Used & Abused: the ERC and Pandemic-Relief Fraud
When we consider how a community or nation recovers from any disaster, our thoughts tend toward the physical acts undertaken: rendering first aid, clearing away debris, beginning to rebuild. Less obvious are the financial mechanisms which support recovery efforts; changes made to the tax code during a crisis, for example, take a backseat to saving lives (and rightfully so). But as time progresses and the immediate danger fades, we ought to consider the financial tools in our arsenal as vital catalysts for long-term recovery, important in their own right. Unfortunately, as with any tool, the fiscal policies we implement to assuage a crisis become implements of self-sabotage when abused by the wrong hands.
The response to COVID-19 provides an instrumental case. For many generations of Americans, having not suffered through a pandemic since 1918 nor even a military draft since the Vietnam War, our prior experience with mass mobilization of federal resources was mostly confined to the aftermath of the 2008 recession. During the last of these, available government funds totaled roughly $725 billion; for the COVID-19 pandemic, this number almost quadrupled to $2.6 trillion. Some of this monetary tsunami was dispersed as much-lauded stimulus checks sent directly to taxpayers, but a significant portion existed in lesser known forms, such as the Employee Retention Credit (“ERC”).
Originally created as part of the Coronavirus Aid, Relief, and Economic Security Act of 2020 and expanded by the American Rescue Plan Act of 2021, the ERC is a legitimate incentive for businesses impacted by the pandemic who retained employees during an economically fraught time. Present tense is important here: due to statutes of limitations expiring on April 15th, 2024 and 2025 (for tax years 2020 and 2021, respectively), eligible businesses are still able to file claims via amended quarterly tax returns for any applicable quarters of 2020 and 2021. The sums of money doled out to business owners aren’t insubstantial, either; employers can be eligible for as much as $5,000 in 2020 and $28,000 in 2021, per employee.
Anyone who isn’t a business owner would be forgiven for having never heard of the ERC before. Yet as the pandemic sinks further into the past, the ERC itself increasingly makes headlines for all the wrong reasons, slowly simmering into the public consciousness due to a cottage industry of fraudsters abusing an important tax credit.Historically, this should come as no surprise; for as long as there have been tax credits, there have been bad actors exploiting them for personal gain. In the case of the ERC, however, the added tragedy is that these fraudsters are typically not the tax filers themselves but third parties preying upon small business owners.
Given the initial chaos of the pandemic and the various legal remedies rolled out to keep the nation and the economy afloat, it is reasonable to assume that many businesses were unaware of the ERC when initially filing tax returns in 2020 and 2021. Third party promoters and preparers have used this lack of awareness surrounding the credit for their own gain, conflating many businesses’ continuing ability to claim the credit with their eligibility for it. This leaves taxpayers vulnerable to fraud that typically unfolds in one of three ways.
The most common of these is when a promoter encourages a business to file, failing to perform the due diligence necessary to ascertain credit eligibility while charging the filer an exorbitant fee. As a fairly complex tax credit, the ERC is not an instance in which the average taxpayer is able to easily check the work of a third party preparer, and many filers may not have a good idea of what constitutes reasonable fees in this space. This leads to the second overarching type of ERC fraud, in which a third party files on behalf of an eligible business but retains most if not all of the credit for themselves. In the last category of fraud, an unscrupulous actor may just use the ERC as a pretense for identity theft, gaining sensitive information from eligible and ineligible businesses alike to apply for the credit themselves and retain all funds.
With so many avenues for malfeasance, the levels of fraud have been truly mind-boggling. Just one individual New Jersey tax preparer was able to submit over 1,000 false claims worth millions, and there have been other cases where the individuals involved were equally prolific; yet even in less dramatic instances, promoters typically file multiple fraudulent claims, meaning that the IRS is struggling with fraud on an exponential scale. This has been an ongoing issue: as early as late 2022, the IRS had already detected more than 11,000 suspicious returns with indicators of potential identity theft, the least common form of ERC fraud, and that number has surely only increased in the intervening 15 months. And in December of 2023 alone, 20,000 disallowance letters were sent out, with thousands of claims flagged for audit at a time when many legislators of a certain political persuasion would prefer to slash IRS funding rather than bolster it.
Clearly, the IRS is fighting a war on three fronts. Seen in this light, what’s surprising isn’t that the agency instituted a moratorium on filing new ERC claims; the real shock is that it took until September 14, 2023 to do so in the first place. Worse yet, the strain placed upon the processing system has extended the time it takes to process a valid claim from 2 months at the credit’s inception to over 6 today, and that’s just for claims that were filed prior to the inception of the moratorium. With the IRS’ recent indefinite extension in December, any claims filed after September 14 of last year won’t be considered until after the moratorium is lifted, and even then will presumably require a further half a year from then on to be processed.
Those with insight into the IRS’ decision-making believe that the moratorium will come to an end at some point early this year, but as of this blog’s publication near the end of Q1, no changes have been announced. We do know that the IRS has been in the process of instituting several new policies and procedures to screen out fraud, in addition to digitizing many previously manually entered information through the use of scanning technology.
In the meantime, the rest of us are left to ask: how can we avoid a disaster of this scale moving forward?
As epidemiologists and public health officials contemplate how best to mitigate future pandemics, those of us in the financial sphere need to ask similarly tough questions surrounding how to safeguard future disaster relief measures from abuse and fraud. Some solutions speak for themselves: much-needed improvements and reforms to the IRS itself would go a long way toward preventing fraud and increasing efficiency, changes which would improve everyone’s tax experience regardless of whether there’s a crisis unfolding.
Other solutions take on a more grass-roots approach. Tax education is never glamorous, but we advocate for enhancing the average taxpayer’s understanding of not only the process but the industry itself. Business owners in particular need to have a better understanding of credits and deductions beyond the obvious incentive to reduce tax burdens, and for complex cases such as the ERC, members of the tax trade should continue hammering home the importance of using trusted professionals. After all, CPAs and tax attorneys are ideally situated to help businesses establish eligibility, prepare substantiation and documentation, and file all relevant forms correctly. By turning to the proper authorities for help, taxpayers can also better avoid price gouging and other causes of fraud.
This is not an exhaustive list. Ultimately, we hope brighter minds prevail and continue to develop policy solutions which safeguard our common prosperity. If we do the hard work of thinking forward, the next time a virus rears its ugly head, we can safely throw every dollar necessary at protecting our economy without worrying about the specters of fraud and misuse.
