What Are the Civil and Criminal ERC Fraud Penalties?

The Employee Retention Credit (ERC) was a refundable tax credit for qualified wages paid between March 2020 and December 2021, designed to help businesses retain employees during the COVID-19 pandemic. Widespread marketing led to a surge in questionable claims, and with filing deadlines passed, the Internal Revenue Service (IRS) has shifted its focus to enforcement. Businesses now face civil and criminal penalties for improper ERC claims.

Defining an Improper ERC Claim

An ERC claim is improper if the business did not meet the eligibility requirements. One of the primary ways to qualify was through a full or partial suspension of operations due to a COVID-related government order. To meet this test, the order must have reduced the business’s ability to provide goods or services by more than 10%.

Many businesses incorrectly claimed the credit based on supply chain disruptions. These disruptions do not qualify a business for the ERC unless they were a direct result of a specific government order affecting the supplier. Simply experiencing delays or increased costs in the supply chain is not sufficient for eligibility.

Another path to eligibility was a decline in gross receipts. For claims in 2020, this meant a decline of more than 50% compared to the same quarter in 2019. For 2021 claims, the threshold was a decline of more than 20% compared to the same 2019 quarter. Errors in this area often stem from incorrect calculation methods or using the wrong comparison periods.

The definition of “qualified wages” has also been a source of improper claims. Wages paid to majority owners and their relatives are not eligible for the credit. Additionally, for large employers—those with more than 100 employees in 2019 for 2020 claims or 500 for 2021 claims—the credit could only be claimed for wages paid to employees who were not providing services. A frequent mistake was including wages for all employees, regardless of their work status.

The rise of “ERC mills” or promoters has contributed to the volume of improper claims. These firms often charge large fees or a percentage of the anticipated refund and provide boilerplate eligibility justifications without a detailed analysis. The IRS has warned businesses to be wary of promoters who guarantee eligibility without a thorough review of financial records. The responsibility for the accuracy of the claim rests with the business owner, not the promoter.

Civil Penalties for Inaccurate Claims

The starting point for any business that has filed an inaccurate ERC claim is the full repayment of the credit received. If the IRS determines a claim was improper, the business is required to return the entire amount of the refund. This repayment is required before any additional penalties or interest are applied.

Interest begins to accrue on the erroneously claimed amount from the date the credit was received, not from when the IRS identifies the error. This interest compounds daily, and the failure-to-pay penalty of 0.5% of the unpaid tax per month can also be applied, increasing the financial burden.

A common penalty for inaccurate ERC claims is the accuracy-related penalty. This penalty is 20% of the underpayment of tax resulting from the improper claim. The IRS may impose this penalty in cases of negligence or disregard of the rules, such as failing to exercise reasonable care in determining eligibility. This is on top of repaying the credit and interest.

For more severe cases, the IRS can impose a civil fraud penalty of 75% of the underpayment attributable to fraud. Unlike the accuracy-related penalty for negligence, the civil fraud penalty requires the IRS to prove willful intent to evade tax. This involves demonstrating that the business owner knowingly filed a false claim.

Criminal Investigation and Prosecution

In severe cases of ERC fraud, business owners and promoters may face criminal investigation and prosecution. These actions are handled by IRS Criminal Investigation (CI), the agency’s law enforcement arm. A criminal investigation is separate from a civil audit and carries more severe consequences, including imprisonment.

The Department of Justice (DOJ) can bring several types of criminal charges in ERC fraud cases. These may include tax evasion, filing a false tax return with false information, wire fraud if electronic communications were used, and conspiracy if multiple individuals worked together to file fraudulent claims.

A criminal conviction for ERC fraud can result in financial penalties, restitution to the government, and a prison sentence. For example, a conviction for tax evasion can lead to fines of up to $100,000 for an individual and up to five years in prison. These criminal penalties are imposed in addition to any civil penalties.

While business owners who knowingly file fraudulent claims can be prosecuted, the IRS and DOJ have placed a strong emphasis on targeting the promoters and preparers who orchestrate fraud schemes. As of early 2025, IRS-CI had initiated over 545 criminal investigations into fraudulent ERC claims totaling more than $5.6 billion, leading to dozens of federal charges and convictions.

IRS Programs for Correcting Claims

The IRS has established programs to help businesses that may have filed an improper ERC claim. For businesses whose claims have not yet been processed or paid, the ERC Claim Withdrawal Process offers a way to retract the submission. To be eligible, the business must have filed an adjusted employment tax return (like Form 941-X) solely to claim the ERC and must wish to withdraw the entire amount.

The withdrawal process requires the business to make a copy of the adjusted return and follow specific IRS instructions for marking it as “Withdrawn” before submission. If a business received a refund check but has not yet cashed or deposited it, they can still use this process by mailing the voided check along with the withdrawal request.