By Matthew D. Lee and Jonathan Wasser
Continued Internal Revenue Service processing delays are preventing businesses from receiving pandemic relief benefits, according to the U.S. Treasury Inspector General for Tax Administration (TIGTA). And at the same time, lax IRS controls have allowed businesses to claim potentially erroneous, nonrefundable employer credits worth $45 million.
According to Report 2022-46-059, the IRS unjustifiably delayed processing Forms 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund. The CARES Act provided businesses that were impacted by the COVID-19 pandemic with three new employer tax credits, including the Employee Retention Credit (ERC). The ERC is a refundable credit against employment taxes that is claimed on either Form 941, Employer’s Quarterly Federal Tax Return, or on Form 941-X. Subsequent to the CARES Act, new legislation and IRS guidance broadened and clarified the ERC, resulting in many taxpayers filing Form 941-X to claim additional ERCs. According to the report:
“Ongoing and considerable delays in the processing of amended Forms 941 filed by businesses resulted in businesses not timely receiving the immediate financial relief for which [the CARES Act] was enacted.”
Lack of Procedures Resulted in a 12 Month Delay Processing Forms 941-X
Although the ERC was enacted in March of 2020, the IRS did not begin processing amended employer tax returns until March of 2021. Just two months later, in May of 2021, the IRS identified programming issues and suspended amended return processing. The IRS restarted processing most Forms 941-X in July 2021, but it was not until February 2022 that the IRS was processing all types of amended employer tax returns. The delay and stop/start led to a backlog of 441,435 Forms 941-X. Over 90% of the backlog consisted of returns that had been filed more than 45 days earlier, which the IRS considers “over-aged,” and over 13% of the returns had been filed more than 180 days earlier.
The IRS attributed the delay to development of processing procedures, guidance that was in flux, complex changes in the law, and programming issues associated with processing claim adjustments. TIGTA, however, did not agree that the IRS’s delay was justified. TIGTA criticized the IRS for not immediately prioritizing Forms 941-X claims that were suspended and for a delay in training staff to process the forms. As of August 1, 2022, there were 90,684 “over-aged” Forms 941-X waiting to be processed.
The IRS Did Not Follow Internal Guidance and Refer Certain Returns to Examination
The IRS issued internal guidance that amended returns that claimed nonrefundable credits above a certain dollar threshold should be referred to examination to prevent potentially fraudulent credits. But TIGTA reviewed a statistically significant sample of 56 returns that met that criteria and found 73 percent (41 returns) were not referred to examination. Based on these findings, TIGTA projected that $45 million in potentially erroneous credits were allowed. More alarmingly, TIGTA found that the IRS’s internal guidance did not include a corresponding process to refer to examination amended employment tax returns that claimed significantrefundable credits. After the Inspector General alerted the IRS of this oversight the IRS updated its referral criteria.
The IRS Did Not Have a Process to Screen Recovery Startup Businesses
In November of 2021, the Infrastructure Investment and Jobs Act limited the availability of the ERC only to wages paid before October 1, 2021, unless the employer is a recovery startup business (“RSB”). One criterion of a RSB is that the employer began carrying on a trade or business after February 15, 2020. TIGTA found that the IRS did not have a process to identify whether a business claiming the ERC is in fact an RSB. TIGTA’s report identified 928 businesses that claimed $17.5 million in refundable ERCs but that had an employer identification number issued before February 15, 2020, indicating that the business may not qualify as an RSB. Further, TIGTA determined that the IRS processed returns for 920 businesses that received $12.6 million in ERCs for the fourth quarter of 2021 in which the taxpayer did not indicate that they were an RSB.
The IRS Agrees to Implement Eight of TIGTA’s Nine Recommendations
TIGTA made nine recommendations to the IRS, including developing plans to prioritize the processing of backlogged claims and the updating of examination referral criteria for Forms 941-X. The IRS agreed to eight of the nine recommendations, but did not agree that employees needed additional training related to referring Forms 941-X to examination. The IRS noted that it has paid out over $68 billion in employer credits to 1.2 million taxpayers. The IRS also notes that it identified 11,096 suspicious returns that claimed more than $2 trillion in credits.
The TIGTA report shines a harsh light on the IRS’s handling of Forms 941-X. Not only did the IRS fail to timely deliver pandemic relief benefits to taxpayers, the IRS also did not implement sufficient safeguards to screen erroneous returns. While the IRS is making progress on the backlog of amended employer tax returns, there were still more than 90,000 “over-aged” returns waiting to be processed as of August 1, 2022. As the IRS has recently implemented additional screening criteria to prevent fraudulent credits, taxpayers who filed Forms 941-X, especially to claim large refunds, should expect examinations once their returns are processed.