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Kostelanetz Alert: IRS Publishes Proposed Regulations for Assessing Interest on Erroneous Employment Tax Credits, Including Employee Retention Credits, as Underpayment of Tax

On July 2, the IRS published proposed regulations providing that the IRS will assess as an underpayment of tax the interest paid to taxpayers on erroneous refunds of the employee retention credit (“ERC”), as well as other employment tax credits, such as the paid sick leave credit and the paid family leave credit. There is a 45-day window from the publication of the proposed regulations (until August 16) for the public to submit comments.

In 2023, the IRS published final regulations (T.D. 9978) that provide for the assessment of erroneous ERC refunds as an underpayment of employment taxes; however, those regulations did not address the overpayment of interest. The Internal Revenue Code provides that if a taxpayer overpays a tax and is entitled to a refund, the taxpayer will also receive interest on the amount of the overpayment. The IRS interest rate for overpayments is currently 8%. Under the proposed regulations, such interest arising from erroneous ERC refunds would be “treated as an underpayment of the applicable employment taxes [that] may be assessed and collected by the IRS in the same manner as the taxes.”

Particularly in light of the Supreme Court’s recent decision in Loper Bright Enterprises v. Raimondo, the proposed regulations can be criticized for going beyond the language of the statute. In Loper Bright Enterprises, the Supreme Court explained that the “question that matters” is, “Does the statute authorize the challenged agency action?”  The proposed regulations regarding interest paid on ERC claims cite section 2301(l) of the CARES Act, which provided that the IRS “shall issue such forms, instructions, regulations, and guidance as are necessary . . . to prevent the avoidance of the purposes of the limitations under this section.” It is debatable whether this statutory language clearly authorizes the IRS to make the proposed assessments for purposes of the new Loper Bright standard.

The proposed regulations reflect the IRS’s continued efforts to attack improper ERC claims. Since 2022, the IRS has warned taxpayers about schemes by promoters making false or misleading statements to potential claimants about ERC eligibility. By September 2023, when the IRS instituted a moratorium on new ERC claims, the IRS had already paid out approximately $230 billion in ERC refunds, with a backlog of over 1 million pending applications. The IRS announced last month that it was resuming processing some ERC claims, noting the majority of such claims presented an “unacceptable level of risk.”

So far, the IRS’s efforts to recover as much money as possible on improper ERC claims have had limited success. A voluntary disclosure program that ended in March 2024 led to the disclosure of approximately $1.1 billion in erroneous refunds, and the IRS has said it is “currently assessing whether to reopen” the program. In February 2024, the House of Representatives passed a bill (H.R. 7024) to end further ERC refunds and increase the IRS’s ability to assess erroneous refunds and seek penalties against ERC promoters, but the bill now languishes in legislative purgatory.

ERC Background

The ERC, created under the CARES Act to assist businesses that continued to pay their employees during the COVID-19 pandemic, is a refundable tax credit that allows employers to offset their employment taxes against a percentage of qualified wages paid to employees. Eligible taxpayers can claim the ERC on an original or amended employment tax return for an eligible period between March 13, 2020, and December 31, 2021. To qualify for the ERC, a business must meet one of the following three criteria:

  • Experienced a full or partial suspension of operations resulting from a government order issued due to the COVID-19 pandemic during 2020 or the first three quarters of 2021;
  • Experienced a significant decline in gross receipts during 2020 or a decline in gross receipts during the first three quarters of 2021 as defined by the criteria set forth in the appropriate IRS guidance (Notice 2021-20 for 2020 and Notice 2021-23 for 2021);
  • Qualified as a recovery startup business for the third or fourth quarters of 2021 as defined in Notice 2021-49.

Since October 2022, the IRS has been warning taxpayers to be wary of dubious ERC schemes. Last March, the IRS issued IR-2023-49, placing abusive ERC schemes at the top of its 2023 list of “Dirty Dozen” transactions. In September 2023, the IRS imposed a moratorium on processing ERC claims.

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