The Employee Retention Credit (ERC), enacted as part of COVID-19 relief legislation, remains under intense scrutiny and administrative flux well into 2025. While the program served as a valuable payroll tax relief mechanism for employers impacted by the pandemic, evolving IRS guidance and enforcement have dramatically altered the risk profile and compliance obligations for businesses participating.
The ERC provided eligible employers with a refundable tax credit against certain employment taxes during eligible periods in 2020 and 2021
The IRS issued administrative guidance to assist taxpayers with claiming credits
There has been significant fraud associated with this program, which has resulted in increased scrutiny and a backlog in processing claims
Taxpayers with outstanding or completed claims should consider whether they comply with requirements to amend taxable income related to periods for which they claimed credits
1. Where Are We?
Background
The ERC was introduced under the CARES Act in 2020 and expanded by the Consolidated Appropriations Act of 2021 and the American Rescue Plan Act. It provided eligible employers with a refundable tax credit against certain employment taxes equal to a percentage of qualified wages paid to employees during eligible periods in 2020 and 2021.
Administrative Guidance Update
In 2023 and 2024, the IRS issued a series of notices and updates to curb aggressive and improper ERC claims. Key among these was IRS Notice 2023-20, which clarified eligibility requirements, substantiation expectations, and standards for reasonable cause. The IRS has emphasized that employers bear the burden of demonstrating eligibility, particularly where taxpayers relied on full or partial suspensions due to governmental orders or in calculating significant declines in gross receipts.
Further, in September 2023, the IRS announced a moratorium on new ERC claims through at least mid-2024, citing a surge in potentially fraudulent submissions. That pause remains as of Q2 2025, although limited administrative movement has resumed for “perfected” or previously validated claims.
Backlog and Refund Status – Statute and Two-Year Claw back Period
The IRS backlog remains significant. As of early 2025, more than 1 million claims remain unprocessed, with increased audit activity and a systematic review of high-risk filings. The IRS prioritizes enforcement under the two-year claw back window for erroneous refunds under IRC Section 6501 (assessment period) and Section 6532 (refund claims).
Situations We Are Currently Seeing
Professionals are encountering several recurring scenarios:
Taxpayers receiving ERC refunds without amending prior returns, raising compliance concerns.
Third-party promoters encouraging aggressive claims that do not meet eligibility criteria.
IRS letters CP2100 and Letter 4523 requesting substantiating documentation or notifying of disallowed claims.
Employers are unsure whether to withdraw, modify, or support previously filed claims.
2. Income Tax Effect, Timing, and Compliance
When Should the Credit Year Return Be Amended to Adjust Wage Deductions?
The ERC reduces the wage expense deduction for the tax year the qualified wages were paid. Originally, once an ERC was claimed or received, taxpayers were required to amend that year’s original income tax return to reduce wage deductions. However, in March of 2025, the IRS announced that it would allow taxpayers to amend tax returns for the tax year in which the refund was received to satisfy the requirement to reduce wage deductions.
ERC Received in a Subsequent Year but Credit-Year Return Not Amended
Taxpayers who received the ERC in 2023 or 2024 for 2020 or 2021 wages, but did not amend the corresponding income tax return, should act immediately. The IRS has signaled that failure to amend the return can result in accuracy-related penalties, especially if the credit is later disallowed and the wage deduction remains unreduced.
ERC Disallowed but Credit-Year Return Was Already Amended
Corrective action is required in cases where taxpayers amended their income tax return in anticipation of ERC approval, but the claim was subsequently denied. A second amended return should be filed to restore the original wage deductions, and taxpayers should maintain documentation explaining the sequence for audit protection.
3. Perfecting, Modifying, and Withdrawing Claims
In response to concerns over incorrect claims, the IRS launched a withdrawal and claim correction program in late 2023, which continues to operate in 2025. Taxpayers can withdraw claims that:
Have not yet been paid
Are under examination or
Were filed based on bad advice or errors
The perfecting process allows submitting missing documentation or clarifications in response to IRS correspondence (e.g., Letter 4523). However, this does not guarantee approval—merely a continuation of review.
The modification process is less formally defined but involves submitting corrected Forms 941-X with explanations. In all cases, communication with the IRS must be timely, well-documented, and ideally routed through experienced tax counsel or CPA firms.
4. Conclusions
Implications
The ERC, once a widely accessible credit, has transitioned into a high-risk compliance area. The IRS is aggressively auditing and disallowing ineligible claims and has requested congressional support to extend the statute of limitations and enhance enforcement.
Future Activity Outlook
Looking ahead:
Processing delays will continue into 2026 due to limited IRS capacity and scrutiny.
Refunds may be clawed back under misrepresentation or fraud theories, even years later.
Additional guidance is expected on the interaction of ERC claims and income tax reporting, especially for disallowed or partially allowed refunds.
Employers are strongly advised to review their ERC positions, respond promptly to IRS notices, and amend income tax filings where necessary. Maintaining thorough records—including eligibility analysis, contemporaneous documentation, and substantiation of wage calculations—cannot be overstated.
Contact your Herbein Tax advisor to stay up-to-date with the latest IRS ERC news in 2025.
Article Contributed by Elizabeth F. Hassler
