IRS Warns Taxpayers to Brace for Demands to Return Funds Wrongly Received for Pandemic-Era Relief

A sign outside the Internal Revenue Service building is seen in Washington, on May 4, 2021. (Patrick Semansky/AP Photo)

The Internal Revenue Service (IRS) has issued a notice to taxpayers that as part of its compliance crackdown on dubious pandemic-era tax credit claims, the agency will be sending out letters to taxpayers demanding the return of funds “erroneously claimed and received.”

The IRS’s latest warning, issued on Dec. 6, relates to a flood of bad claims for the pandemic-era relief program known as the Employee Retention Credit (ERC). This is a refundable tax credit designed for businesses that continued paying employees during COVID-19 shutdowns.

A large number of improper ERC claims were pushed by predatory promoters on unwitting businesses, with an investigation by the IRS Criminal Investigation (IRS-CI) division uncovering over $2.8 billion of potentially fraudulent ERC claims.

The tidal wave of improper ERC claims prompted the IRS to announce a moratorium on processing new ERC claims in mid September, with the agency noting at the time that that it had referred thousands of ERC cases for audit.

Not only that, but the IRS said that it was undertaking “enhanced compliance reviews” of existing claims made prior to the moratorium.

Those enforcement actions have now come home to roost, with the IRS putting taxpayers on notice that 20,000 letters have been sent telling them that their ERC claims have been disallowed.

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The 20,000 letters are just the first step, however, with the IRS telling taxpayers that another round of notifications is coming—this one demanding a return of funds wrongly claimed and received.

“With the aggressive marketing we saw with this credit, it’s not surprising that we’re seeing claims that clearly fall outside of the legal requirements,” IRS Commissioner Danny Werfel said in a statement.

“The action we are taking today is part of an initial set of steps in our compliance work in this area, and more letters will be going out in the near future, including both disallowance letters and letters seeking the return of funds erroneously claimed and received,” he added.

More Details

Starting this week, ineligible taxpayers who applied for the pandemic-era tax credit will begin receiving copies of Letter 105 C, Claim Disallowed, according to the IRS.

The first round of letters targets taxpayers who aren’t entitled to receive the ERC either because the business entity associated with the claim didn’t exist or they did not have employees for the time period when the credit was claimed.

A subsequent round of letters will be sent to those taxpayers that wrongly received ERC money and must pay it back.

“As we continue our audit and criminal investigation work involving the Employee Retention Credits, we continue to urge people who submitted a claim to review the rules with a trusted tax professional,” Mr. Werfel said. “If they filed an inaccurate claim, we urge them to consider withdrawing their pending claim or use the upcoming disclosure program to repay improper refunds to avoid future action.”

The mass mailing campaign is the latest in an expanded compliance crackdown that includes a special withdrawal program  for taxpayers with pending ERC claims who realize they may have filed an inaccurate tax return.

Later in November, the IRS will be rolling out a separate disclosure program for those who received questionable payments to come forward and avoid future IRS action, which could include penalties.

The IRS’s criminal investigations division has uncovered suspected pandemic fraud totaling over $8 billion, including over $2.8 billion relating to fraudulent ERC claims.

So far, 15 fraudulent ERC cases have resulted in federal charges and, of these, six have resulted in convictions. Four of those cases have reached the sentencing phase, with the average sentence being 21 months, the IRS said.

Special Withdrawal Process

Because of the huge number of improper ERC claims, IRS on Oct. 19 announced a special withdrawal process that allows businesses that filed a questionable claim to withdraw it and avoid the risk of getting an illegal refund that could prove costly.

Anyone who improperly claims the ERC must pay it back, possibly with penalties and interest. The IRS has warned that a business or tax-exempt group could find itself in a much worse cash position if it has to pay back an improperly claimed tax credit than if they had never claimed it in the first place.

The new withdrawal option lets employers avoid future problems by withdrawing pending ERC claims that they suspect they may have been tricked into filing.

Claims that are withdrawn will be treated by the IRS as if they were never filed, and the agency won’t impose penalties or interest.

Even if a taxpayer has received the ERC refund check, but hasn’t yet cashed or deposited it, they can still withdraw their claim.

The ERC tax credit, which is somewhat complex, is available to employers, not individual taxpayers.

Since the program was enacted, over 3.6 million claims have come in, with ERC-related fraud getting worse over time.

The IRS found out over the summer that the further out from the pandemic, the bigger the percentage of illegitimate ERC claims.

This is due to what Mr. Werfel called an “onslaught” of misleading marketing from predatory promoters pushing businesses to file dubious claims.