What Business Owners Need to Know if They Received an ERC Disallowance Letter from the IRS

On December 6, 2023, the Internal Revenue Service (IRS) announced that it was sending an “initial round” of 20,000 letters to taxpayers informing them that their Employee Retention Credit (ERC) claims had been denied. According to the IRS’ press release, the letters reflect the agency’s “increased scrutiny of ERC claims in response to misleading marketing campaigns that have targeted small businesses and other organizations.” As the IRS continues to target ERC fraud heading into 2024, all businesses that improperly claimed the ERC face risks; and, even if a business fell victim to an ERC filing scam or misleading marketing campaign, it must still take proactive steps to avoid unnecessary consequences.

What to Know if Your Business Received an ERC Disallowance Letter

With this in mind, if your business is on the IRS’ list of initial recipients, there is a lot you need to know. Here are some important considerations for businesses that received an ERC disallowance letter from the IRS:

The IRS Has Determined that Your Business is Ineligible for the ERC

If your business received an ERC disallowance letter, this means the IRS has specifically determined that your business is ineligible for the Employee Retention Credit. With its initial round of letters, the IRS is contacting businesses that have had their claims disallowed for two primary reasons:

• The business entity was established after December 31, 2021, and therefore does not have any “qualified wages” (which must have been paid between March 13, 2020, and December 31, 2021); or,
• The business did not report paying any qualified wages during the eligibility period.

While the IRS’ press release acknowledges that many business owners fell victim to ERC filing scams, it also makes clear that all taxpayers are ultimately responsible for the contents of their filings. Thus, while business owners no longer need to worry about withdrawing their ERC claims if their claims have been disallowed, they must still carefully assess their risk and make informed decisions about their next steps.

You Have the Right to Challenge the IRS’ Determination

Business owners who believe that the IRS has improperly disallowed their ERC claims have the right to challenge the IRS’ determination of ineligibility. As the IRS’ press release explains, to challenge the IRS’ determination, business owners can either “respond with documentation that supports their eligibility or claim amount, or they can file an administrative appeal.”

For business owners who believe they have grounds to challenge the IRS’s determination, it will be important to make informed decisions about how to proceed. While responding to the IRS’ disallowance letter with supporting documentation might be the most efficient approach, voluntarily providing information to the IRS can be risky. Challenging the IRS’ determination will also invite additional scrutiny, and while this might not be a concern, business owners need to ensure that they are confident in the accuracy of their returns before interacting with the agency.

The IRS Could Still Be Looking Into Your Business’ ERC Claim

For businesses that improperly claimed the ERC, receiving a disallowance letter isn’t necessarily the end of the story. While the IRS is sending its disallowance letters to “[s]ave IRS resources by disallowing incorrect credits before they enter the audit process,” businesses (and their owners) can still face scrutiny in relation to their disallowed claims.

A disallowance letter is a form of notification. It does not provide the recipient with any protections or additional rights. As a result, in some cases, the IRS may be disallowing claims initially to preserve taxpayers’ funds with the intent of further scrutinizing recipients’ returns.

Allegations of Intentionally Attempting to Claim the ERC Despite Ineligibility Could Lead to Criminal Charges

Under federal law, businesses (and individuals) accused of intentionally submitting false claims to the government can face serious criminal charges. For example, tax evasion charges under 26 U.S.C. Section 7201 carry up to a $500,000 fine for businesses and a $100,000 for individuals, plus up to five years of federal imprisonment.

To secure an indictment for tax evasion, federal prosecutors do not need to prove that a defendant successfully evaded tax. Rather, evidence that the defendant “willfully attempt[ed] in any manner to evade or defeat tax” is enough to justify criminal prosecution. As a result, even if the IRS disallows a business’s ERC claim, the business (and its owners) could still be at risk of facing tax evasion charges under Section 7201—in addition to charges for various other federal crimes.

What if Your Business Didn’t Receive an ERC Disallowance Letter?

Now, what if your business didn’t receive an ERC disallowance letter from the IRS? First and foremost, a disallowance letter could still be forthcoming. As noted above, the 20,000 letters that the IRS sent in early December were just the “initial round.” As the IRS continues to examine businesses’ ERC claims, more disallowance letters will be forthcoming.

With that said, rather than waiting to see if they receive a disallowance letter, business owners should take a proactive approach to mitigating their ERC-related risk. While this might mean filing to withdraw their ERC claims, requesting withdrawal presents risks of its own. Depending on the circumstances, other options may be more advisable—as filing for withdrawal does not provide protection from IRS scrutiny.

Ultimately, as with all potential tax controversies, avoiding unnecessary consequences requires informed decision-making. With this in mind, business owners who have concerns about their companies’ ERC claims should consult with experienced tax counsel promptly. Once the IRS initiates an audit or opens an investigation, certain options will go off the table, and this will make it more difficult (though not impossible) to achieve a favorable resolution.

Request a Confidential Consultation at Brown Tax, P.C.

If you have concerns about facing IRS scrutiny in relation to your business’ Employee Retention Claim, we invite you to get in touch. Please call 888-870-0025 or contact us online to request a confidential consultation with a federal tax lawyer at Brown Tax, P.C.