Meme Madness: An Update on the ERC Saga

Written by:  Rachel Libowitz and Jason Peckham, Esq., Tax Guard

One of the better gifts we received for Christmas was the game, “What’s That Meme?”. It was fun to see how the family, especially the kids, used memes to communicate, connect, and illustrate ideas. When thinking about the IRS and the Employee Retention Credit (ERC) program, several memes come to mind (many NSFW). For example, it’s easy to envision the “Disaster Girl” meme, a slight smile on the IRS’s face while the ERC program burns.

The ERC program is a boondoggle. What started as an initiative to help businesses through unprecedented times of the pandemic ultimately failed because of confusing criteria, which were exploited by unscrupulous promoters. Over the past five years, the program transitioned from gladagascar, to sadagascar, to Madagascar, and, finally, to outtagascar.

Origins

The CARES Act introduced ERCs in March 2020 to encourage eligible employers to keep employees on their payroll, despite experiencing economic hardship related to COVID-19. Congress later extended and enhanced the credits with two additional pieces of legislation in 2020 and 2021. The additional legislation also served to further complicate what were already confusing eligibility criteria. 

Generally, the credits, which could offset certain employment taxes, came in two flavors:  refundable and non-refundable. The refundable tax credits were especially advantageous. Not only could those credits offset employment taxes, but qualifying employers could receive a cash refund if the credit was greater than the amount due per the return. In theory, businesses could use the refunds to resolve cash flow issues, including federal tax liabilities. Unscrupulous promoters picked up on the refundable nature of the credit and aggressively marketed them like candy, incorrectly claiming, “everybody qualifies!” The number of applications exploded.

Big ‘Ol Backlog

Fraudulent claims quickly overwhelmed IRS resources. The IRS largely attributes the unexpected volume of claims to aggressive promoters, who misrepresented eligibility and inflated credit amounts. Initial estimates projected the cost of the ERC program at $50 billion. But by the end of 2023, updated projections ballooned to over $550 billion (WSJ, January 24, 2024). As of April 2024, the IRS faced a backlog of 1.4 million ERC claims (Treasury Inspector General for Tax Administration (“TIGTA”) report, September 30, 2024).

At the most basic level, eligibility requires satisfying one of three tests. The eligible employer must have (1) sustained a full or partial suspension of operations due to a qualifying government order related to COVID-19, (2) experienced a significant decline in gross receipts when comparing a quarter in 2019 to the corresponding quarter in 2020 or 2021, or (c) met the definition of a “recovery startup business”. For the purposes of this article, we can ignore the third test due to limited applicability. Unfortunately for employers, the actual eligibility criteria are complicated and fact specific.

Everyone Qualifies! Not So Fast…

Most ERC claims were submitted under the first test – suspended operations due to a qualifying government order. Promoters relied heavily on OSHA’s general stay-at-home guidelines to satisfy the “qualified government order” requirement. Like Oprah yelling, “You get a car, and you get a car…”, promoters sold employers on the idea that everyone qualified. An important distinction is that Oprah had cars to give away. Promoters had nothing to support their expansive and bold interpretation. Unsurprisingly, the IRS pushed back, especially when confronted with a large backlog of pending claims.

The IRS vigorously warned employers about aggressive tax positions and unscrupulous promoters. It added ERC fraud to its “Dirty Dozen” list of the worst tax scams in April 2023. Later that year, the IRS announced a moratorium on processing ERCs, beginning September 14, 2023. The moratorium, which the IRS used to work through the extensive number of fraudulent claims and formulate a solution, lasted almost an entire year into August 2024 (IR-2024-203). An IRS memo from November 2023 dealt the biggest blow to the promoters’ rationale (GLAM 2023-007). The memo specifically excluded the OSHA guidelines as a qualified government order because the recommendations did not limit commerce, travel, or group meetings. By slamming the door on the OSHA guidelines, the IRS forced employers to pivot to the second test – a decline in gross receipts.

Gross Receipts Pivot

Undoubtedly, many businesses suffered declines in gross receipts in 2020 and 2021. However, nothing is simple with the IRS, and the ERC criteria are no exception. The three pieces of legislation created different thresholds for comparing the 2020 quarters to 2019 (50%+ decline) than those for comparing the 2021 quarters to 2019 (20%+ decline). Additionally, there was little guidance for documenting a decline in gross receipts until March 2021, when the IRS issued Notice 2021-20. To be fair, the IRS quickly (relatively speaking) interpreted the poorly worded legislation and drafted regulations, an undeniably daunting task. Because of delays in IRS guidance and the promoters’ reliance on the government order test, most claims do not include gross receipts documentation. 

