Employee Retention Tax Credit Fraud and Tax Evasion Charges Compared

The Employee Retention Tax Credit (ERTC) was created by the CARES Act in March 2020 to help businesses retain employees during the COVID-19 pandemic. While the credit provided vital relief for many businesses, it has also become a major target of fraudsters looking to illegally obtain funds. This article will compare ERTC fraud with tax evasion charges, examining the key differences and potential penalties.

ERTC Fraud Schemes

Unfortunately, the ERTC has been exploited by fraudsters using a variety of schemes:

• Fictitious businesses: Fraudsters create fake businesses and file tax returns with fabricated employee data to claim large ERTC refunds.
• Stolen identities: Real employee names and Social Security numbers are used without authorization to claim credits.
• Inflated employee wages: Larger credits are claimed by inflating employee wages on tax returns.
• Ineligible employees: Independent contractors are claimed as employees to qualify for the credit.

Many promoters aggressively advertised services to obtain ERTC refunds for ineligible employers. The IRS has identified thousands of potentially fraudulent claims.

Comparing ERTC Fraud to Tax Evasion

While both ERTC fraud and tax evasion involve illegal actions to reduce tax liability, there are some important differences:

• Intent: Tax evasion requires willful intent to violate tax laws. With ERTC fraud, eligibility rules may have been misunderstood.
• Affirmative deceptions: Tax evasion may involve affirmative acts of deception like concealing income. ERTC fraud can be more passive, such as claiming credits without proper documentation.
• Civil vs. criminal penalties: Both ERTC fraud and tax evasion can result in repayment of funds plus civil penalties and interest. But only tax evasion carries criminal penalties like imprisonment.
• Types of taxes: ERTC fraud relates to employment taxes, while tax evasion applies more broadly to income, estate, excise, and other tax types.
• Promoters: ERTC fraud often involves promoters who solicit businesses by promising large, easy refunds. Most tax evasion schemes are initiated by the taxpayers themselves.

While ERTC fraud can potentially lead to criminal charges in egregious cases, tax evasion is defined by willfully violating tax laws and automatically results in criminal prosecution if convicted.

Penalties for ERTC Fraud vs. Tax Evasion

Both ERTC fraud and tax evasion can lead to substantial civil and criminal penalties:

Civil Penalties

• ERTC Fraud: Must repay erroneous refunds plus interest and penalties, including a 20% accuracy penalty on underpayments over $5,000.
• Tax Evasion: Must pay back taxes owed plus interest and penalties, including a 75% civil fraud penalty.

Criminal Penalties

• ERTC Fraud: Potential criminal charges if fraud is willful, including fines up to $250,000 and imprisonment up to 5 years.
• Tax Evasion: Fines up to $100,000 and imprisonment up to 5 years. Also includes prosecution for filing false returns under penalties of perjury.

The IRS treats fraudulent refunds related to the ERTC as tax underpayments, allowing them to impose penalties. But criminal prosecution for ERTC fraud depends on proving willful intent and not just misunderstanding complex rules.

IRS Enforcement of ERTC Fraud

The IRS has made identifying and prosecuting ERTC fraud a top priority:

• Screening suspicious returns and freezing refunds
• Auditing returns prepared by promoters under investigation
• Assessing underpayments and imposing civil penalties
• Pursuing criminal charges when substantial tax evasion is identified
• Warning employers about potential scams and eligibility concerns

The IRS warns that employers will be held responsible, even if a promoter facilitated the fraudulent claims. Thoroughly vet any third-parties offering ERTC services and ensure eligibility is properly documented before claiming credits.

Protecting Against ERTC Fraud Penalties

For employers who claimed credits in good faith, taking these steps can help demonstrate lack of intent if audited:

• Review eligibility requirements and document qualifications
• Verify employee wage data on returns
• Retain copies of government orders showing operations were suspended
• Calculate declines in gross receipts accurately per IRS rules
• Consult a reputable CPA or tax attorney on unclear issues
• Respond to IRS promptly if audited and highlight evidence of eligibility

Documenting due diligence helps prove credits were claimed correctly to the best of the employer’s knowledge. Seeking qualified tax advice also shows intent to comply with complex rules.

Conclusion

While the ERTC provided vital assistance, complex rules and large potential refunds attracted fraudsters. Understanding the differences between civil ERTC fraud penalties and criminal tax evasion charges can help businesses assess risks and respond appropriately if audited. Thoroughly vetting preparers, documenting eligibility, and consulting qualified advisors can help demonstrate good faith efforts to claim credits properly. With billions issued in ERTC refunds, the IRS will likely continue aggressive audits and enforcement actions against fraudulent claims.