The Employee Retention Credit: Voluntary Disclosure Program

The Internal Revenue Service (“IRS”) announced on December 21, 2023 its Voluntary Disclosure Program (“VDP”) for the Employee Retention Credit (“ERC”). The ERC VDP aims to help taxpayer businesses who feel as if they incorrectly filed their ERC pay monies back to the Service and is part of a larger effort by the IRS to curb aggressive marketing of the tax credit.

The IRS previously announced an ERC withdrawal option in October 2023, for taxpayers that filed claims and had not yet received refunds. This allowed taxpayers to withdraw their submission and avoid future repayment, interest, and penalties. Further, the Service imposed a moratorium on the tax credit earlier in 2023 as the IRS faced a surge of questionable claims.

Issues with the ERC were highlighted by the Taxpayer Advocate in her Annual Report, discussed in greater detail below, which noted that, since its inception, taxpayers had struggled to determine ERC eligibility while the IRS had difficulties with processing claims due to both the volume of submissions and complexity of the law. In fact, by the end of September 2023, there were more than 800,000 pending 941-X claims, which had swelled to one million by early December.

Regarding the IRS’ ERC VDP, taxpayers had the option to “get right” with the Service at a lower financial cost. The program, which was open through March 22, 2024, will also help the IRS gather information on ERC promoters who have aggressively pushed taxpayers to apply for the credit.

The ERC VDP required taxpayers to pay back 80 percent of their claimed credit and cooperate with the IRS regarding any other information related to the taxpayer’s claim.

Further, the program required taxpayers to sign a closing agreement wherein all appeals rights are relinquished. The agency will not charge penalties or interest on the claimed ERC amount if the full 80 percent of the credit is repaid by the time of the signed closing agreement.

What is in it for the taxpayer? The taxpayer retains 20 percent of the claimed credit and the interest income that was received on the full refund amount. The taxpayer does not have to amend income tax returns to reduce the wage expenses, even for the 20 percent retained.

In terms of eligibility, there are several requirements taxpayers needed to meet to be able to take part in the program.

To apply for the ERC VDP, taxpayers must have prepared a Form 15434, Application for Employee Retention Credit Voluntary Disclosure Program, which may require certain information of the taxpayer, including Form SS-10, to extend the assessment statute of limitations if the ERC application includes tax periods ending in 2020, and Form 433-B with supporting documentation if the taxpayer wants to be considered for an installment agreement.

The application for the ERC VDP had to be submitted online using the agency’s Document Upload Tool (“DUT”). Taxpayers whose applications are rejected will receive a letter explaining the agency’s rationale and alternative options for the taxpayer.

National Taxpayer Advocate’s 2023 Annual Report to Congress (Annual Report)

The National Taxpayer Advocate (“NTA”) recently released the 2023 Annual Report, naming the 10 “most serious” IRS problems (MSPs). Although all of these problems cannot be addressed in this column, we have attempted to highlight a few that directly impact tax practitioners, but all have a great deal of detail to them. The most serious problem identified by the NTA was processing. According to the report, millions of taxpayers continue to experience significant burdens and frustrations while awaiting refunds or other IRS actions that are necessary to comply with their tax obligations or resolve other issues.

The NTA highlighted the negative consequences of delayed refunds for taxpayers due to processing issues and reported that a negative impact for the government was $1.4 billion in additional interest paid on these refunds.

Further, NTA found that the IRS’ success in eliminating its backlog of Forms 1040 did not translate into eliminating the backlog of individual amended returns, business amended tax returns, or correspondence. Specifically, as of October 28, 2023, the IRS had a backlog of six million pieces of Accounts Management (“AM”) correspondence and amended returns.

The NTA acknowledged that some processing activities were impacted by Treasury Secretary Yellen’s commitment to increase IRS telephone services by answering 85 percent of calls to the agency’s toll-free 1040 line, cutting wait times for telephone service in half during the filing season, and fully staffing IRS Taxpayer Assistance Center offices. The IRS transfer of resources from one agency activity to another created a continuing problem in processing.

As a result, the NTA recommended striking a better balance between telephone service and processing inventory. And with the agency’s increase in hiring and paperless processing, the NTA recommended that the IRS reexamine its use of Customer Service Reps (“CSRs”) in its remote call centers to improve flexibility between telephone and processing activities.

Relevant to the processing of amended returns, the NTA Annual Report included a legislative recommendation to address IRS response to amended returns.

The report noted that millions of taxpayers file claims for credit or refund each year, and under current law, there is no requirement that the agency pay or deny them. In fact, the IRS may simply ignore them. The taxpayers’ remedy is to file a refund suit, which, for many taxpayers, is not an option. According to the NTA, the absence of a processing requirement is a poster child for non-responsive government and needs to be remedied.

A specific processing issue highlighted by the NTA is First Time Abatement (FTA). Under existing administrative procedures, the IRS may provide penalty relief for failure-to-file, failure-to-pay, and failure-to-deposit penalties. The administrative abatement is provided if a taxpayer is otherwise compliant and has not used FTA within the prior three years. However, many taxpayers are unaware of this administrative relief provision, and IRS generally provides FTA only if a taxpayer requests it or requests reasonable cause relief.

