What Do Virginia Business Owners Need to Know About Defending Against IRS Allegations of ERC Fraud?

For businesses in Virginia that have claimed the Employee Retention Credit (ERC), the risk of facing fraud allegations from the Internal Revenue Service (IRS) is a very real concern. Businesses have filed billions of dollars in fraudulent claims—some intentionally, and some not—and the IRS is now in the process of seeking to recoup as many taxpayer dollars as possible.

If you own a business that has claimed the ERC, what does this mean for you? Virginia tax lawyer Kevin E. Thorn, Managing Partner of Thorn Law Group, explains:

5 Key Facts for Virginia Businesses That Claimed the ERC

With the IRS focusing on ERC fraud, business owners who have received refunds under the program must be very careful to protect themselves. Even if unintentional, submitting fraudulent ERC claims can expose business owners to substantial penalties. The IRS is actively targeting businesses that claimed the ERC in audits and investigations, and those that fail to take proactive steps to protect themselves will be at the greatest risk for civil or criminal penalties.

With this in mind, here are five key facts about the IRS’ ongoing efforts to combat ERC fraud for business owners in Virginia:

1. Allegations of ERC Fraud Present Substantial Risks for Businesses and Their Owners

Whether civil or criminal in nature, an IRS inquiry into a business’s ERC claim can present substantial risks. In addition to imposing civil liability directly, the IRS can also work with the U.S. Department of Justice (DOJ) to pursue criminal charges when warranted. In civil enforcement cases, the potential penalties consequences include:

• Back Taxes – Businesses that improperly claimed the ERC are liable for all back taxes they owe. This may include repayment of ERC refunds as well as payment of additional outstanding tax liability.
• Interest – Past-due taxes begin accruing interest immediately. Taxpayers’ interest obligations can substantially increase the amount they owe.
• Penalties – Penalties also begin accruing immediately, and they can substantially add to taxpayers’ liability as well. As a result, even in civil cases, businesses and business owners can be held liable for significantly more than the amount of their tax underpayment.

When the IRS works with the DOJ to pursue criminal indictments, several charges can be on the table. These include tax fraud charges under 26 U.S.C. Section 7201 (which applies to “willful[] attempts . . . to evade or defeat any tax”), among many others. In prosecutions under Section 7201, businesses and business owners can face penalties including:

• Criminal Fines – Criminal fines under Section 7201 can be up to $100,000 for individuals and $500,000 for corporations.
• Federal Imprisonment – In addition to criminal fines, business owners prosecuted under Section 7201 can face up to five years of federal imprisonment.

Charges for wire fraud, money laundering, conspiracy and other crimes also carry substantial fines and prison time. As a result, in large-scale ERC fraud cases, it is not unusual for millions of dollars in fines and decades of imprisonment to be on the table.

2. The IRS Is Targeting Businesses that Both Knowingly and Unknowingly Submitted Fraudulent ERC Claims

In its efforts to combat ERC fraud and recover taxpayer funds, the IRS is targeting businesses that both knowingly and unknowingly submitted fraudulent claims. This means that even if you inadvertently submitted an invalid or excessive ERC claim—and even if you hired a third party to file your business’s ERC claim—you can still face liability for fraud.

The IRS has acknowledged that many business owners fell victim to fraudulent ERC filing schemes, and its ERC claim withdrawal process (discussed in detail below) is intended specifically to help business owners in this scenario. However, even business owners who have been victimized have an obligation to pay what they owe. As a result, all business owners in Virginia should review their companies’ ERC claims, and they should consult with a Virginia tax lawyer promptly if they have any questions or concerns.

3. The ERC Eligibility Criteria (and Calculation Methods) Changed Not Only Year-to-Year But Quarter-to-Quarter

One of the many challenges involved with assessing businesses’ ERC eligibility relates to the fact that the eligibility criteria changed not only year-to-year but quarter-to-quarter during the pandemic. The same was true for the calculation methods and maximum credit amounts. While these changes generally opened up the credit to more businesses, it is entirely possible that a business could have qualified for the ERC in one quarter but not the next.

