Is the ERC Tax Credit Legit? What You Need to Know

The Employee Retention Credit (ERC) was a legitimate, temporary tax credit established during the COVID-19 pandemic to encourage businesses to retain employees. Part of the CARES Act, it aimed to provide financial relief to employers facing economic disruption. While the ERC is a valid government program, aggressive promotion by some third-party entities and fraudulent claims have led to public confusion and increased Internal Revenue Service (IRS) scrutiny.

The IRS has warned businesses about misleading claims and implemented measures to combat fraud, including a temporary moratorium on processing new claims. This created a perception that the ERC program might not be legitimate. However, the credit was a lawful provision intended to support businesses. Challenges now arise from misinterpretations of eligibility rules and improper claims, not the credit’s inherent legitimacy. Businesses that properly qualified can still claim the credit.

What the Employee Retention Credit Is

The Employee Retention Credit originated with the CARES Act in March 2020 as a refundable tax credit to incentivize employers to keep their workforce employed during the COVID-19 pandemic. Congress expanded the ERC through subsequent legislation, including the Consolidated Appropriations Act of 2021 and the American Rescue Plan Act. The credit was generally available for qualified wages paid between March 13, 2020, and September 30, 2021, for most employers; for recovery startup businesses, it extended through December 31, 2021.

The ERC functioned as a credit against employer’s share of Social Security tax. Its refundable nature meant that if the credit exceeded payroll tax liability, the business received a direct refund, providing significant liquidity during the pandemic.

For 2020, the credit was 50% of qualified wages, up to $10,000 per employee ($5,000 maximum credit). For 2021, the credit was 70% of qualified wages, up to $10,000 per employee per quarter ($7,000 maximum per quarter). This could total up to $21,000 per employee for the first three quarters of 2021, or $28,000 for the entire year. The credit helped businesses offset payroll costs, including health plan expenses, during governmental orders and economic downturns.

Determining Eligibility

To qualify for the ERC, businesses met criteria in 2020 and 2021, primarily a significant decline in gross receipts or a full or partial suspension of operations due to a governmental order.

The “decline in gross receipts” test compared quarterly gross receipts to 2019. For 2020, a business qualified if gross receipts were less than 50% of the same 2019 quarter, continuing until they exceeded 80%. For 2021, the threshold was a 20% decline compared to the same 2019 quarter, or the immediately preceding quarter.

The “full or partial suspension of business operations” test applied if a governmental order limited commerce, travel, or group meetings due to COVID-19, impacting operations. This included orders closing a business, limiting capacity, or restricting hours. A partial suspension meant a “nominal portion” (at least 10% of gross receipts or employee hours) was suspended. Supply chain disruptions or general demand decline not tied to a specific order generally did not qualify.

Businesses with Paycheck Protection Program (PPP) loans could qualify for the ERC, but the same wages could not be used for both. Qualified wages, including health plan expenses, formed the credit basis. For larger employers (over 100 employees in 2019 for 2020, or over 500 for 2021), qualified wages were limited to those paid to employees not providing services. Smaller employers could count wages paid to all employees. Aggregation rules treated commonly owned businesses as a single employer for eligibility.

How to Claim the Credit

Businesses claimed the ERC on amended employment tax returns, not income tax returns. This ensured proper filing.

They primarily used Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund. This form adjusted previously filed quarterly employment tax returns (Form 941) to reflect the credit, reporting the ERC amount based on qualified wages and health plan expenses.

The credit was calculated by applying the applicable percentage (50% for 2020 or 70% for 2021) to qualified wages paid during eligible quarters, up to per-employee limits. For example, $10,000 in 2021 qualified wages for an employee yielded a $7,000 credit. The total credit was applied against employer’s Social Security taxes, with any excess refunded.

The completed Form 941-X was mailed to the IRS. Businesses must retain thorough documentation, including payroll records, governmental orders, gross receipts calculations, and employee counts. This documentation substantiates the claim if reviewed. Deadlines for filing amended returns were three years from the original Form 941 filing or two years from tax payment, whichever was later. For 2020 claims, the deadline was typically April 15, 2024; for 2021 claims, it is generally April 15, 2025.

Navigating Common Misconceptions and Scams

The ERC’s legitimate nature has been overshadowed by confusion and scams. Aggressive marketing by third-party promoters has led many businesses to believe they qualify when they do not, creating risks. The IRS has highlighted these issues.

Promoters often use unsolicited calls, emails, or advertisements, guaranteeing ERC eligibility or promising large refunds. They might charge excessive upfront or contingency fees. These tactics misrepresent eligibility criteria, particularly the “partial suspension” test. For instance, they might suggest general supply chain issues or a broad economic downturn qualify a business, rather than a specific governmental order.

The IRS warned about fraudulent schemes and, in September 2023, announced an immediate moratorium on processing new ERC claims. This moratorium combats improper claims and increases agency scrutiny. The IRS expressed concern that businesses were misled into filing ineligible claims, putting them at financial risk.

Filing an improper ERC claim can have serious consequences, including repayment with penalties and interest. The IRS has initiated criminal investigations into fraudulent claims and promoters. To help businesses that mistakenly filed improper claims, the IRS introduced a Voluntary Disclosure Program, allowing eligible taxpayers to repay a portion of the credit to avoid further penalties. A claim withdrawal process is also available for claims not yet processed or refund checks not cashed. These programs help businesses rectify errors.

Post-Claim Considerations

After submitting an ERC claim, businesses face ongoing considerations due to increased IRS scrutiny. Understanding these aspects helps businesses remain compliant and prepared for future interactions.

Processing times for ERC claims are lengthy, extended by the moratorium on new claims. Claims submitted before the moratorium are subject to additional review, potentially extending processing from 90 to 180 days or longer. The IRS has begun processing some “low-risk” claims, but a backlog remains.

Maintaining thorough records is important. Businesses should retain all supporting documentation for at least four years after filing. This includes payroll records (Forms 941 and 941-X), qualified wage calculations, governmental orders, and quarterly gross receipts data. These records are essential if the IRS audits the claim.

An IRS audit related to an ERC claim is a possibility. Businesses should be prepared to substantiate eligibility and calculation accuracy with retained documentation. If a business discovers an improper claim, the IRS provides repayment and withdrawal options. The Voluntary Disclosure Program, reopened in August 2024, allows businesses to repay 85% of the credit to avoid penalties and interest under certain conditions. The ERC claim withdrawal process allows businesses to retract unprocessed claims or uncashed refund checks, avoiding penalties.