Understanding ERC Audit Penalties & Fraud Risks

December 5, 2023 | ERC

Penalties & Consequences for Erroneous ERC Claims

During COVID, the ERC credit, as well as many other government incentives, helped many businesses keep their doors open, but these programs were also rife with abuse. Now, the IRS is paying special attention to ERC audits, and at the time of writing, the agency has stopped processing new ERC claims and issued several warnings about ERC fraud.  This news can feel pretty scary to business owners, especially if you claimed the ERC and are worried about the legitimacy of your claim. To get help today, contact us now for a free consultation, or keep reading for an overview of the situation. 

Penalties for Incorrect ERC Claims

If the IRS selects your payroll tax return for an audit and discovers that you claimed this credit incorrectly, the agency will rescind the credit, and you will have to repay it. In some cases, that may be the end of the story, but the IRS may also decide to levy the following penalties:
  • Failure-to-deposit penalty — 10% of the unpaid taxes. This penalty applies when you deposit payroll taxes late. 
  • Failure-to-pay penalty — .5% of the unpaid taxes for every month they are late, up to 25% of the balance. If the IRS disallows your ERC claim, the auditor may backdate this penalty to the original due date of the return. 
  • Accuracy-related penalty — 20% of the unpaid balance, usually applied when the auditor believes that you negligently underreported the tax. 
  • Fraud penalties — 75% of the unreported tax and applies in cases of fraudulent claims. 
If the IRS audits your payroll return and finds a small mistake, the penalties will likely be minimal. However, the penalties can get significantly higher when fraud or negligence is involved. Due to the generous nature of the ERC credit, this can lead to very high penalties. 

How Much Are ERC Penalties?

ERC penalties may be based on the underreported tax. In 2021, the ERC was worth up to $28,000 per employee. Now, imagine that you claimed the full value of this credit, and the IRS disallows your credit and assesses an accuracy-related penalty. The penalty would be $5,600 (that’s 20% of $28,000). A fraud penalty would be $21,000.  If you claimed the credit on multiple employees, it can escalate quickly. To continue with the above numbers, an accuracy-related penalty on 10 employees with the full credit would be $56,000, and a fraud penalty would be $210,000. These are the types of tax penalties that could put a business under. With so much at stake, you may be worried about your claim. 

Signs You Filed an Erroneous ERC Claim

How do you figure out if your ERC claim was erroneous? The rules for claiming this credit were very complex, and if you like, you can review the rules to see if you likely had a legitimate claim. However, that can be tricky to determine.  Here are some other tell-tale signs that you may have worked with a fraudulent ERC company:
  • You worked with a company focused on the ERC rather than a traditional CPA or legal tax firm.
  • The company told you that you qualified before they knew much about your situation. 
  • You spoke to salespeople rather than CPAs or tax attorneys.
  • The company charged you a percentage of the credit as their fee. For example, many ERC mills charged about 25% of the credit as a contingency fee.
  • You found the company through aggressive advertising campaigns, especially on social media. 
  • The company bragged about the high number of credits it was processing.
  • You didn’t have a significant decline in revenue during the COVID-19 pandemic, and you were not subject to government restrictions on your business. 
If any of these points describe your situation, you may have worked with an ERC mill, and you may have claimed the credit fraudulently. This can expose you to significant risks, but there are options. 

What to Do if You Filed an Erroneous ERC Claim

If you’re worried about ERC credit fraud on your payroll tax returns, you may want to have an experienced tax attorney review your claims to make sure that they are correct. If you know that your claims are erroneous, consider the following:

Withdraw your ERC claim

As of October 2023, you can withdraw an ERC claim if the following are true:
  • You claimed the ERC on an amended return, such as a 941-X. You did not claim the ERC on your originally filed tax return. 
  • The only change on the amended return was to claim the credit. You didn’t alter any other information. 
  • The IRS hasn’t paid the claim yet, or the IRS has issued a check that you haven’t cashed yet. 
  • You want to withdraw the entire amount of the credit.
If you withdraw your claim, it’s like you never submitted the amended return. However, if you committed fraud, the IRS can still hold you responsible for that. Luckily, most taxpayers who were misled by an ERC mill don’t have to worry about fraud.  That said, you are responsible for the information on your tax return. Even if you paid someone to file it, you are responsible for the details. 

