Many taxpayers that received refunds for Employee Retention Credit (ERC) claims incorrectly believe that they have been approved for the credit by the Internal Revenue Service (IRS). In reality, the IRS can, and has begun to, audit claims after taxpayers have received refunds. Furthermore, as the deadline for 2020 ERC claims approaches, taxpayers should be aware that the IRS is not required to accept any taxpayer’s amended return.1 Moreover, returns filed close to the deadline may be denied by the IRS without investigation. In that case, taxpayers may have to seek an administrative remedy to force the IRS to accept the return. Finally, if the IRS decides to indefinitely stop processing ERC claims, taxpayers will have to institute lengthy and costly suits for refund in either U.S. District Court of the Court of Federal Claims.
Once ERC refunds are in an employer’s hands, it’s easy to understand how the recipient may feel like the matter is closed in their favor. Instead, there’s still ample time for the IRS to challenge the claim. ERC recipients must understand that until the expiration of any and all applicable statutes of limitations, the IRS may challenge an ERC refund.
The IRS issued final regulations in July that allows it to treat an erroneous refund as an underpayment of taxes.2 Just as taxpayers have a time limit to file an amended return to claim the ERC, the IRS has a time limit to assess additional tax against a taxpayer. Specifically, for 2020 ERC claims, the IRS must make an assessment, and taxpayers must file an amended return, by April 15, 2024. Since this rapidly approaching date means the IRS’s audit window is closing, it is more aggressively combing through the millions of ERC claims to find those it suspects are fraudulent or incorrect. After April 15, 2024, the IRS may be very limited in the means it can subsequently employ to assess additional tax or recoup erroneous refunds.
Employers should also be mindful that, in the case of an ERC claim for the third quarter of 2021, the statute of limitations for IRS assessments is expanded—providing the IRS with five years, beyond the normal statute of limitations, to assess additional tax for a potential erroneous ERC claim. This would give the IRS until 2027 to assess additional tax. Additionally, as explained in the U.S. Department of Treasury’s Greenbook, the current administration’s fiscal year 2024 budget includes a proposal to subject all quarters for which ERC is available to a five-year statute of limitations on tax assessments. It is also important to remember that the IRS is not subject to a statute of limitations of any kind for making an assessment when the underlying return was filed with fraudulent intent or where there is a willful attempt to evade taxes. Additionally, a tax preparer’s fraudulent acts may be imputed to the taxpayer.
Taxpayers would be wise to get second opinions on ERC claims to ensure that the claims are warranted and accurate. Besides, a second review may even reveal additional eligibility that was originally overlooked.
The Internal Revenue Code gives the IRS, in cases involving income taxes, an automatic 60-day extension of the assessment statute of limitations when a taxpayer files an amended return close to the statute end date.3 Unlike income tax return amendments, there is not an automatic extension of the assessment statute of limitations for employment tax returns. Some are concerned that this could result in the IRS becoming more likely to reject an ERC claim filed close to the assessment statute end date.
The IRS may reject or deny amended returns, even if the taxpayer timely submitted it to the IRS. Since the IRS has indicated that more recently filed ERC claims are, in its belief, more likely to be fraudulent,4 some practitioners are concerned that the IRS may, in some cases, attempt to deny ERC claims rather than pay refunds after the period for tax assessments has expired. This would result in taxpayers having to seek administrative remedies to force the IRS to accept their amended returns.
If the IRS does process and pay ERC claims, the IRS can fall back on its ability to institute suits for erroneous refunds to claw back funds.5 The IRS can generally start a refund suit for up to two years from making the refund.6 That period can be extended up to five years if the government can show that the refund was induced by fraud or a misrepresentation of a material fact.7
Perhaps, the worst-case scenario for taxpayers would occur if the IRS decides to stop processing ERC claims indefinitely.8 In that case, the taxpayer would have to institute a suit for refund in either U.S. District Court or the Court of Federal Claims. This process would likely take months, if not years, to work through. Additionally, the cost of hiring appropriate representation may make filing a claim disadvantageous.
Taxpayers who file well before the refund statute of limitations give the IRS more time to process their amended return. Therefore, should the IRS deny the amended return before issuing the refund, the taxpayer would have administrative alternatives to filing a lawsuit in order to obtain their refund. These methods are significantly less costly and time consuming when compared to litigations.
With less than a year remaining before the clock runs out on 2020 ERC claims, now is the time to have a professional examine your claim. Whether you are just now learning about ERC or have already filed a claim and feel like a second look is prudent, it is best to have experienced tax professionals examine your claim. As we approach the deadline for claims, the IRS could take a more hardline approach to ERC claims. This is not an issue that is best to leave until the last minute.
Finally, employers are urged to keep the 2024 and 2025 deadlines in mind if they want to file a protective claim for refund. Unfortunately, the important role of protective claims for refunds in the ERC context gets less attention than it deserves. But if you properly amended your federal income tax return to reduce payroll expenses by the ERC amount you claimed and your ERC claim is still pending, then you need to seriously consider filing a protective claim for refund. In the event that you are unsuccessful in an ERC audit (or end up repaying ERC for some other reason), filing a protective claim for refund to reverse that expense disallowance is the only way to preserve your right to claim a refund after the limitations period.