Employee Retention Credit (ERC): Processing Delays and Challenges

In response to the economic challenges caused by the COVID-19 pandemic, Congress introduced the Employee Retention Tax Credit (ERC or ERTC) back in March of 2020 to provide a refundable tax credit to businesses and nonprofit organizations affected by government-imposed restrictions.  

Although the ERC was designed to incentivize businesses to retain employees on their payroll by offering tax credits for qualified wages paid, the program’s complexity has led to numerous challenges for both taxpayers and the Internal Revenue Service (IRS). 

In this article, we break down what led to the significant delays and how this has complicated business for many employers. 

Core Issues: Why The ERC Refund Processing Time Has Been Delayed 

There are many factors behind the delays for issuing refund checks to eligible employers. In general, the core problems include complex regulations, misleading claims, the IRS moratorium, communication challenges, and misplaced ERC refund checks. 

1. Complex Regulations

From the beginning, the ERC statutes have been intricate, making it challenging for businesses to navigate eligibility criteria and filing requirements.  

For example, businesses initially could not qualify for the ERC if they also participated in the Paycheck Protection Program. Congress later amended this ruling by saying businesses could apply for both programs but simply could not double dip with claiming credits for the same employee.  

Although this allowed more employers to participate in the program if they had paid qualified wages to employees while having the required decline in gross receipts or were shut down due to a government order, it also sparked confusion. 

2. Fraudulent Claims

Due to the large claim payout and an opportunity for "ERC Mills" to take advantage, the program began to be exploited by aggressive marketers posed as bad actors who mislead businesses into believing they could qualify for the credit. As a result, the IRS became inundated with fraudulent claims, further straining its processing capacity. 

3. IRS Moratorium and Processing Delays

In September 2023, the IRS implemented a moratorium on processing new ERC claims because of the overwhelming volume and fraudulent submissions. This decision exacerbated existing delays, leaving many businesses in financial limbo.  

By 2024, many claims filed before the moratorium remained unprocessed, causing significant harm to businesses reliant on ERC refunds for post-pandemic recovery. 

4. IRS Communication Challenges

Once the moratorium ended, the IRS issued notices that were confusing and contained errors, which created more setbacks for ERC claims filed. Let's break these down for more clarification. 

Confusing and Inaccurate Notices 

The IRS issued approximately 28,000 notices of ERC claim disallowance in mid-2024. However, these notices were criticized for: 

• Omitting taxpayer rights, such as the ability to seek review by the Independent Office of Appeals or through the courts. 

• Providing vague or inaccurate explanations for disallowance. 

• Failing to specify the required documentation for disputes. 

Overall, the notices lacked clarity about whether taxpayers needed to provide documentation for the entire ERC claim or just the disallowed portion. This confusion led to significant frustration among taxpayers and practitioners, many of whom felt unprepared to respond adequately. 

Delayed Clarifications 

In September 2024, about a month after issuing the disallowance notices, the IRS addressed some of the issues to clear confusion, but the delay left taxpayers uncertain about how to proceed. Many had already submitted responses without the benefit of updated guidance. The lack of timely, clear communication undermined taxpayer confidence and complicated the appeals process. 

Omissions in Recapture Notices 

The IRS also issued regulations to recapture erroneously paid ERC claims; however, the recapture notices failed to inform taxpayers of their administrative appeal rights if they wanted to contest their claim being illegitimate. This omission violated taxpayers' rights to challenge the IRS’s position and seek resolution. 

Deviations from Standard Exam Procedures 

To deal with the backlog of claims, the IRS pivoted to adopt several unconventional methods to speed up the process. However, abandoning the standard audit process created several other problems.  

For example, the new ERC streamlined audit process bypasses several administrative steps that have made appeals much more time-intensive when claims are disallowed. Another new process does a reverse audit where a risk scoring model analysis is used to identify improper claims without including human input. This process has sparked issues such as: 

• Many notices have been deemed erroneous, leading to unnecessary disputes. 

• Taxpayers have been subjected to lengthy review processes, delaying access to appeals and prolonging resolution. 

• The two-year statute of limitations for refunds begins running from the date of the disallowance notice, creating additional pressure to resolve disputes quickly. 

The increase in appeals to these unconventional methods that were intended to streamline claims processing will likely further delay legitimate claims made by eligible businesses. 

5. Missing ERC Checks 

Some businesses have been notified of their claims being processed but have faced additional frustrations due to stolen, misplaced, or misdelivered refund checks. In fact, as of September 30, 2024, over 21,000 taxpayers had reported not receiving their ERC checks.

To resolve a missing check, the taxpayer must file Form 3911 for the Bureau of the Fiscal Service (BFS) to investigate, which can take up to nine months. Then, once resolved, the IRS reissues a paper check, as its system cannot currently facilitate direct deposit for replacement refunds.  

Have ERC Processing Delays Really Created a Financial Hardship on Businesses? 

Where it has been so many years since the Employee Retention Credit was enacted, many people have asked whether the ERC has really created a hardship. In short, tens of thousands of businesses have faced severe financial challenges due to these delays.  

Companies awaiting refunds have struggled to cover operational costs, taken out loans accruing interest, or, in some cases, been forced to shut down. Additionally, taxpayers who amended their income tax returns to reflect reduced wage deductions (as required when claiming the ERC) have accrued penalties and interest on unpaid liabilities while waiting for their refunds. There are also issues with claiming credits on an amended payroll tax return, which triggers a ticking time clock for everything to be finalized within a specific timeframe. 

Did the Voluntary Withdrawal Programs Help? 

After being inundated by fraudulent claims, the IRS launched a campaign to educate employers and offer disclosure programs to help them address improper ERC claims. These programs allowed employers to resolve their incorrect claims without being penalized.  

A withdrawal process that was initiated in October 2023 received over 11,800 requests, most of which were processed by late 2024. But the subsequent initiative called the Voluntary Disclosure Program (VDP) had limited participation, even though it offered partial repayment without penalties. In fact, the first VDP received just over 2,600 applications, while a second program announced in August 2024 saw only 48 applicants. 

Overall, these voluntary withdrawal programs lightened the IRS load slightly, but not to the degree that was needed. 

What Improvements Should the IRS Make Going Forward? 

The Taxpayer Advocate Service has outlined several recommendations for the IRS to make improvements for processing ERC claims. Their suggestions include expediting claim processing, prioritizing cases of financial hardship, enhancing communication, offering detailed disallowance explanations, and enabling direct deposit for replacement checks. They also identified the need for technology to refine its algorithms for improved accuracy and to include manual reviews to ensure fairness and accuracy. 

Overall, the IRS must fulfill its responsibility to support American businesses by streamlining processes, addressing taxpayer needs promptly, and ensuring equitable treatment while safeguarding against fraud. These measures are essential to delivering the relief Congress intended and supporting businesses’ recovery from the pandemic. 

Conclusion 

While the Employee Retention Credit appeared to be a vital lifeline for businesses during the pandemic, its complex implementation and subsequent processing delays have caused significant frustration and financial hardship for taxpayers. Stratus HR will continue doing everything within our power to receive status updates and keep clients informed about ERC claims, as our trade association, NAPEO, along with our advocates in Washington, continue to pressure the IRS for action.

Source: 
Taxpayeradvocate.irs