Without documentation to demonstrate the requisite decline in gross receipts, the IRS is stuck. Think Ross from Friends yelling “Pivot!” to Rachel and Chandler in the stairwell until the sofa they are moving becomes hopelessly wedged in the landing (despite Ross’s sketch). The IRS is pivoting to review gross receipts, but it is missing crucial information. To acquire the necessary documentation, the IRS must conduct labor-intensive audits. Unless the IRS can overcome problems related to staffing and a lack of cooperation or responses from employers, it, like Ross’s sofa, is stuck.

In 2024, the IRS cleared 400,000 of the easier claims representing $10 billion. But that still leaves 1 million “harder” claims to resolve, likely requiring documentation. The $10 billion figure may seem large, but it represents less than .2 % of the total projected cost. TIGTA’s September 2024 report summarized two IRS pilot audits from earlier in year, presumably centered around acquiring the requisite documentation. Those pilot audits were small (500 claims) and suffered from poor response rates (approximately 50 percent). If one reads between the lines in the report, it’s going to be difficult for the IRS to expand its review to the entire backlog of pending claims, which is necessary to (a) recapture erroneously paid out claims and (b) identify the minority of claims that meet the gross receipts criteria. The difficulty in resolving “harder” claims partially explains why the IRS pushed its voluntary withdrawal program, with limited success.

Time to Move On?

Frustrated employers should not look to Congress for help. H.R. 7024, which would have ended the ERC program, failed in a Senate vote in August 2024. However, the bill enjoyed bipartisan support for ERC provisions favorable to the IRS. For example, to combat the widely recognized rampant fraud within the program, the bill would have extended the statute of limitations for the IRS to recapture fraudulent credits to 2030.

A few businesses filed lawsuits in 2024, attempting to force the IRS to process their ERCs. The lawsuits include an Ohio-based staffing company ($5.1 million), a North Carolina day care ($394,000), and a Maryland government contractor ($3.6 million). Although interesting, these lawsuits are not likely to have an impact on the 1 million pending claims. Delaying decisions based on these ongoing lawsuits is unwise. Litigation can take years, and the facts will likely not apply to most businesses. For example, the government contractor’s claim is based on a decline in gross receipts and well-documented. Most employers cannot provide similar documentation.

It’s been five years since the passage of the CARES Act (how crazy is that?). There’s a mix of frustration and, in many cases, misplaced hope. Employers planned on using the credits to offset issues with cash flow. When the credits didn’t materialize, many “borrowed” money from the federal government in the form of federal tax liabilities. Unfortunately, it’s unlikely these employers will receive ERCs to repay the IRS. Like the “Distracted Boyfriend” ogling the attractive ERCs walking down the street, employers (and lenders) need to return their attention to the tried-and-true basics, an installment agreement and subordination of federal tax lien.

Exposure & Mitigating Risk

Lenders funding businesses with federal tax liabilities, including those waiting for phantom ERCs, face the same two primary risks as always: levies and federal tax liens. A levy is the same as a seizure – it takes an asset. The most common levies attach to bank accounts or receivables, but the IRS can also seize inventory, equipment, real property, etc. In contrast, a federal tax lien does not take or seize anything. Instead, it secures the government’s interest in the property, provides notice to third parties, and establishes priority relative to other secured interests.

Passively waiting for the IRS to process ERCs exposes businesses (and lenders) to IRS levies and liens. Hope is not a strategy. Instead, businesses (and lenders) should address IRS liabilities through established and proven strategies – an installment agreement and subordination of federal tax lien.

An installment agreement, based on the business’s ability to pay, repays all or some of an IRS liability over time. An agreement in good standing prevents the IRS from levying bank accounts or receivables, protecting the business and the lender. An installment agreement is also a requirement for a subordination of federal tax lien.

The subordination does not discharge or remove a federal tax lien. Instead, when the IRS subordinates or gives up its priority position, it allows the lender’s secured interest to move back into first position relative to the collateral, the receivables. An installment agreement and subordination of federal tax lien protects businesses, protects lenders, and preserves the funding relationship.

If your client still thinks after five years that their pending ERC is the golden ticket for resolving their cash flow issues, including IRS liabilities, then spoilers – it’s not. The IRS is in a difficult position. They recognize most businesses don’t qualify for credits, but they cannot provide the certainty of a final answer absent an effective review process. If it was easier to roll off the tongue, the ERC program could become a meme associated with delaying something to death (but, we doubt “you’ve been ERCed” will catch on). Instead of waiting for ERCs, the better play for businesses with federal tax liabilities is to get current and compliant with federal tax deposits, then negotiate an installment agreement.

The views expressed in the Commercial Factor website are those of the authors and do not necessarily represent the views of, and should not be attributed to, the International Factoring Association.