IRS Announces A Second Voluntary Disclosure Program For COVID-Era Employee Retention Credit Claims

On Aug. 15, 2024, the IRS announced the much-anticipated reopening of a second Voluntary Disclosure Program (the "Second ERC-VDP") to help businesses address incorrect Employee Retention Credit ("ERC") claims as the agency continues its compliance work. The Second ERC-VDP will run through Nov. 22 and allows businesses a chance to correct improper payments at a 15% discount and avoid future audits, penalties and interest. We expect parties to continue their focus on the ERC front in M&A transactions, both with respect to their due-diligence efforts as well as in terms of the contractual provisions addressing ERC claims, related refunds and participation in ERC specific programs such as the Second ERC-VDP and the ERC claim withdrawal program.

Background

As described in prior Kramer Levin client alerts (see here, here and here), the ERC is a refundable payroll tax credit that was created by the CARES Act in 2020 to help certain businesses that continued paying qualified wages during the COVID-19 pandemic. Amid growing concerns about a flood of fraudulent ERC claims, the IRS adopted multiple measures to help the agency and taxpayers better manage the complexity and uncertainty. Following a moratorium on processing ERC claims as of September 2023, the IRS introduced a withdrawal process and later a special voluntary disclosure program (the "First ERC-VDP"). The First ERC-VDP which had closed in March 22, 2024, allowed taxpayers to keep 20% of the ERC claimed and avoid penalties and interest. Despite its short duration the First ERC-VDP resulted in more than 2,600 applications totaling more than $1 billion in disclosed ERC claims. In recent weeks, the IRS announced it was taking additional steps to move forward with ERC claims, including updates on the processing moratorium, compliance actions and upcoming payments. Separately, the IRS sent out 28,000 disallowance letters to businesses whose pending claims showed a high risk of being incorrect. The IRS estimates that these disallowances will prevent up to $5 billion in improper payments. The IRS has also identified 50,000 valid ERC claims and is quickly moving them into the pipeline for payment processing in coming weeks. These payments are part of a low-risk group of claims. The IRS continues compliance work on questionable ERC claims on multiple fronts, with thousands of audits underway and 460 criminal cases initiated. Businesses that previously filed claims for ERC payments should further examine the validity of such claims, taking into account the IRS published warning signs and to the extent applicable, consider whether to pursue any of the options currently available to taxpayers, including a withdrawal program and the Second ERC-VDP.

Second ERC-VDP

On Aug. 15, 2024, the IRS announced the much-anticipated reopening of the Second ERC-VDP to help businesses address incorrect ERC claims as the agency continues its compliance work. The Second ERC-VDP will run through Nov. 22 and allows businesses a chance to correct improper payments at a 15% discount and avoid future audits, penalties and interest. Consistent with statements made by IRS officials when the First ERC-VDP was introduced, the Second ERC-VDP offers a slightly less favorable discount rate of 15% as compared to the 20% discount under its predecessor. The IRS encouraged taxpayers to act soon to resolve incorrect claim and avoid potential future issues such as audits, full repayment, penalties and interest. The full detail of the Second ERCVDP are set forth in IRS Announcement 2040-30 with highlights outlined in IRS news release, IR-2024-213.

ERC Withdrawal Program Remains Available for Pending Claims

Back in Oct. 2023, the IRS introduced a withdrawal program for ERC claims that were not yet processed by the IRS (the "ERC Withdrawal Program") that allows taxpayers to withdraw pending ERC claims without penalties or interest. That program remains available to taxpayers and has led to more than 7,300 taxpayers withdrawing over $670 million. The IRS continues to urge taxpayers with pending, unpaid ERC claims to consider the ERC Withdrawal Program.

Twelve Warning Signs of Incorrect ERC Claims

On July 26, 2024, the IRS added five additional warning signs that are commonly seen in incorrect ERC claims supplementing a previously highlighted list of seven signs. Those warning signs include (items 8 – 12 were included in the most recent IRS announcement):

1. Too many quarters being claimed.
2. Government orders that do not qualify.
3. Too many employees and wrong calculations.
4. Business citing supply chain issues.
5. Business claiming ERC for too much of a tax period.
6. Business did not pay wages or didn't exist during eligibility period.
7. Promoter says there is nothing to lose.
8. Essential businesses during the pandemic that could fully operate and did not have a decline in gross receipts.
9. Business unable to support how a government order fully or partially suspended business operations.
10. Business reporting family members' wages as qualified wages.
11. Business using wages already used for Paycheck Protection Program (PPP) loan forgiveness.
12. Large employers claiming wages for employees who provided services.

Continuing Focus on ERC in M&A Transactions

We expect parties to continue focusing on the ERC front in M&A transactions. We have witnessed enhanced diligence by acquirers of both pending and previously processed ERC claims. Similarly, it appears that taxpayers are taking a second look as to the validity of ERC claims previously filed in preparation for potential sale processes. Parties also appear to further develop contractual arrangements and measures to address uncertainties and risks related to ERC. Those include, among other things, the implementation of special escrow and indemnity provisions and the integration of covenants related to participation in voluntary disclosures, withdrawals or similar program, control of related tax audits and related amendments of previously filed income tax returns.