Business owners now have a convenient method to withdraw ERC claims that were filed improperly, but how do they know if withdrawing is necessary?
Unscrupulous tax credit pop-up companies have taken advantage of the Employee Retention Credit (ERC), advising small businesses to claim the ERC even if they do not qualify. These pop-up companies, dubbed “ERC mills,” have flooded the IRS with improperly claimed credits, putting thousands of employers at risk of potential tax penalties, interest payments, and potential criminal prosecution.
To address this problem, the IRS recently developed an ERC withdrawal process available to business owners who have now discovered that they do not qualify for the credits claimed on tax returns prepared by ERC mills. This option allows businesses to rescind any improper ERC claims and avoid potential penalties and interest.
Who Can Request to Withdraw ERC?
According to the IRS, employers can use the ERC claim withdrawal process if all of the following apply:
- They made the claim on an adjusted employment return (Forms 941-X, 943-X, 944-X, CT-1X).
- They filed the adjusted return only to claim the ERC, and they made no other adjustments.
- They want to withdraw the entire amount of their ERC claim.
- The IRS has not paid their claim, or the IRS has paid the claim, but they haven’t cashed or deposited the refund check.
Taxpayers who are not eligible to use the withdrawal process can reduce or eliminate their ERC claim by filing an amended return to reverse the claim.
Do Your Due Diligence Before Withdrawing
While the new ERC withdrawal process provides a safe option if you firmly believe you do not qualify for the credits you claimed, it also means voiding and returning your tax refund checks, or effectively canceling the claim before the IRS processes it. Depending on the size of your business, your ERC claim may be worth thousands or even millions of dollars. This poses a difficult decision—the IRS intends to aggressively review ERC claims and will be auditing claims even if they have been paid.
Business owners who legitimately meet the eligibility criteria should not have to forfeit their refunds. Before you withdraw your ERC, you need to carefully review your case and confidently determine your eligibility status.
Confusion Around ERC Eligibility Criteria
The Employee Retention Credit is a complex tax credit. That’s precisely why ERC mills have been able to exploit it—by misrepresenting the eligibility criteria to unwitting small business owners.
The ERC was designed to help employers whose gross receipts declined significantly during the pandemic, or whose business operations were significantly impacted by government orders. Gaining a better understanding of ERC eligibility rules, and becoming aware of the signs you may have claimed it improperly, can help you make an informed decision on withdrawing your ERC claim.
If your business meets any of the below criteria, you should contact a qualified tax professional who can evaluate your ERC claim and assist you in substantiating, amending, or withdrawing it, if necessary.
Five Signs You Should Consider Withdrawing Your ERC Claim
1. Your third-party provider fits the “ERC mill” profile
The first sign you may need to withdraw you ERC is if your provider is an ERC mill. You probably won’t know with certainty for quite a while, as any potential prosecution will take months if not years. However, the IRS has provided a profile to help taxpayers identify and avoid the shady business tactics of ERC mills. If you answer ‘no’ to multiple questions below, you should reassess your eligibility with a trusted tax professional:
Was your provider in business before 2020?
In the last three years, many ERC specialists have popped up specifically to prey on small businesses and take advantage of the tax credit. If your provider has a short business history, they may lack the experience necessary to provide reliable and trustworthy service.
Does your provider offer services beyond ERC filing?
Many of these untrustworthy pop-ups don’t provide any additional services. This is one of the telltale signs of ERC mills.
Did your provider gather documentation to substantiate your ERC claim?
Legitimate providers will require you to submit an exhaustive list of business documents necessary to determine your eligibility. If your provider did not take any of these essential steps, it would be impossible for them to properly qualify you for the ERC.
Did your provider sign your amended tax returns?
Accountable tax professionals will sign your returns as paid preparers, showing they stand by their work. When your provider does not sign, they are seeking anonymity to limit their own risk, shifting all of the risk to you.
Even if your provider was, in fact, an ERC mill, that does not mean your business is definitely ineligible to receive the tax credit—but it does mean you should take a second look at your claim to reassess your eligibility and take any corrective steps necessary.
2. You don’t know how you qualify
ERC mills have deceived many small business owners because they don’t understand the rules that apply to ERC eligibility. While determining qualification status and calculating the credit can be complex, there are two paths to eligibility that most employers must take (with the exception of Recovery Startup Businesses). Once you understand your eligibility path, you can better determine if your business truly meets the criteria and make an informed decision about withdrawing your ERC.
