Navigating the Employee Retention Credit: Key Issues from the Taxpayer Advocate's Report

The Employee Retention Credit (ERC) was introduced as a lifeline for businesses during the COVID-19 pandemic, aiming to support struggling businesses and exempt organizations by providing a tax credit to keep employees on the payroll. If you follow this blog, you are aware that the IRS has been slow to pay many ERC claims and believes a vast amount of filed ERC claims were invalid.

The Taxpayer Advocate is an independent branch of the IRS that is statutorily required to identify areas where taxpayers have problems in dealings with the IRS. Joel Crouch previously provided an overview of the problems identified in the Taxpayer Advocate’s most recent Annual Report to Congress (link).

One of the significant problems identified in Joel Crouch’s article, and by the Taxpayer Advocate, is related to ERC. Specifically, the Taxpayer Advocate's report highlights several key issues relating to ERC that have presented significant challenges for taxpayers. This blog drills down on the ERC issues highlighted by the Taxpayer Advocate. Those issues are described below.

Lengthy Processing Times: One of the most pressing issues identified in the report is the lengthy processing times for ERC claims. As of October 26, 2024, approximately 1.2 million claims remain unprocessed, leaving taxpayers without updates on their claim status or what to expect moving forward. This delay has created uncertainty and frustration among business owners who are dependent on these funds for their recovery.

My additional comment: While some claims have been processed after October 26, 2024, all indications are that there remains a substantial inventory of unprocessed claims.

Downstream Consequences: The delays in processing ERC claims have had negative downstream consequences, forcing taxpayers to make difficult decisions. For instance, some taxpayers have had to choose whether to amend their individual income tax returns to account for an ERC refund not yet received. This situation has added to the financial strain on businesses already struggling to stay afloat.

My additional comment: The IRS has still not provided sufficient sensible guidance for how taxpayers should deal with this issue. There are many other business consequences that have been caused by the ERC processing delays. For example, some taxpayers may have determined their employment tax liability based on the expectation that they would receive an ERC credit. Without a timely processing of the ERC claims, taxpayers are often required to deal with stressful (and potentially unnecessary) employment tax collection proceedings, which it bears noting also strains IRS resources.

Poor Communication: The report also highlights poor communication from the IRS as a significant issue. IRS disallowance notices issued prior to an examination have been confusing and have omitted critical information. This lack of clarity has left taxpayers and practitioners uncertain about the steps they need to take to resolve their claims. The Taxpayer Advocate specifically listed the following three significant problems with respect to poor communication:

1. Omitting information about the taxpayer’s right to seek review by the Independent Office of Appeals (Appeals), a U.S. district court, or the U.S. Court of Federal Claims;
2. Including inaccurate or vague explanations about why the IRS disallowed the claim; and
3. Failing to inform the taxpayer that the IRS would subject the responses to an exam-like review prior to sending the matter to Appeals.

My additional comment: This is not an issue limited to ERC, but IRS communications are frequently difficult to understand.

Abandonment of Standard Exam Procedures: The IRS has largely abandoned its standard procedures when reviewing ERC claims, opting for curtailed processes that do not provide taxpayers with adequate opportunities to respond. This approach has increased the risk of exceeding the time the IRS has to issue a refund, further complicating the situation for taxpayers.

The Taxpayer Advocate’s discussion on this topic is copied below. The suggested approach appears sensible:

This drawn-out process is especially concerning because the IRS’s issuance of a notice of disallowance begins the running of a two-year period during which the IRS must issue any refund. Specifically, the two-year timeframe in which the taxpayer can either file suit or the IRS can issue a refund begins from the date on the notice of claim disallowance. Under the law, any refund the IRS issues after this two-year time period is considered erroneous. The taxpayer can extend the two-year time period under IRC § 6532 for the IRS to issue a refund only when they submit Form 907, which requires both the IRS and taxpayer to agree and sign.

The IRS could address this lengthy review process by sending taxpayers a letter prior to the official notice of claim disallowance informing them that it is inclined to disallow their claim. The letter could provide taxpayers an opportunity to send the IRS necessary documentation to support the claim and request an Appeals hearing. If the taxpayer does not respond, the IRS can move forward and issue the official notice of claim disallowance. If the taxpayer responds to the notice and sends in documentation to support the claim, the IRS will not issue a notice of claim disallowance until an Exam employee has reviewed the taxpayer’s information and Appeals has reviewed the IRS’s decision. Only after that process should the IRS issue an official notice of claim disallowance, which would essentially move the entire claim review process before the two-year clock starts. The IRS could easily do this by substituting an initial letter for the notices of claim disallowance requesting additional information and reserving the IRS’s issuance of a notice of claim disallowance until after Exam and Appeals complete their reviews.

Stolen Check Delays: Another issue identified in the report is the delay experienced by some eligible businesses when their ERC refund checks were stolen. These businesses had to wait months or longer for the IRS to conclude an investigation and issue a new check. This additional delay has exacerbated the financial difficulties faced by these businesses.

Low Participation in Voluntary Disclosure Programs: The report notes that taxpayer participation in the IRS's ERC disclosure programs has been low, and the IRS has not acted swiftly to approve taxpayer applications. This lack of participation and slow response from the IRS has hindered the resolution of improper claims and added to the backlog of unprocessed claims.

My additional comment: This was foreseeable. There still is an apparent disconnect regarding what the IRS views as a valid claim and what taxpayers may understand to be a valid claim. If taxpayers believe they have a valid claim, they are not likely to participate in a program that would include ERC refund repayment.

The Taxpayer Advocate's report sheds light on the significant challenges faced by businesses in navigating the complexities of the ERC. It is crucial for the IRS to address the issues in the report as soon as possible to limit additional taxpayer problems.

If you have any questions about this article, ERC, or any other civil or criminal tax problem, please contact me at jglassman@meadowscollier.com or 214-749-2417.