For some time, the IRS has targeted fraudulent employee retention credit (“ERC”) claims. More recently, on December 21, 2023, the IRS issued guidance on a new voluntary disclosure program (the “ERC-VDP”) that the agency intends to use to identify more of these types of claims. Significantly, the terms and conditions of the new program strongly suggest that the IRS will use the information from the ERC-VDP to go after third-party promoters who assisted employers in filing false ERC claims. But employers who used these same third-party ERC promoters should be aware that they too may be ensnared in a later civil or criminal examination of the promoter.
Traditional Voluntary Disclosure Programs.
Voluntary disclosure programs are nothing new at the IRS. For example, more than a decade ago, the IRS became aware of taxpayers hiding foreign accounts and assets overseas. In response, the IRS created the Offshore Voluntary Disclosure Program (“OVDP”), which permitted these taxpayers to regain compliance with their foreign reporting and income tax obligations. After the closure of the OVDP, the IRS revamped its existing voluntary disclosure program (“VDP”), which in its current iteration assists taxpayers in regaining compliance with matters associated with income taxes, employment taxes, estate and gift taxes, and international tax matters.
Although the requirements of the various voluntary disclosure programs change over the years, they often share similar characteristics. Generally, each program has required taxpayers to come forward prior to the time in which the IRS obtains or could obtain information regarding the noncompliance (e.g., through a civil or criminal investigation). Traditional voluntary disclosure programs have also had information-sharing and repayment requirements. Each of these is discussed more fully below in conjunction with the requirements of the new ERC-VDP.
Unsurprisingly, the ERC-VDP shares many common threads with its predecessors. Similar to the traditional disclosure programs, the ERC-VDP requires employers to make a disclosure prior to the IRS obtaining the information. Therefore, employers are prohibited from making an ERC-VDP disclosure if the IRS has initiated a civil or criminal investigation. Employers are also prohibited from making an ERC-VDP disclosure if the IRS has notified the employer of the disallowance of the ERC claim.
Also similar to voluntary disclosure programs of the past, the ERC-VDP requires employers to provide the identities of third parties who assisted in the noncompliance—here, the submission of false ERC claims. With past voluntary disclosure programs, the IRS has used this information to initiate criminal and civil investigations of third parties and their clients, particularly if the third parties are tax professionals.
In at least one material respect, however, the ERC-VDP differs substantially from the traditional disclosure programs. Generally, the traditional programs have required taxpayers to full pay the taxes—at least with respect to a specified period of time—and also pay a civil penalty. By way of example, the current VDP requires taxpayers seeking to regain income tax compliance to generally pay 6 years of back taxes and a 75% fraud penalty. On the other hand, the ERC-VDP only requires employers to repay 80% of the claimed ERCs without penalties.
At first glance, the IRS’s significant departure from the traditional voluntary disclosure norms may seem perplexing. But the IRS’s “more generous” disclosure terms can be answered based on the economics of most third-party ERC promoter transactions. In many of these transactions, ERC promoters sold the idea of the ERC to employers through promises of no professional or out-of-pocket expenses for their services unless the IRS issued an ERC refund. Only if a refund occurred would the employer be responsible for professional fees, which were often a fixed percentage of the amount refunded to the employer.
Given the economics of these transactions, very few employers would agree to submit a voluntary disclosure requiring full repayment of the ERC with penalties. In these instances, the employer would be out-of-pocket not only 100% of the ERC with penalties but also the fixed-percentage fee already paid out to the promoter. By permitting employers to retain 20% of the ERC without penalty, more employers should participate in the ERC-VDP as the 20% compensates the employer for some or all of the promoter fees.
Moreover, the IRS no doubt recognizes that it may recover more ERC funds from the information that it obtains from employers via the ERC-VDP. With this new information, the IRS can eventually initiate civil and criminal examinations of third-party promoters, potentially resulting in criminal restitution and civil penalties. Regrettably, however, these same criminal and civil investigations may also cause the IRS to obtain the promoter’s client list. In these cases, employers who used the promoter may also be caught up in their own criminal or civil investigation associated with their separate ERC claim made through the promoter. Also a concern to employers is that the client list received from a promoter may disqualify them from participation in the ERC-VDP and the benefits of mitigating their own risks.
The ERC-VDP will provide the IRS with a wealth of new information related to false ERC claims. Ultimately, this information should further the IRS’s immediate goals of initiating more criminal and civil investigations against promoters. However, more innocent employers who used these same promoters should be cautious that they also may end up a target of an IRS civil or criminal investigation and disclosure in another proceeding could disqualify them from participation. Because the ERC-VDP expires on March 22, 2024, employers with questionable ERC claims should consult with a tax professional immediately regarding whether they should also participate in the new ERC-VDP.