Your eligibility status is determined on a quarterly basis, meaning that a business can use the first path in Q1, the second path in Q2, and may not qualify by either path in Q3. Assess your case for eligibility and your withdrawal decision independently for each quarter.
Below is a summary of two eligibility paths; visit IRS.gov to explore complete requirements.
Decline in gross receipts
This eligibility path is for businesses that lost significant revenue during the pandemic:.
- If claiming ERC on 2020 tax returns, your business must have experienced a 50% loss of income from a single quarter of 2019 to the corresponding quarter of 2020. Going forward from the eligible quarter, your business continues to be eligible until the quarter after the quarter in which your gross receipts rebound to more than 80% of the same quarter in 2019.
- If claiming ERC on 2021 tax returns, your business must have experienced a 20% loss of income from a single quarter of 2019 to the corresponding quarter of 2021. For calendar quarters in 2021, employers can also use the alternative quarter election rule to look at the prior calendar quarter and compare to the same calendar quarter in 2019 to determine whether there was a 20% decline in gross receipts.
Full or partial suspension by government order
This eligibility path is for businesses that significantly modified operations to comply with pandemic-related government orders. Some of the common modifications may include:
- Full/partial shutdown mandates
- Work-from-home orders
- Customer capacity limits
- Reduced operating hours
- Social distancing orders
- Staggered work schedules
These modifications must have caused a “more than nominal disruption” to your business operations, quantified by a decline in productivity of at least 10%.
If you don’t know which road your business took to qualify, you should contact your ERC provider and request a complete breakdown of your eligibility pathway. If they cannot or will not provide you with this information, they may be one of the ERC mills the IRS has warned about.
3. You don’t have documentation to substantiate your ERC claim
Even if you’re confident your business truly qualifies for the Employee Retention Credit, you need to be prepared to substantiate the claim if the IRS reviews it. IRS Notice 2021-20, Q/A 70 provides guidance regarding what types of substantiation a taxpayer should expect to produce to the IRS if their ERC claims are challenged. This evidence includes, but is not limited to:
- Documentation to show how the employer determined it was an eligible employer that paid qualified wages, including:
- Any governmental order to suspend the employer’s business operations;
- Any records the employer relied upon to determine whether more than a nominal portion of its operations were suspended due to a governmental order or whether a governmental order had more than a nominal effect on its business operations;
- Any records the employer used to determine it had experienced a significant decline in gross receipts;
- Any records of which employees received qualified wages and in what amounts; and
- In the case of a large eligible employer, work records and documentation showing that wages were paid for time an employee was not providing services.
- Documentation to show how the employer determined the amount of allocable qualified health plan expenses.
- Documentation related to the determination of whether the employer is a member of an aggregated group treated as a single employer for purposes of the employee retention credit and, if so, how the aggregation affects the determination and allocation of the credit.
- Copies of any Forms 7200 that the employer submitted to the IRS.
- Copies of the completed federal employment tax returns that the employer submitted to the IRS (or, for employers that use third-party payers to meet their employment tax obligations, records of information provided to the third party payer regarding the employer’s entitlement to the credit claimed on the federal employment tax return).
If you don’t have these records on file demonstrating a clear path to qualification, you should revisit your ERC claim and try to gather the necessary documents. If your third-party provider cannot or will not provide you with written documentation showing how you were qualified for the ERC and how the credit was calculated, you likely need an independent qualified tax professional to review your claim—even if you already cashed your refund checks. In the end, you may need to withdraw your ERC if you cannot substantiate the claim.
4. You Have a Weak Case for Eligibility
Many business owners claimed the ERC without doing due diligence of their own. ERC mills made the eligibility requirements sound overly simple, when they are actually quite complicated. You will need to withdraw your ERC if your business does not truly meet the eligibility requirements. Here are some of the common signs that your business may not have a strong case for eligibility:
You Did Not Experience a Sufficient Revenue Decline
Qualifying for the ERC through a decline in gross receipts is fairly straightforward. Have you done the math to show your business meets the relevant thresholds?
You may know that your sales declined during the pandemic. But do you have documentation verifying that your business meets the 50% or 20% threshold for gross receipts decline in 2020 or 2021, respectively?