The Annual Report puts this in perspective by noting that as of October 2023, the IRS had granted FTA to nearly 125,000 taxpayers for penalties associated with filing their 2022 tax returns. However, another 1.4 million taxpayers appeared to be eligible for FTA penalty relief but did not request it.

A relatively small percentage of sophisticated taxpayers (or taxpayers paying for professional assistance) received penalty abatements just by asking while the overwhelming majority of taxpayers did not request or receive such relief. According to the NTA, the systemic application of FTA would have the benefit of increasing taxpayer fairness while reducing the volume of calls and correspondence received regarding these penalty abatement requests.

Another MSP identified was IRS Transparency. “Transparency” is the government’s obligation to share with citizens the information they need to make informed decisions. Taxpayers and tax professionals struggle to access information from the IRS, including finding clear and timely guidance on which they can rely, determining the status of pending issues, understanding IRS correspondence and whether they must respond to it, and reaching an IRS employee with the knowledge to answer their questions and the authority to resolve their problems.

The IRS’ Strategic Operating Plan (“SOP”) acknowledges numerous problems impacting taxpayers and tax professionals and lays out a high-level framework for how the agency intends to transform its operations to address the challenges it faces. While the NTA commends the IRS for recognizing the numerous problems, there is concern with the broad scope and lack of specificity noted. The NTA recommends that IRS foster closer relationships with stakeholders and create open two-way lines of communication for stakeholders to provide insights on the problems that the IRS needs to address.

An example of a transparency concern, the NTA notes that the IRS should provide full and candid information about the state of its operations, not just select the data that makes the agency look best. An example building on the amended return issue addressed above deals with the ability for taxpayers to electronically submit Form 1040-X, Amended U.S. Individual Tax Return. The IRS has not emphasized that the agency continues to process these forms manually, resulting in lengthy delays in both data intake and the issuance of refunds.

At the end of the 2023 filing season, it took the IRS about seven months to process Forms 1040-X, and as of November 11, 2023, about 770,000 Forms 1040-X remain unprocessed. The Annual Report notes that IRS messaging should not overstate what it has accomplished, and it needs to set realistic expectations regarding timing. Taxpayers and tax professionals who submit documents electronically likely expect faster processing times than with paper submissions and are confused and surprised to find that significant delays still occur.

Another example of lack of transparency concerns ERC claims. The Annual Report notes that statements on the status of ERC claims have not always matched reality. “In September 2023, the IRS announced a moratorium on the processing of newly filed claims but indicated it would continue to process ERC claims filed prior to the moratorium. However, data shows that the IRS had all but stopped processing these claims by that time, and they continue to be paused as of the writing of this Most Serious Problem.”

Although the term “processing” generally means taking an action such as allowing the claim in full or part, disallowing the claim in full or part, or assigning to a revenue agent for examination, the IRS seems to be using the term “processing” to include stepping back and strategizing how to proceed—not the actions most taxpayers think of as processing. As a result, hundreds of thousands of premoratorium claims are still waiting on the IRS to process them, and taxpayers await refunds while the number of post-moratorium claims continues to pile up.

The last examples of IRS Transparency detail the lack of guidance provided to taxpayers in determining their filing obligations. Two mentioned in particular for filing season 2023 were:

a. The taxability for federal income tax purposes of special state relief payments or tax refunds paid in 2022 to help offset the costs of inflation or the pandemic. Despite uncertainty on the federal tax treatment of such payments and requests by numerous states for guidance, the IRS did not clarify its position until February 10, 2023.

b. The changes to reporting thresholds for the issuance of Forms 1099-K, Payment Card, and Third-Party Network Transactions, for which the IRS had repeatedly been asked for guidance. While there were two years of lead time to issue guidance, the IRS has postponed implementation for two additional years.

Building on the discussion above, another MSP is titled Telephone and In-Person Service. In 2023, telephone service was considerably better in filing season than in prior years. That being said, IRS is still not providing the level of service (“LOS”) that taxpayers and tax professionals need throughout the year.

Treasury Secretary Yellen set ambitious goals for the IRS. “The Treasury Inspector General for Tax Administration (TIGTA) performed a study to assess how the IRS performed during Filing Season (FS) 2023 in meeting the expectations laid out by Secretary Yellen. It found that the IRS met only two of the Secretary’s five expectations, one of which was improving Customer Service Rep (CSR) Level of Service (LOS) on the Accounts Management (AM) toll-free phone lines during FS 2023 from approximately 15 percent to 85 percent and the other of which was reducing the average wait time from nearly 30 minutes to 15 minutes.”

Much has been said about the 85 percent LOS achieved during the 2023 filing season. This was achieved on key toll-free lines, but the IRS only answered 35 percent of the calls it received, and only 29 percent of callers reached an IRS employee during the full fiscal year. The Annual Report noted, “the IRS selectively chooses data for its LOS metric in several ways, and the LOS metric does not equate to the percentage of total calls that live assistors answered.” The LOS is not the same for all lines, with some lines having a lower LOS than others, which was not fully disclosed by the IRS. For the Practitioner Priority Service (PPS) line, the LOS was only 34 percent, with an average wait time of 16 minutes.