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On July 2, 2024, the IRS published proposed regulations (REG-109032-23) that would assess as an underpayment of tax any interest paid to a taxpayer on an erroneous refund of any of the COVID-19 employment tax credits. The proposed regulations would apply to all interest paid under IRC Section 6611 on these erroneous refunds on or after July 2, 2024.

Comments and requests for a public hearing must be received by August 16, 2024.

Proposed regulations

In July 2023, the IRS issued final regulations (TD 9978) under IRC Sections 3111 and 3221 treating the overpayment of employment tax credits under the Families First Coronavirus Response Act (FFCRA) and the Coronavirus Aid, Relief, and Economic Security (CARES) Act as an underpayment of federal employment tax. The final regulations adopted, with minor modifications, the temporary and proposed regulations (see Tax Alert 2020-1907). Accordingly, the IRS is authorized to assess any portion of the credits erroneously credited, paid or refunded as if those amounts were tax liabilities under IRC Sections 3111(a) and 3221(a), subject to assessment and administrative collection procedures. TD 9978 did not address, however, the overpayment of interest paid to a taxpayer on an erroneous refund.

The new proposed regulations would assess this interest as an underpayment of tax. The regulations would amend IRC Sections 3111, 3131, 3132, 3134 and 3221 to treat the overpayment interest on erroneous refunds of COVID-19 credits as an underpayment of the applicable employment taxes and allow the IRS to assess and collect the overpayment in the same manner as the taxes.

Status of ERC claims

On June 20, 2024, the IRS announced in News Release IR-2024-169 that 10% to 20% of ERC claims show a low risk of being erroneous, 60% to 70% show an unacceptable level of risk, and the final 10% to 20% are high-risk. The IRS said it will begin "judiciously processing" the low-risk claims and anticipates that some of the first payments in this group will be made later in the summer following a final review for calculation errors. The IRS added that the oldest of the low-risk claims will generally be worked first. The IRS also said that taxpayers with claims do not need to take any action at this point and should await further notification from the IRS.

According to News Release IR-2024-169, ERC claims continued at a rate of more than 17,000 a week after the moratorium on processing claims announced in September 2023, with the ERC inventory currently at 1.4 million (see Tax Alert 2023-1561 for information about the moratorium). The IRS added that it is keeping the moratorium in place and those with unprocessed claims that were incorrectly claimed should consider the IRS ERC Withdrawal Program (see Tax Alert 2023-1790).

Warning signs

In IRS News Release IR-2024-198, issued on July 26, 2024, the IRS listed five additional "warning signs" that compliance teams have seen when analyzing and processing ERC claims:

• Essential businesses that could fully operate during the pandemic and did not have a decline in gross receipts
• Businesses that did not provide enough information on how a government order fully or partially suspended their business operations
• Businesses that reported family members' wages as qualified wages
• Businesses that used wages already used for the Paycheck Protection Program loan forgiveness
• Large employers that claimed wages for employees who provided services

Statute of limitations

While the general three-year statute of limitations on assessment expired on April 15, 2024, for 2020 ERC claims (and is April 15, 2025, for 2021 claims), the IRS has an additional two years from issuance of any erroneous refund to seek its repayment in court, even if the general three-year statute of limitations has expired (see Tax Alert 2023-0887). Additionally, a special five-year statute of limitations applies to IRS assessments for the third quarter of 2021 (this single-quarter anomaly arose from the statutory changes to the ERC made by the American Rescue Plan Act). There is no statutory deadline for the IRS to process refund claims, and the statute of limitations does not prevent the IRS from challenging the validity of pending refund claims (including 2020 ERC claims).

Implications

Qualifying taxpayers may still amend Forms 941, Employer's Quarterly Federal Tax Return, for the first three quarters of 2021 to claim an ERC refund. The deadline for filing for the 2021 Form 941X remains April 15, 2025. The Tax Relief for American Families and Workers Act of 2024 (H.R. 7024) would have disallowed ERC claims made after January 31, 2024; however, it failed to garner enough support to clear the 60-vote threshold for Senate passage on August 1, 2024. Through a motion to reconsider, a second floor vote on the bill could be considered after the August recess.

Taxpayers filing for a 2021 claim need to be aware of the "warning signs" in IR-2024-198 and are encouraged to consult with their tax advisor before filing. Essential businesses claiming to be "partially suspended" because of a government order can still qualify for the ERC but need to document that they were impacted more than nominally by government orders or had the prescribed decline in gross receipts as outlined in the statute.

While the statute of limitations has expired for assessments of 2020 claims, the IRS and Treasury have advocated for a statutory extension of the limit. In addition, the IRS can file suit for return of erroneous refunds for two years following their issuance.

The recent News Releases make it clear that the IRS is skeptical of many of the claims already filed. Accordingly, taxpayers that have already filed and do not receive refunds in the coming months could receive an information document request (IDR) asking for additional support to defend their claim. Preparing documentation now will allow for efficient responses to IRS questions.