make an ERC claim and no other adjustments were made on the adjusted return;
  • The employer wishes to withdraw the ERC claim in its entirety; and
  • The IRS has not yet paid the employer’s ERC claim, or the IRS has paid the claim but the employer has not cashed or deposited the refund check.

An employer who does not meet all of the above criteria can reduce or eliminate its ERC claim only by filing an amended payroll tax return.

If a taxpayer’s withdrawal request is accepted, the IRS will treat the claim as though it was never filed. Note, however, neither program provides protection against potential criminal charges for willfully filed fraudulent claims.

Final Thoughts

Whether you need a qualified advisor to substantiate your ERC claim or defend against a potential or active ERC audit, the guidance of seasoned professionals, namely CPAs and tax attorneys, is indispensable. A team of experts at Sagemont Advisors can navigate you through the intricate process of eligibility or represent you under an IRS audit.

At Sagemont Advisors, we take pride in offering comprehensive tax controversy services. Our confidence stems from our profound understanding of the tax code and ERC laws / guidance. We encourage you to reach out to one of our advisors today to explore how we can assist you or your clients in a current or potential ERC audit or through a review of previously filed claims to ensure any eligibility and the corresponding calculation was correct and accurate.

Reach out to Sagemont Advisors today to get the support and expertise you need.

Written By:


Maxwell Burns, CPA

Managing Director
Maxwell Burns, CPA

Maxwell Burns, CPA

Managing Director
Maxwell Burns is a highly technical CPA with over ten years of public accounting and M&A tax experience. As a Managing Director at Sagemont Advisors, Maxwell leads Sagemont's team of tax, payroll, and accounting professionals and supervises the entire accounting process from start to finish. Maxwell also supervises Sagemont's tax controversy practice, with specific focus on Employee Retention Credit resolution. Along with tenure at KPMG...
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