Employee Retention Credit (ERC) — §3134

ERC Overview and Current Status

The Employee Retention Credit (ERC) was enacted under the CARES Act (§2301) for 2020 and extended and expanded under the Consolidated Appropriations Act of 2021 and the American Rescue Plan Act of 2021 (§3134) for 2021. The credit was designed to encourage employers to retain employees during the COVID-19 pandemic by providing a refundable payroll tax credit against the employer's share of Social Security taxes.

The IRS imposed a moratorium on processing new ERC claims in September 2023 due to a high volume of improper claims submitted by ERC mills — promoters who aggressively marketed the credit to ineligible employers. As of 2026, the IRS continues to process a backlog of claims while conducting compliance reviews. Employers who filed improper ERC claims have options: the ERC Voluntary Disclosure Program (VDP) allows employers to repay 80% of the credit received and avoid penalties and interest; the ERC claim withdrawal program allows employers to withdraw pending claims before they are processed.

Practitioners should be aware that the IRS has announced a series of ERC audits and has issued thousands of audit notices to employers who claimed the credit. The statute of limitations for ERC audits is 5 years from the date the claim was filed (extended from the normal 3-year period by the Inflation Reduction Act of 2022).

ERC Eligibility: Two Tests

To claim the ERC, an employer must satisfy one of two eligibility tests for each quarter in which the credit is claimed: (1) the government orders test, or (2) the gross receipts test.

The government orders test requires that a government order (federal, state, or local) fully or partially suspended the employer's operations. A general stay-at-home order that did not specifically restrict the employer's business does not qualify. The IRS has issued guidance (Notice 2021-20, Notice 2021-49) clarifying that the government orders test requires a nexus between the government order and the suspension of the employer's operations.

ERC Credit Calculation

The ERC is calculated as a percentage of qualified wages paid to eligible employees during the qualifying period.

Qualified wages for large employers (more than 100 FTEs in 2020; more than 500 FTEs in 2021) are limited to wages paid to employees who are not providing services. Qualified wages for small employers include wages paid to all employees, regardless of whether they are providing services. The distinction is significant: a large employer can only claim the ERC for wages paid to employees who are not working; a small employer can claim the ERC for wages paid to all employees during the qualifying period.

ERC Audit Risk and Voluntary Disclosure

The IRS has identified ERC as a high-priority compliance area. The IRS Criminal Investigation division has initiated criminal investigations of ERC promoters and employers who filed fraudulent claims. Civil audits are ongoing for thousands of employers. The statute of limitations for ERC audits is 5 years from the date the claim was filed.

Employers who claimed the ERC improperly have two options: (1) the ERC Voluntary Disclosure Program (VDP), which allows employers to repay 80% of the credit received and avoid penalties and interest; and (2) the ERC claim withdrawal program, which allows employers to withdraw pending claims before they are processed. Practitioners should advise clients who claimed the ERC based on promoter advice to review their eligibility and consider the VDP if the claim was improper.

Frequently Asked Questions