Take another look at the first section of this blog, “Decline in gross receipts.” You’ll need to examine historic Profit & Loss Statements from each quarter you claimed the credit to measure your losses against the corresponding quarters of 2019. For example, if you claimed the ERC in Q2 2020, you need to show that your business pulled in 50% less quarterly revenue compared to Q2 2019.
You Cannot Cite a Specific Government Order That Impacted Business Operations
Qualifying for ERC through a full or partial suspension by government order may sound simple, but is actually quite complex. Many business owners believe the government’s response to the pandemic played a big role in diminishing their business’s revenue. But this eligibility path is for businesses that had to modify specific operations to comply with government orders—not just guidance or recommendations.
The modifications to your business must have caused at least a 10% decline in some form of productivity, compared to the corresponding quarter of 2019. Allowable forms of productivity are gross receipts, operating hours, or employee work hours.
Take another look at your ERC claim to see if you, or your third-party provider, cited specific government orders and documented the 10% decline in productivity with your payroll data or gross receipts.
You Claimed ERC Due to Supply Chain Issues
Many thought leaders on the ERC agree that supply chain issues are one of the ERC mills’ favorite paths to eligibility. Every business across the world experienced supply chain issues during the pandemic, right? …Sure.
But for ERC eligibility, supply chain issues are narrowly defined and difficult to document. In July 2023, the IRS Office of Chief Counsel released a supply chain disruption memorandum clarifying the three requirements to be eligible under this caveat:
- A US government order must have directly impacted your supplier’s ability to deliver critical goods (this may require written testimony from your supplier).
- There must be a lack of alternative suppliers to purchase the critical goods from (this can be difficult to substantiate).
- This lack of critical goods must have caused your business to fully or partially suspend operations.
If your business claimed the ERC due to supply chain issues, you certainly need to revisit your claim and ensure you have documentation to substantiate each of the above requirements. If you cannot substantiate this, you should consider withdrawing your ERC claim.
5. You Made a Common Error Highlighted by IRS Auditors
IRS auditors highlighted three errors they have consistently found when reviewing ERC claims. If you made any of these errors, it does not mean you necessarily need to withdraw your ERC claim, rather, you need to adjust the claim by further amending your tax returns.
You Claimed ERC on Wages Paid With PPP Loans
Businesses that received government loans through the Paycheck Protection Program (PPP) may still be eligible to claim the ERC. However, claiming the ERC on employee wages paid with PPP loans is impermissible. If your business received PPP and your third-party provider did not examine your PPP documentation, they would not have been able to avoid claiming the ERC on wages paid with PPP.
You Claimed ERC on Wages Used to Claim Other Tax Credits
Businesses are not allowed to “double-dip” by claiming multiple tax credits on the same wages. Businesses that claim multiple credits must carefully segregate the claims and be transparent about which wages are used for each credit. If your business claimed a tax credit on its original 2020 or 2021 filing, and later claimed the ERC retroactively, check that the employee wages used on your original tax credit filing were subsequently backed out of your ERC claim.
You Didn’t Reduce Wage-Paid Deductions on Employer Income Tax Returns
Claiming the ERC reduces the wages-paid deductions on the business’s income tax return. When a business owner claims the ERC retroactively, they must amend the same year’s income tax return reducing deductions for wages paid by the amount of the credit. Examine your business’s income tax amendments to be certain that you did so.
Should you withdraw your ERC claim and forfeit your tax refunds? Or maintain your active claim and potentially risk tax penalties and interest payments? You don’t have to make this decision alone.
Omega Accounting Solutions provides a comprehensive ERC Compliance Review to assess existing ERC claims for compliance with IRS eligibility rules on a quarter-by-quarter basis. Our review report will identify any potential liabilities or errors in your ERC claims and recommend ways to solve those problems, which may include filing amended claims, withdrawing your existing claims, or waiting for the IRS to process your claims. ERC Compliance Review can give you peace of mind moving forward.If the IRS decides to challenge the validity of your claim, the Tax Controversy Group at Omega is also able to represent you before the IRS during your audit and any appeals process that might occur.
Your Employee Retention Credit claim is likely worth a significant amount of money to your business. Do not withdraw your ERC without first consulting a trusted tax credit expert. Contact Omega to find the best solution to any problem that may arise from your ERC tax credit claim.