Employee Retention Credit Scams: Red Flags, Penalties, and Withdrawal

Employee Retention Credit scams typically come from third-party promoters who promise a large refund without reviewing your payroll records, charge a percentage of whatever they get you, and skip the eligibility rules that actually govern the credit. If you already filed a claim built on one of those pitches, you are personally on the hook: the IRS can claw back the full refund, add a penalty of 20% for negligence or 75% for fraud, and in serious cases refer the case for criminal prosecution. Both filing windows are now closed, so anyone still soliciting new ERC claims is running a scam on its face.

How the Pitch Usually Sounds

Promoters reach business owners through unsolicited calls, texts, emails, and radio or television ads. The message is almost always the same. Your business qualifies. The process takes minutes. There is no risk. Some promoters claim they can confirm eligibility without looking at a single financial record. That alone should end the conversation, because no honest tax professional can tell you what you are owed before reviewing your books.

The language is engineered to make the credit sound like free money. The government is handing out funds. Every small business qualifies. The credit is guaranteed. None of that is true. The ERC has strict statutory requirements, and most promoter-driven claims did not meet them. A qualified CPA or enrolled agent will ask detailed questions about your operations, walk through your gross receipts quarter by quarter, and refuse to promise a dollar figure before finishing that analysis.

The fee structure is usually the clearest tell. The IRS has flagged promoters who charge contingency fees as high as 25% of the refund, meaning they pocket more when they inflate the claim.¹ A qualified professional charges for the work, not a cut of the refund.

The Eligibility Rules Promoters Misrepresent

To qualify for the ERC, a business had to meet at least one of three tests: a full or partial suspension of operations caused by a government order, a significant decline in gross receipts, or status as a recovery startup business (which applied only to Q3 and Q4 of 2021).² Promoters routinely misrepresent all three.

The suspension-of-operations test is where most fraud lives. Promoters tell business owners that general supply chain problems or vague pandemic inconveniences count as a qualifying government order. They do not. The order had to specifically limit commerce, travel, or group meetings, and it had to cause a full or partial shutdown of the business’s operations. A restaurant forced to close indoor dining by a local health order could qualify. A consulting firm that switched to remote work on its own probably could not.

The gross receipts test gets manipulated just as often. For 2020, the business needed a quarter where gross receipts dropped more than 50% compared to the same quarter in 2019. For 2021, the threshold was a 20% decline. Promoters sometimes tell businesses with flat or growing revenue that they still qualify, either by cherry-picking comparison periods or by ignoring the test entirely and filing based on the suspension rule with no actual government order behind it.

Paycheck Protection Program wages are another tripwire. If your PPP loan was forgiven, the wages that supported that forgiveness cannot also be used to calculate the ERC. You can claim the credit on remaining qualified wages, but not on the same dollars twice.² Promoters regularly ignore this rule, producing claims that get flagged through IRS data matching.

The IRS Red Flag Checklist

The IRS has published specific warning signs that suggest a claim is inflated or fraudulent. Treat these as a checklist when reviewing any promoter’s work:¹

The claim covers every quarter the credit was available, regardless of whether the business met the eligibility tests in each period.
The promoter charges a contingency fee based on a percentage of the refund.
The promoter did not ask for payroll records, government orders, gross receipts data, or PPP loan forgiveness details.
The claim includes wages already reported as payroll costs for PPP loan forgiveness.
The promoter filed the amended payroll return but did not tell you your income tax return also needs to be amended. Claiming the ERC reduces your deductible wage expense, which increases your income tax liability for that period.³
The filing shows more employees or higher wages than your actual payroll records support.

That income tax adjustment trips up a lot of businesses. Even if the ERC claim itself were legitimate, failing to reduce your wage deduction on your income tax return creates a separate underpayment that accrues its own interest and penalties.

Filing Windows Are Closed

Both ERC filing windows have expired. The deadline for 2020 wages was April 15, 2024, and the deadline for 2021 wages was April 15, 2025. No new claims can be filed. Any promoter still pitching ERC filings is either lying or has no idea what they are doing.

Claims filed before the deadlines are still working through the pipeline under significantly higher scrutiny. If you filed through a promoter and have not received payment, that does not mean approval is coming. The IRS may be taking a closer look.⁴

What a Bad Claim Costs You

Business owners are personally responsible for every claim filed on their returns, even when a third party prepared the paperwork. Blaming the promoter does not reduce your liability.

Civil Penalties

At minimum, you owe back the full credit plus interest running from the date the refund was issued. The IRS can add an accuracy-related penalty of 20% on the underpayment if it resulted from negligence or disregard of the rules.⁵ If the IRS can show the claim was filed with intent to defraud, the penalty jumps to 75%.⁶

In dollar terms: a business that received a $200,000 ERC refund it did not qualify for could owe back the $200,000, years of interest, and a fraud penalty of $150,000. The total repayment easily exceeds the original refund.