Consider reporting the ERC mill

If you worked with an abusive ERC mill, you can opt to report them to the IRS. To do so, file form 14242 (Report Suspected Abusive Tax Promotions or Preparers). Also, send any supporting documents you have about them. 

Amend your tax return

If you are entitled to a partial credit, and you simply need to fix some errors on your tax return, you may want to amend it. However, you should do so carefully. Do not make changes to the ERC claim without consulting with a tax attorney who truly understands this credit. Also, when working with any professional, request a sheet showing the computations they used to calculate the credit.

Look into IRS Voluntary Disclosure

If the credit was already paid and you know that you claimed it incorrectly, you may want to look into the IRS’s voluntary disclosure practice. This program allows you to “come clean” with the IRS, and in exchange, the agency limits penalties and criminal exposure. However, you have to be proactive. You only qualify if you reach out first. You cannot qualify if the IRS has contacted you about an audit or any other issue. You should always consult with an attorney before going a voluntary disclosure.

The Bottom Line With Erroneous ERC Claims

If you believe you may have made an erroneous ERC claim, you should contact a tax attorney for help. They can talk with you about your audit risk, potential ERC penalties, and the best path forward. The audit penalties and risks are just too high — you cannot expect an erroneous claim to go unnoticed.  The risks may be even higher if you filed your amended payroll return in 2023. The IRS has stated that the risk of fraud is higher with newly submitted returns. As a result, your return may face additional scrutiny if it was amended significantly after the quarter in which you paid the wages.

How Long Do You Need to Worry?

Unfortunately, this issue isn’t going away quickly. The IRS extended the statute of limitations on some payroll tax returns with ERC claims to five years. This means that the agency can audit Q3 and Q4 2021 payroll tax returns until April 15, 2027.  The statute of limitations for all other payroll tax returns is only three years. The IRS has until April 15, 2024, to audit ERC claims from 2020 and until April 15, 2025, to audit ERC claims from Q1 and Q2 2021. At the time of writing, this is true, but some analysts speculate that the IRS may extend the audit statute of limitations on all employer tax returns with ERC claims.  However, the audit statute of limitations applies in usual cases, and the ERC is not the norm. the IRS may lean on other rules to extend this timeline, such as the following.

Civil action to recover erroneous refunds

Under IRC Section 7405(b), the government has the right to recover erroneous tax refunds through civil lawsuits. This rule applies in cases where taxpayers claimed refunds that they weren’t legally entitled to, and thus, it may apply to certain ERC claims. The IRS has two years from the date the refund was issued or up to five years if fraud was involved. 

Civil fraud assessments

Additionally, the IRS has an unlimited amount of time to review tax returns for civil fraud assessments. The agency generally only has three to six years to bring criminal fraud charges against a taxpayer, but with civil fraud, there is no statute of limitations. If the IRS believes fraud is involved, it may invoke these rules.  

Get Help With ERC Audits, Penalties, and More Now

If you’re worried about an ERC audit, curious about changing your claim or dealing with any other ERC-related issues, you need high-quality help. Due to the very complex nature of this credit, you need to work with a tax attorney who’s experienced with the ERC and IRS payroll tax problems. To get help today, contact us at the Timothy S. Hart Law Group, P.C. 

Attorney Timothy Hart

Timothy S Hart, the founding partner of the tax law firm of Timothy S. Hart Law Group, P.C. is both a New York Tax Lawyer & Certified Public Accountant. His area of expertise includes innovative solutions to solve your Internal Revenue Service and New York State tax problems, including tax settlements through the Federal and New York State offer in compromise programs, filing unfiled tax returns, voluntary disclosures, tax audits, and criminal investigations. [ Attorney Bio ]