When reviewing their ERC claims, business owners need to keep this in mind. They must independently assess their companies’ eligibility for each quarter based on the relevant set of rules and requirements. They must take the same approach to ensuring that they calculated the ERC correctly—and if they improperly claimed or calculated the credit, they will need to work with an experienced Virginia tax lawyer to determine the best defense strategy based on the circumstances at hand.

4. While Withdrawal is an Option for Qualifying Businesses, Withdrawing a Fraudulent ERC Claim Can Be Risky

Many businesses are eligible to withdraw their ERC claims under the IRS’ ERC claim withdrawal program announced on October 19, 2023. This includes many businesses that are already facing IRS audits. However, while filing for withdrawal can protect business owners from liability for back taxes, interest and penalties (assuming the IRS accepts their withdrawal), it can be risky as well.

As the IRS makes clear, “withdrawing a fraudulent claim will not exempt [a business or business owner] from potential criminal investigation and prosecution.” As a result, in some circumstances, filing for withdrawal could trigger IRS scrutiny. When this is the case, the best approach may not be to submit a withdrawal, but instead to pursue a different option that provides greater certainty.

5. There Are Several Potential Ways to Resolve Issues Related to Invalid ERC Claims

While filing for withdrawal is one option for eligible businesses, there are several potential ways to resolve legal issues related to ERC claims. Depending on the circumstances, these may include:

• Submitting an amended return and paying any amounts owed
• Submitting an offer in compromise
• Negotiating a tax settlement with the IRS
• Submitting a voluntary disclosure to the IRS CI

Just like filing for withdrawal, each of these options has its own benefits and limitations, and each is available in different circumstances. In all circumstances, however, a proactive approach is generally best, as many opportunities go off of the table once the IRS initiates an audit or investigation.

What Should You Do if the IRS is Auditing or Investigating Your ERC Claim(s)?

What if the IRS has already initiated an audit or investigation? If the IRS is looking into your business’s ERC claim (or claims), you need to proceed very carefully. To protect yourself (and your business) to the fullest extent possible, you should:

• Determine if Your Business was Eligible for the ERC in Each Quarter for Which it Filed a Claim – The first step is to determine whether your business was eligible for the ERC in each quarter for which it filed a claim. If your business was eligible—and you can prove it—the supporting documentation you have on hand could play a key role in your defense.
• Determine Whether Your Business Accurately Calculated its Credits for Each Quarter – Along with determining your business’s eligibility, you will also want to determine whether your business accurately calculated its credits for each quarter. Improperly claiming and improperly calculating the ERC can both have similar consequences.
• Do Not Assume that Withdrawal is the Best Option – While filing for withdrawal might be your best option, this isn’t necessarily the case. Before you admit to submitting a fraudulent claim to the IRS, you need to make sure that this is the best path forward.
• Play an Active (But Cautious) Role in the IRS’ Audit or Investigation – Any time you are dealing with an IRS audit or investigation, it is important to play an active role. You do not want to simply let the inquiry run its course. But you also need to be cautious any time you are dealing with the IRS (or IRS CI). Voluntarily providing information can be dangerous, and it is best to have your legal counsel communicate on your behalf.
• Make Informed Decisions Based on Your Virginia Tax Lawyer’s Advice – In all ERC-related matters, informed decision-making is key. To ensure that you are making sound decisions with your (and your company’s) long-term best interests in mind, you should seek advice from a Virginia tax lawyer promptly.

Arrange a Confidential Initial Consultation with Virginia Tax Lawyer Kevin E. Thorn

Virginia tax lawyer Kevin E. Thorn, Managing Partner of Thorn Law Group, represents businesses and business owners in all ERC-related matters. If you have questions or concerns related to your business’ ERC claim(s), he can help you decide what to do next. To arrange a confidential initial consultation at Thorn Law Group, please call 703-752-3752 or tell us how we can reach you online today.