The Employee Retention Credit (ERC) was introduced in March 2020 as part of the CARES Act, alongside the Paycheck Protection Program (PPP), to help businesses weather the COVID-19 storm. “Originally, all of the small businesses in the US were thinking they couldn’t do the ERC if they did the PPP,” recalled Jenn McCabe, Partner-in-Charge at U.S. accounting firm Armanino. “…[Y]ou can do both, as long as you don’t use the same wages for both programs,” she added. This clarification helped many small businesses access much-needed aid.
As the pandemic evolved, so did the ERC. Subsequent legislation extended eligibility into 2021, but McCabe noted, “In retrospect, [the extension] was unnecessary, because most businesses were recovering by Q1 of 2021.” The complexity of eligibility increased, and the IRS was slow to provide guidance, leading to widespread confusion and, eventually, abuse.
The Rise of the Mills—and the Roots of Fraud
Ivan Yates, a Senior Manager at Armanino, described how “credit mills”—firms and agencies with little tax expertise—flooded the market, aggressively marketing ERC services. He attributed some of the uncertainty in the ERC space to late and subjective IRS guidance. “This stuff wasn’t initially codified in the Internal Revenue Code,” Yates noted.
“There were law firms and credit agencies and people who had no business in the credit world turning their entire businesses over to ERC work because it was so lucrative and because the perception was the IRS wasn’t really going to look,” McCabe said. Mills often misled businesses, claiming eligibility based on geography or industry rather than the required quarter-by-quarter analysis. “Our firm saw hundreds of millions of dollars worth of fraud,” McCabe admitted, “and we lost clients over saying no to them and saying no, you don’t qualify.”
Yates added, “Most of these credit mills, what we’ve seen is our clients are the ones who are self-attesting. These due diligence requirements now in the [One Big Beautiful Bill Act] are trying to tighten that up, but there’s uncertainty whether these due diligence requirements are going to be really applicable moving forward or retroactively.”
The One Big Beautiful Bill Act: New Rules, New Risks
Signed into law on July 4, 2025, the One Big Beautiful Bill Act (OBBBA) introduced important changes to the ERC program. Most notably, it retroactively disallows any ERC claims for the third and fourth quarters of 2021 to be filed after January 31, 2024. “A repeal of Q3 21 should not have [a] huge impact in the big picture, because by Q3 [20]21 so many companies were back on their feet,” McCabe explained. “It was pretty hard to qualify in Q3 [20]21, so the dollars, arguably, in my mind, shouldn’t be that big.”
However, Yates cautioned, “There are lots of taxpayers that fall into the category where they do qualify based on a gross receipts decline. Unfortunately for those taxpayers…if they didn’t file before January 31, 2024…[n]ow there is a retroactive repeal saying, ‘Well, you filed after a subjective date that was established after the fact.’ So, I genuinely really feel for those taxpayers who did everything right, and they were actually eligible.”
The OBBBA also extended the statute of limitations for IRS audits of third and fourth quarter 2021 ERC claims to six years, giving the IRS more time to scrutinize claims, demand documentation, and assess penalties. “If you filed, it’s automatic after [January 31, 2024], it’s automatically going to get denied,” Yates warned. “If you have a known credit mill [that] did the work, it’s also likely going to face additional scrutiny.”
Voluntary Disclosure: A Lifeline for the Misled
The IRS responded to the flood of improper claims with voluntary disclosure programs, allowing businesses to correct mistakes at a discount and avoid future audits, penalties, and interest. McCabe recounted stopping a ski trip in Taos, New Mexico when she heard the news of the program to begin writing advisory articles about it. “People like us really tried to talk to people about it… we encouraged them to voluntarily disclose that they had filed, if they had not received the money, we unwound it for them.”
Yates noted, “There was a second VDP program that one was 15% that the taxpayer got to keep. The IRS kind of shut down the first VDP for a while. The dust settled there. A new moratorium was put in place, and then a second VDP program came up.” Both explained that with IRS staffing shortages, many businesses have struggled to resolve their claims, sometimes receiving conflicting notices or being unable to reach assigned agents.
Due Diligence and Penalties: New Standards for Promoters and Employers
The OBBBA imposes strict due diligence requirements and penalties on ERC promoters—service providers who marketed or advised on ERC claims. “…[T]he government is signaling promoters: We know you’re out there. We’re going to set definitions on how you qualify as a promoter, and we’re going to establish strict requirements on due diligence,” Yates explained. Failure to comply can result in $1,000 fines per violation and a 20% penalty on erroneous refund claims.
McCabe emphasized the seriousness of payroll tax penalties: “It should be alarming when penalties apply to payroll taxes withheld because payroll taxes are a fiduciary responsibility of an owner of a business, and the liability for payroll taxes can’t be put on the business exclusively. It actually can apply to the directors and officers of the company.”
Audit Risks and Recordkeeping: What Practitioners Need to Know
With the IRS ramping up audits and extending the window for scrutiny, Yates advised employers to preserve related records, eligibility documentation, and correspondence with ERC advisors.” McCabe added, “And they need to have time records, payroll records by person – every bit of payroll and time keeping, and the revenue records – going back to 2019.”
Even businesses that received their ERC refunds years ago may still face audits, especially if they worked with a credit mill or lack proper documentation. “There is no requirement to process a claim for refund,” Yates warned. “A lot of these are just going to sit there.”
Technology, IRS Staffing, and the Future
Both experts agreed that IRS staffing shortages and outdated technology have contributed to the backlog and confusion. “The IRS has been understaffed for years,” McCabe said. “If they used robotic processing or AI…maybe, yes, it’s possible that technology would help them, because they don’t have manpower.” Yates added, “AI is not perfect. It may help, but it’s also going to lead to some wrong answers initially, that then the taxpayer is going to have to go back and prove that no, this was correct.”
The Road Ahead: More Guidance Needed
As the IRS continues to process claims and issue new guidance, uncertainty remains. “There has been such excessive fraud that the United States government is owed money,” McCabe concluded. “It’s good for the United States taxpayer…that they’re trying to put a lid on this, but it is an inadequate lid. The IRS is understaffed to execute on this provision.”
Yates agreed, “There’s a budgetary impact. Of course, it’s signaling that there is a governmental shift towards greater scrutiny, tighter legislative guardrails and less tolerance for expensive interpretations of this. Do I think that there will be more guidance issued? Yes, I think there needs to be some more guidance.”
Key Takeaways for Practitioners and Employers:
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- Claims for the third and fourth quarters of 2021 filed after January 31, 2024, are now disallowed.
- The IRS has six years to audit certain ERC claims.
- Voluntary disclosure programs offer a path to correct improper claims.
- Due diligence and documentation are more critical than ever.
- Penalties for erroneous claims and promoters are steep.
- IRS guidance is evolving—stay informed and consult reputable professionals.
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