Employee Retention Credit Challenges: IRS Backlogs and Business Frustration

In its 2024 Annual Report to Congress, the Taxpayer Advocate Service (TAS) identified the Employee Retention Credit first on the list of what it believes are the most serious challenges taxpayers face. This issue has far-reaching implications for businesses still grappling with the economic fallout of the COVID-19 pandemic. The ERC, a program designed to incentivize businesses to retain employees during the pandemic, has become a source of frustration due to processing delays, poor communication and administrative inefficiencies with the Internal Revenue Service (IRS).

Background and Complexity of the ERC

The ERC was enacted as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act in March 2020, providing refundable tax credits to businesses and nonprofits that experienced significant revenue losses or government-mandated shutdowns. Subsequent legislative amendments expanded eligibility and benefits, allowing businesses to claim up to $21,000 per employee in 2021, compared to $5,000 in 2020.

However, the program’s complexity created challenges. Eligibility criteria—including gross receipts thresholds and rules for partial suspension of operations—proved difficult to navigate, leading to confusion among taxpayers and opportunities for fraudulent claims. The IRS’s initial rapid rollout of the program was marred by inconsistent guidance, creating further complications for businesses and tax professionals.

IRS Delays and Moratoriums

Facing an influx of ERC claims—some legitimate, others potentially fraudulent—the IRS nearly brought processing to a halt  in mid-2023. On Sept. 14, 2023, it imposed a moratorium on new ERC claims, citing the need to focus on sorting valid claims from invalid ones and drastically reduced the processing of claims filed before the moratorium. As a result of these measures, the backlog ballooned to approximately 1.2 million unprocessed claims by October 2024, leaving most businesses waiting well over a year for refunds.

The TAS highlighted the downstream effects of these delays in its report, including:

• Financial Hardship: Many businesses depend on ERC funds to recover from pandemic-related losses. Delays have forced some to close or take out high-interest loans.
• Tax Implications: Taxpayers faced dilemmas about whether to amend prior-year tax returns to reflect anticipated ERC refunds, risking overpayment or underpayment of taxes.
• Eroded Trust: Poor IRS communication, including vague or incorrect status updates, and unsupported claim disallowances compounded frustrations among taxpayers.
  Administrative Shortcomings

The report identifies several administrative deficiencies in the IRS’s handling of ERC claims:

• Inadequate Communication – The IRS provided limited updates on claim statuses, making it difficult for businesses to remain fully informed about the processing of their claims. Some notices of disallowance also lacked critical information about appeal rights or reasons for denial.
• Abandonment of Standard Procedures – To expedite reviews, the IRS deviated from established protocols, such as standard examination procedures, which reduced taxpayers’ opportunities to contest decisions.
• Flawed Risk Scoring Models – The IRS’s reliance on risk scoring models to flag improper claims resulted in errors, with legitimate claims being erroneously denied or delayed.
  Resource Constraints: Insufficient staffing and training hindered the IRS’s ability to manage the program effectively, exacerbating delays.

Recommendations for Improvement

The TAS did issue several recommendations to address these challenges and hopefully work to restore taxpayer confidence:

• Accelerate Processing: The IRS should prioritize clearing the backlog of claims filed before the revised Jan. 31, 2024, moratorium on new claims and provide a clear timeline for resuming normal operations.
• Enhance Transparency: Regular updates on claim statuses and estimated processing times are essential. Notices of disallowance should include detailed explanations and appeal options.
  Strengthen Oversight: The IRS must refine its risk scoring models to minimize errors and ensure that legitimate claims are not unfairly flagged.
• Streamline Communication: Developing a centralized system for taxpayers to track the status of their claims would reduce uncertainty and alleviate pressure on IRS call centers.
• Improve Training: IRS employees must be adequately trained to handle the complexities of ERC claims, ensuring consistent and accurate evaluations.
• Explore Alternative Dispute Resolution: Programs such as Fast Track Settlement could help resolve disputes more efficiently, reducing the burden on both taxpayers and the IRS.

Actionable Steps for Claimants

For businesses that have filed an ERC claim or are awaiting processing, there are proactive steps that can help address and mitigate challenges and uncertainties:

• Consult a Trusted Financial Advisor: Work closely with a knowledgeable ERC tax professional to understand your claim’s status and evaluate your options. They can provide guidance on amending tax returns and preparing for possible audits or appeals.
• Prepare Documentation: Gather all relevant records supporting your ERC claim, including payroll data, gross receipts documentation and details of government-mandated shutdowns, since readily available information will help to streamline any requests from the IRS.
• Evaluate Tax Implications: If you’ve amended or plan to amend prior tax returns in anticipation of an ERC refund, discuss with your advisor the potential impact of delays or disallowances on your overall tax liability.
• Consider Financial Contingencies: In the face of prolonged delays, explore alternative financing options to address cash flow issues. Be mindful of interest rates and repayment terms if considering loans.
• Be Ready to Appeal: If your claim is denied, work with your advisor to file an appeal or provide additional documentation promptly. Understanding your rights and the appeals process is crucial for a successful resolution.

Windham Brannon’s Tax Controversy Practice includes a team of ERC experts that can help you better understand the credit, provide a second look at the eligibility and amount of your ERC claim and file your amended return, if necessary. We can also represent you during the ERC audits and appeals process, bringing peace of mind that a trusted advisor with ERC expertise is by your side. To get more insight into your unique ERC claim situation, reach out to your Windham Brannon advisor today, or contact Tomika Bullet.