How Employee Retention Credit Became a Target for Fraud
During the Covid-19 pandemic, Congress enacted several laws intended to provide relief for businesses and individual, including the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020 and the American Rescue Plan Act of 2021 (ARPA). The CARES Act included an Employee Retention Tax Credit (ERC) for businesses and tax-exempt organizations that paid wages to employees between March 13, 2020 and December 31, 2021 and whose operations were fully or partially suspended by government orders during the pandemic, or whose gross receipts declined by more than 50 percent from the same quarter in 2019. The CARES Act also included the Paycheck Protection Plan for small businesses and prohibited them from applying for both ERC and PPP. But ARPA repealed that prohibition, and by June 2025, the ERC had provided $283 billion in tax credits.
A February 10, 2026, Government Accountability Office (GAO) report on the ERC noted that among other problems that enhanced the potential for losses in the program, the Internal Revenue Service (IRS) had not provided an estimate of improper payments. GAO made several recommendations to improve the management of future emergency employment relief programs.
The issues related to the ERC cited by GAO included complex and retroactive eligibility criteria, the unpreparedness of the IRS to handle large surges in tax credit claims, manual processing of amended returns, and a lack of communication between the IRS and stakeholders. According to GAO, the government suspension criteria for ERC eligibility set by the CARES Act were subjective and did not clearly define a government order. In addition, decreases in gross receipts originally did not apply to nonprofits, which made eligibility vetting more difficult and unreliable for those organizations.
Manual processing of claims created further problems, as GAO noted that 86 percent of ERC claims were filed on Form 941-X as amended returns. The IRS did not enable electronic filing of Form 941-X until mid-June 2024, subjecting the agency to additional risk for fraud. Key ERC eligibility information was not required on employment tax returns, which further complicated processing. GAO noted that the IRS was unable to provide ERC filers with timely updates despite its efforts to do so.
As a result of its investigation of the ERC issues, GAO recommended that the IRS modernize processing and data capture of amended employment tax returns, report an improper payment estimate for the ERC payments, update the public about the current status of the ERC claims, and adhere more closely to GAO’s guidance for managing improper payments in emergency assistance programs. Preventing fraud before it happens would be better for the IRS and the taxpayers that it serves, but for now, the IRS should direct its mitigation efforts at tracking and retrieving as many improper payments as possible and continuing to pursue fraud cases.