Criminal Exposure

Filing a false claim against the federal government is a crime carrying up to five years in prison.⁷ IRS Criminal Investigation has opened more than 500 investigations involving over $5.5 billion in ERC claims, with dozens of federal indictments already returned. Prosecutors focus on promoters most often, but business owners who knowingly signed false returns are not immune. If you reviewed a Form 941-X before submitting it and the numbers did not match your actual payroll, that becomes evidence you knew.

Longer Audit Window

The standard statute of limitations for IRS assessment is three years, but Congress extended it to five years for ERC claims filed in Q3 and Q4 of 2021. Audits can arrive years after the money was received. During an audit, you must produce documentation proving you met either the suspension-of-operations test or the gross receipts decline test. If that documentation does not exist, the credit gets disallowed and the tax bill comes due.

If You Already Filed a Bad Claim

Waiting for the IRS to find the problem is the worst option. Acting first almost always produces a better outcome.

Withdrawing an Unpaid Claim

If the IRS has not yet paid your claim, or if you received a refund check but have not cashed it, you can withdraw the claim entirely. All of these conditions must be true: the claim was filed on an adjusted return like Form 941-X, the return was filed only to claim the ERC with no other adjustments, you are withdrawing the entire credit, and the IRS has not paid the claim or you have not deposited the check.⁸

To withdraw, make a copy of the adjusted return, write “Withdrawn” in the left margin of the first page, have an authorized person sign and date the right margin with their name and title, and fax the annotated copy to 855-738-7609. If the claim is already under audit, work through your assigned examiner instead. A successful withdrawal means the IRS treats the return as if it were never filed, with no penalties or interest. Withdrawal does not protect against criminal investigation if the original filing was willfully fraudulent.⁸

Voluntary Disclosure Program (Closed)

For businesses that already received and spent the refund, the IRS offered a Voluntary Disclosure Program allowing repayment of 85% of the credit with no interest or penalties. The second round closed on November 22, 2024.⁹ Businesses that did not participate now face the full repayment plus penalties and interest if the IRS pursues the claim.

If the IRS Has Already Disallowed Your Claim

If the IRS reviews your claim and decides you do not qualify, you will receive Letter 105-C formally disallowing the credit. The letter explains the reason, the tax period involved, and your appeal rights.¹⁰

From the date of that letter, you have two years to act. You can request an appeal through the IRS Independent Office of Appeals, provide additional documentation, reach an agreement with the IRS, or file a refund suit in federal court. If none of those happen within two years, you lose the ability to receive the refund permanently, even if your claim was valid. The IRS is legally barred from paying it after that window closes.¹⁰

If you need more time, you and the IRS can sign Form 907 to extend the two-year deadline, but that agreement has to be in place before the original deadline expires.

Reporting a Promoter

If a promoter misled you or you know of someone filing fraudulent claims, the IRS uses Form 14242, Report Suspected Abusive Tax Promotions or Preparers.¹¹ The form asks for the promoter’s contact information, a description of the scheme, and any marketing materials you can attach. Submit it through the IRS Document Upload Tool or mail it to the IRS Lead Development Center at MS7900, 1973 N. Rulon White Blvd., Ogden, UT 84404.¹²

Larger cases carry a financial incentive. Under the IRS whistleblower program, if the taxes, penalties, and interest in dispute exceed $2 million (and the target’s gross income exceeds $200,000 for individuals), the whistleblower is entitled to 15% to 30% of the proceeds the IRS collects.¹³ That program uses Form 211 through the IRS Whistleblower Office. When a promoter has many clients, that $2 million threshold is not hard to clear.

Include as much detail as possible: fee agreements, emails, the promoter’s website, and the specific claims they made about eligibility. Investigators build cases from those specifics.

1
Internal Revenue Service. Red Flags for Employee Retention Credit Claims
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Internal Revenue Service. Frequently Asked Questions About the Employee Retention Credit
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Internal Revenue Service. Employee Retention Credit
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Taxpayer Advocate Service. The ERC Claim Period Has Closed
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Office of the Law Revision Counsel. 26 U.S. Code 6662 – Imposition of Accuracy-Related Penalty on Underpayments
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Office of the Law Revision Counsel. 26 U.S. Code 6663 – Imposition of Fraud Penalty
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Office of the Law Revision Counsel. 18 U.S. Code 287 – False, Fictitious, or Fraudulent Claims
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Internal Revenue Service. Withdraw an Employee Retention Credit (ERC) Claim
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Internal Revenue Service. Employee Retention Credit – Voluntary Disclosure Program
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Internal Revenue Service. Understanding Letter 105-C, Disallowance of the Employee Retention Credit
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Internal Revenue Service. Abusive Trust Tax Evasion Schemes – Referrals – Contacts
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Internal Revenue Service. Office of Promoter Investigations at a Glance
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Office of the Law Revision Counsel. 26 U.S. Code 7623 – Expenses of Detection of Underpayments and Fraud