In a significant escalation of its enforcement posture, the Internal Revenue Service has signaled that it intends to substantially slow the processing of new Employee Retention Credit claims while it addresses a surge of fraudulent and improper filings. Although a formal moratorium announcement would come later in 2023, the warning signs are unmistakable: the IRS has identified the ERC as one of its top compliance priorities and has devoted significant resources to examining the flood of claims that third-party promoters have generated over the past two years.

The Scope of the Problem

The ERC was designed as a targeted relief measure for businesses genuinely affected by the COVID-19 pandemic, offering refundable credits of up to $26,000 per employee across the eligible quarters. As we discussed in our earlier analysis of aggressive ERC promoters, the size of the potential credit attracted a wave of promoters who solicited businesses indiscriminately, often without conducting any meaningful eligibility analysis. The result has been a backlog of claims at the IRS, many of which the Service believes are improper or fraudulent.^[1]

The IRS has publicly estimated that a substantial percentage of pending ERC claims contain errors or are wholly without merit. Commissioner Daniel Werfel has described the situation as one of the largest fraud schemes the Service has confronted, and senior IRS officials have indicated that the volume of suspicious claims has overwhelmed the Service's ability to process legitimate claims in a timely manner. The backlog is measured in hundreds of thousands of claims, and processing times that were once measured in weeks have stretched to months.

What the Slowdown Means for Businesses with Pending Claims

For businesses that have filed ERC claims and are awaiting refunds, the processing slowdown means extended wait times with no clear timeline for resolution. The IRS has not published a formal schedule for working through the backlog, and businesses should anticipate that claims filed in 2023 may take considerably longer to process than claims filed in 2021 or early 2022. This is particularly problematic for businesses that relied on the anticipated refund for cash flow purposes or that incurred fees payable to promoters upon receipt of the credit.

Businesses with pending claims should take several steps. First, review the underlying claim with a qualified tax professional to confirm that the claim is substantively defensible. If the claim was prepared by a promoter, this review is essential. Second, maintain all documentation supporting the claim, including the specific government orders relied upon, gross receipts calculations, and records of the wages for which the credit was claimed. Third, be prepared for the possibility that the IRS will examine the claim before issuing the refund. The Service has indicated that it is implementing additional screening procedures for ERC claims, and a request for additional information or a formal examination is increasingly likely.

Heightened Audit Risk

The IRS has announced the creation of specialized audit teams dedicated to ERC compliance. These teams are trained to evaluate the specific eligibility requirements of the ERC, including the government order test, the gross receipts test, and the supply chain disruption theory. Businesses whose claims rely on aggressive interpretations of these tests—particularly the supply chain disruption argument—face elevated audit risk.^[2]

The consequences of an adverse determination on an ERC claim are substantial. The business must repay the full credit amount plus interest, which has been accruing since the date the refund was received. The IRS may also assert accuracy-related penalties under IRC § 6662, which can add 20 percent to the underpayment. In cases involving fraud, the civil fraud penalty under IRC § 6663 imposes a 75 percent addition to tax, and criminal referrals are possible in egregious cases. For businesses that received large refunds based on promoter-driven claims, the potential exposure is significant.

The Voluntary Disclosure Option

For businesses that have received ERC refunds and now have concerns about the validity of their claims, the most prudent course of action may be voluntary correction. The IRS has signaled that it will treat voluntary corrections more favorably than claims that are discovered during examination. By filing amended employment tax returns to correct an improper ERC claim, a business can eliminate or substantially reduce its penalty exposure and demonstrate good faith. The interest on the repayment will still accrue, but the savings on penalties can be substantial.^[3]

Businesses considering voluntary correction should consult with experienced tax counsel before filing amended returns. The decision to amend involves an analysis of the strength of the original claim, the potential penalty exposure, and the likelihood of examination. In some cases, the claim may be defensible on its merits, and amendment may not be warranted. In others, the risk-reward calculus clearly favors correction. A qualified advisor can help evaluate the specific facts and develop an appropriate strategy.

What Comes Next

The IRS's aggressive posture on ERC enforcement is likely to intensify throughout 2023 and beyond. The Service received substantial additional funding through the Inflation Reduction Act, and a meaningful portion of those resources is being directed toward compliance initiatives targeting high-risk areas—with the ERC at the top of the list. Businesses that have claimed the ERC should treat the current environment as a call to action: review existing claims, ensure documentation is in order, and consult with qualified professionals to assess whether correction or additional preparation is warranted. The businesses that address these issues proactively will be far better positioned than those that wait for the IRS to come to them.