Is the Employee Retention Tax Credit Legitimate?

The Employee Retention Credit (ERC) is a legitimate government relief measure, but its complexity has led to widespread misinformation. Aggressive marketing campaigns have caused many business owners to question the program’s validity, leading to a high number of improper claims and increased scrutiny from the Internal Revenue Service (IRS). While the credit is a valid tax benefit, the confusion surrounding it requires a clear understanding of the official rules to distinguish between legitimate eligibility and misleading promises.

The Employee Retention Credit as a Government Relief Program

The Employee Retention Credit was established by the Coronavirus Aid, Relief, and Economic Security (CARES) Act in March 2020. It was designed to provide a financial incentive for businesses to retain employees during the economic uncertainty of the COVID-19 pandemic. For 2020, the credit was 50% of up to $10,000 in qualified wages per employee for the year, with a maximum credit of $5,000 per employee. Initially, businesses that received a Paycheck Protection Program (PPP) loan were ineligible.

Subsequent legislation expanded the program, retroactively allowing PPP loan recipients to claim the credit on wages not used for PPP forgiveness. The legislation also increased the credit amount for 2021 to 70% of qualified wages up to $10,000 per employee per quarter. Eligibility for the fourth quarter of 2021 was later repealed for most businesses, except for those qualifying as a “recovery startup business.”

Official IRS Qualification Standards

To be eligible for the ERC for a calendar quarter, a business must meet one of two tests defined by the IRS: a significant decline in gross receipts or a full or partial suspension of operations due to a government order. Careful documentation is required to substantiate any claim.

Significant Decline in Gross Receipts

The first method for qualification is based on a measurable decline in revenue. For the 2020 tax year, a business is eligible for a quarter if its gross receipts were less than 50% of the gross receipts for the same calendar quarter in 2019. Eligibility under this test continues until the quarter after the business’s gross receipts exceed 80% of the amount from the corresponding 2019 quarter.

For the first three quarters of 2021, the rules were relaxed, and a business could qualify if its gross receipts for a quarter were less than 80% of the gross receipts from the same quarter in 2019. The law also introduced an alternative lookback rule for 2021, allowing employers to use the gross receipts of the immediately preceding calendar quarter compared to the same quarter in 2019 to determine eligibility.

Full or Partial Suspension of Operations

The second path to eligibility requires that a business’s operations were fully or partially suspended during a quarter due to a COVID-19-related government order. Eligibility requires a specific, mandatory directive from a government authority that limited commerce, travel, or group meetings. General recommendations, such as a public health advisory, do not meet this standard.

For a partial suspension, the government order must have had a “more than nominal” impact on operations, which the IRS defines as more than a 10% reduction in the ability to provide goods or services. For example, a restaurant forced by a mandate to cease all indoor dining would likely qualify. A business that experienced minor inconveniences, such as needing to hold virtual meetings, would not meet this threshold.

An employer may also qualify for supply chain disruptions if it had to suspend operations because a supplier was unable to deliver essential goods due to a government order affecting that supplier. The disruption must be directly traceable to a government mandate on the supplier, not just general supply chain issues. This requires documentation linking the supplier’s shutdown to a government order and showing the supplier’s products were necessary for business operations.

It is important to note that the statutory deadlines to file an amended return to claim the ERC have passed. The deadline for claims related to the 2020 tax year was April 15, 2024, and the deadline for all 2021 claims was April 15, 2025.

The Role of Third-Party ERC Promoters

The ERC’s complexity led to an industry of third-party promoters, or “ERC mills,” that aggressively market their services to businesses. They often charge a contingency fee, sometimes as high as 25% of the refund amount. This incentivizes them to maximize the credit, sometimes by encouraging ineligible businesses to apply. The IRS has issued warnings about these promoters and identified several red flags indicating potentially fraudulent advice.

• Claims of determining eligibility within minutes without a thorough review of financial records.
• Broad, generalized statements that nearly every business qualifies for the credit.
• Failure to provide detailed documentation or workpapers to support their calculations.
• Advisors who are not licensed attorneys or Certified Public Accountants with experience in federal tax matters.
• Requests for the business to sign a hold-harmless agreement, shifting all liability for an improper claim onto the business owner.

IRS Enforcement and Correcting Improper Claims

The IRS has increased its enforcement activities in response to questionable applications, including a moratorium on processing new claims filed after September 14, 2023. Improper claims face a high risk of audit, and businesses may be liable for full repayment of the credit, penalties, and interest. The IRS has also initiated criminal investigations into promoters and businesses associated with fraudulent claims.

The IRS established programs to help taxpayers correct improper claims. The ERC claim withdrawal process is available for businesses that filed a claim but have not yet received or cashed the refund. This allows the claim to be retracted without penalty or interest.

The IRS also offered two Voluntary Disclosure Programs (VDPs) for businesses that already received funds they were not entitled to, but both are now closed. The first program closed in March 2024, and a second program closed in November 2024. No special VDP is currently available for businesses that improperly received the ERC.