Government Accountability Office Report on IRS Implementation of COVID-19 Tax Relief

The original CARES Act, which established tax incentives in response to the COVID-19 pandemic including the Employee Retention Credit, required the Government Accountability Office (GAO) to report on the implementation and efficacy of those efforts. GAO has issued several reports dealing with the early implementation of pandemic response tax provisions by the IRS. On May 17, 2022, they published a more comprehensive report, “IRS Implemented Tax Relief for Employers Quickly, but Could Strengthen Its Compliance Efforts.”

Use of Employee Retention Credit in 2020

According to the report, the IRS completed processing forms 941 for all four quarter of 2020 on December 14, 2021. IRS form 941 is used for quarterly payroll tax filing and was required for timely ERC claims. Employers unable to file timely must amend using form 941-X to claim ERC retroactively within the statute of limitations. Using data available as of January 2022, GAO found that there were 119,834 ERC claims (where each claim represents a claim in one calendar quarter) for a total of $10.9 billion. The average credit in each quarterly claim was $92,182.

These figures do not include taxpayers claiming ERC via amended forms 941-X. As the report states, “As of January 19, 2022, IRS had approximately 440,000 unprocessed Forms 941-X,” which could include a combination of claims for 2020 and 2021. IRS reports that, “As of May 11, 2022, our total inventory of unprocessed Forms 941-X was approximately 287,000.” Of course, new amendments were likely to have been filed between January and May.

GAO did find 8,564 941-X forms claiming about $470.5 million in ERC likely attributable to quarters in 2020.

Using similar data, an economist at the U.S. Department of Treasury estimated that the take-up rate for ERC was only 1% of firms likely to be affected in 2020. But that report acknowledges that available data do not yet include claims made via amended returns.

Increased But Modest Use in 2021

However, even with incomplete data, GAO found that as of January 2022, there were 367,285 ERC quarterly claims for a total of about $32 billion for 2021. Using somewhat earlier data, the Treasury Department economist also found that take-up of ERC in the first two quarters of 2021 was nearly triple that of 2020. IRS is still processing forms 941 for 2021, and neither of these reports account for ERC claimed on amended returns.

The GAO’s finding is consistent with the Congressional Budget Office’s (CBO) report published on July 16, 2021 (the “CBO Report”).  The CBO Report concluded that while impossible to track ERC utilization accurately, the ERC was significantly underutilized based on available information and projections.  Specifically, the CBO estimated a budgetary deficit resulting from the ERC in 2020 and 2021 of approximately $85 billion.  As of the date of the report, the CBO referenced the IRS records indicating employer ERC claims of $10.5 billion in 2020 and $7.9 billion in the first quarter of 2021.  The CBO Report acknowledges that the IRS paper return backlog complicates an accurate tracking of ERC claims to date.

ERC Use by Sector

GAO identified the top business sectors claiming ERC in 2020. With 15% of total ERC dollars claimed, the Accommodation and Food Service sector was the most frequent user of the program, followed by Retail Trade, and then Manufacturing.

There is no indication that IRS plans to focus on examining credit compliance within certain sectors more than others. A representative from GAO said that IRS should address compliance regardless of sector since even those businesses that were generally affected more by the pandemic could still represent a compliance risk.

IRS Compliance Plan
A significant focus of the GAO report is an analysis of IRS’s plans to address potential noncompliance for ERC claims. The report criticizes IRS for its lack of a coherent plan and makes several recommendations:

1. The IRS should develop an integrated project management plan for COVID-19 credit compliance enforcement.

The IRS responded that they disagree with this recommendation. They reasoned that the credits are temporary provisions and that the IRS can follow existing processes to enforce compliance.

2. The IRS should document the processes being used to address compliance risks associated with ERC to ensure accountability and transparency.

The IRS agreed with this recommendation.

3. The IRS should document the process being used to address the specific compliance risk associated with wages that are restricted from use for more than one type of credit.

IRS agreed with this recommendation as well.

4. IRS should implement additional controls to identify tax credit recipients that may not be eligible employers such as those with fabricated EINs, EINs established after March 2020 that did not file employment tax returns after filing for an ERC, or government instrumentalities.

The IRS disagreed with this recommendation because they believe they already have mechanisms in place to address such issues.

5. IRS should implement compliance or examination activities to address potentially invalid or inaccurate ERC claims that were not prevented by internal controls.

IRS also disagreed with this last recommendation explaining that, “eligibility for the credits is based on factors not reported on the employment tax return or worksheets… GAO has made assumptions about taxpayer payroll information to reach conclusions that, unfortunately, cannot be determined without taxpayer contact. To appropriately determine the accuracy of a credit, review of books and records used to complete the worksheets is integral.”

How Will IRS Audit?

The compliance risks associated with the ERC seem to fall into three primary categories:

  1. Fraudulent claims by individuals using stolen tax identification numbers, or entities created just for the purpose of claiming the credit.
  2. Calculation errors including where wages may have been used for more than one type of credit Including the risk that wages used for PPP loan forgiveness may also have been used for ERC.
  3. Employer eligibility erroneously established based on the government orders or gross receipts tests.

GAO’s discussion of examination and compliance focused on the first two issues and did not address the third.

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