IRS weighs guidance for small business tax credit. ‘People were duped,’ taxpayer advocate says

After a flood of business returns with a pandemic-era tax credit, the IRS is weighing guidance for those who wrongly claimed the tax break.

The employee retention credit was created to support small businesses during the Covid-19 pandemic. There’s still time to amend returns and claim the credit, which is worth up to $5,000 per employee for 2020 or $28,000 per employee in 2021.

Experts say the opportunity has sparked a wave of specialist firms falsely promising business owners they qualify for the complicated tax break.

“I do think people were duped,” said National Taxpayer Advocate Erin Collins, speaking at the American Institute of Certified Public Accountants’ annual conference this month. People claimed the credit and may have already received a refund, she added.

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The IRS warned business owners about “third parties” promoting the employee retention credit in October and recently renewed its warning by adding the issue to its annual list of Dirty Dozen tax scams for 2023.

As of March 3, just over 866,000 companies claimed and received employee retention credits totaling over $152.6 billion, according to the latest IRS Data Book.

Currently, there’s a backlog of Form 941-Xs, known as the adjusted employer’s quarterly federal tax return, which businesses must use to amend returns to claim the employee retention credit for 2020 or 2021. As of June 14, there were roughly 537,000 unprocessed Form 941-Xs, according to the IRS.

Collins said the IRS is working on guidance for filers who may have wrongly claimed the credit.

“I think now there’s a bit of buyer’s remorse,” she told CNBC in early June, noting that ineligible filers should start thinking about “ways to undo this” if they realize they don’t qualify. 

“The biggest thing is to come forward first,” said Rosemary Sereti, managing director of Deloitte Tax and a former IRS senior executive, when speaking to CNBC about employee retention credit mistakes. “Once [the IRS] comes to you, it’s a little too late.” 

Of course, the current backlog of Form 941-Xs also includes a lot of “legitimate claims” for the employee retention credit, which have been delayed as the IRS reviews the filings, Collins said. The IRS website says the agency is working on the inventory at two sites with “trained staff” to review possible Covid-19 credits.

If you wrongly claimed the employee retention credit, you may be subject to an IRS penalty, according to Debra Estrem, managing director of private wealth controversy at Deloitte Tax, who also worked at the IRS Office of the Chief Counsel.

She said you may be subject to the “erroneous claim for refund or credit penalty,” which is typically 20% of the excess amount claimed. But the type of penalty depends on whether the error occurred on the original filing or an amended return.