PUBLISHED IN
Byline from Kathy Petronchak, Director of IRS Practice & Procedure at alliantgroup,
Eric Hylton, Former IRS Commissioner of the Small Business/Self Employed Division; alliantgroup National Director,
Donald Sniezek, Senior Technical Advisor at alliantgroup,
Darren Guillot, Former IRS Commissioner of the Small Business/Self Employed Division; alliantgroup National Director, and Matthew Beddingfield, Senior Associate at Zerbe, Miller, Fingeret, Frank & Jadav LLP
If you have any questions about this article, please send us a message.
One of the welcome changes at the IRS included the agency’s creation of a new office to assist taxpayers with resolving tax disputes before potentially needless litigation comes to the surface.
The IRS generally agreed with the GAO report and its recommendations to improve ADR programs. In July 2023, the IRS invited public comment on how to improve its ADR programs. As a result of the report and public comments, the IRS established the new ADR PMO, which intends to increase awareness, change, and revitalize these existing programs and pilot new approaches by making them more attractive and accessible for all eligible taxpayers. Specifically, the ADR PMO will pilot changes to Fast Track Settlement, a program that allows Appeals to mediate disputes between a taxpayer and the IRS while the case is still in Exam’s jurisdiction. The new office will also remove barriers to participating in Post-Appeals Mediation, a program that introduces a new mediator if the parties are unable to reach an agreement during traditional Appeals settlement negotiations.
In addition, the office plans to:
■ Test ADR programs that allow Appeals to help resolve or mediate disputes earlier in the examination process;
■ Streamline and clarify existing guidance;
■ Remove barriers to enable easier use of and access to ADR; and
■ Collaborate with IRS Business Operating Divisions to perform outreach and education, coordinate the training and support of mediators, collect data, and monitor the effectiveness of ADR offerings.
Taken together, these are all good first steps towards helping taxpayers resolve their issues and improve overall voluntary compliance in tax administration.
II. IRS Reopens ERC VoluntaryDisclosure Program and Provides an Update to the ERC Moratorium
On August 15, 2024, IRS announced a second ERC Voluntary Disclosure Program (“VDP”). The reopening of the program is designed to help businesses with questionable claims to rectify and repay the credits they received after filing ERC claims in error. The program will run through November 22, 2024, and allow businesses to correct improper payments at a 15% discount and avoid future audits, penalties, and interest. It should be noted that the new round only applies to tax periods in 2021 and does not apply to 2020 tax periods.
To underscore the importance of participating in the VDP, the IRS also announced it plans to mail up to 30,000 new letters to reverse or recapture potentially more than $1 billion in improper ERC claims. Thousands more mailings on additional questionable payments will be made in the fall.
As with the previous ERC VDP, to qualify businesses must provide the IRS with the names and addresses and details about the services provided by any advisors or tax preparers who advised or assisted the business with the claim. In addition, acceptance into the program does not absolve the businesses of any criminal exposure.
Additionally, on August 8, 2024, IRS issued IR-2024-203 announcing a partial lift to the moratorium for processing ERC claims, a move that has significant implications for businesses across the United States.
More importantly, the IRS also has identified 50,000 low-risk ERC claims that will be processed expeditiously and money distributed within the coming weeks. The tax credit was introduced as part of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act in March 2020 to encourage businesses to keep employees on their payroll during the COVID-19 pandemic. As we discuss below, the IRS lifting the ERC moratorium has a direct impact on U.S. taxpayer businesses, which must now determine how they can navigate these changes effectively.
The ERC was designed to provide a refundable tax credit to businesses that retained employees despite experiencing a decline in gross receipts or being subject to a government-ordered shutdown due to COVID-19. Initially set to cover wages paid from March 13, 2020, through December 31, 2020, the program was extended and expanded under subsequent legislation, including the Consolidated Appropriations Act, 2021 and the American Rescue Plan Act of 2021.
Eligible employers can claim a credit of up to $5,000 per employee for 2020 (although the refund statute has now expired for those who did not file by April 15, 2024) and up to $7,000 per employee per quarter for the first three quarters of 2021. The credit was available to businesses of all sizes, including tax-exempt organizations, although certain conditions apply.
However, in September 2023, the IRS imposed a temporary moratorium on processing new ERC claims. The decision came in response to concerns over fraudulent claims and a significant backlog of applications, which overwhelmed the agency’s ability to process them efficiently. The moratorium was intended to give the IRS time to strengthen its review processes, enhance fraud detection measures, and clear the backlog of legitimate claims. According to the Taxpayer Advocate Fiscal Year 2025 Objectives Report to Congress, the IRS used this time to pivot from processing claims to using analytics to review and identify incorrect claims.
With IR-2024-203, the IRS announced that it would partially lift the moratorium on ERC claims thereby processing lower-risk ERC claims while also denying tens of thousands of high-risk ERC claims.The agency stated that it has implemented improved systems and processes to handle the influx of claims and conducted a detailed review of potential erroneous claims to protect taxpayers and small businesses.
Based on the IRS analysis, the following is a breakdown of claims with low, unacceptable, and elevated risks:
■ 10–20% Low-Risk Claims,
■ 60–70% Unacceptable-Risk Claims, and
■ 10–20% High-Risk Claims.
With this breakdown, the IRS has issued a new round of 28,000 disallowance letters of purportedly high-risk claims worth an estimated $5 billion. The assumption is that the new disallowance letters will follow the same indicia of fraud of the 20,000 letters issued in December 2023.
Commissioner Werfel also wanted to emphasize the complexity of ERC from an administrative and enforcement perspective.
“The Employee Retention Credit is one of the most complex tax provisions ever administered by the IRS, and the agency continues working hard to balance our work to protect taxpayers from improper claims while also making payments to qualifying businesses,” said Commissioner Werfel. “It has been a time-consuming process to separate valid claims from invalid ones. During the past year, we maintained a steady cadence of both ERC approvals and disapprovals.”
The agency’s lifting of the moratorium has several immediate effects on both the IRS and taxpayer businesses. First, the agency will resume claim processing. Previously, the agency was not processing claims filed after September 14, 2023. As the agency moves forward, it will now start judiciously processing claims filed between September 14, 2023 and January 31, 2024. This development provides an opportunity for eligible employers to access crucial financial relief. This is necessary relief as there were 665,000 ERC claims when the moratorium began but that number had grown to over 1.3 million in nine months.
This tsunami of issues regarding ERC has put the IRS behind the eight ball and caught between a rock and a hard place by either issuing thousands of suspected improper credits or, with its limited resources, taking years to distribute legitimate credits to the heartbeat of America’s— small and midsize businesses.
However, the tax credit now will have increased scrutiny and documentation requirements. Businesses should be prepared for increased scrutiny as the IRS seeks to prevent fraudulent claims. Employers will need to ensure that they have accurate and comprehensive documentation to support their eligibility for the credit, including records of declined gross receipts, government shutdown orders, and payroll data.
This increased compliance scrutiny has led to the following results:
■ ERC Claim Withdrawal Program: The claim withdrawal process for unprocessed ERC claims has led to more than 7,300 entities withdrawing $677 million.
■ ERC VDP: During the first VDP, which ended in March 2024, the IRS received more than 2,600 applications from ERC recipients that disclosed $1.09 billion worth of credits.
■ Criminal investigations: As of July 1, 2024, IRS Criminal Investigation has initiated 460 criminal cases, with potentially fraudulent claims worth nearly $7 billion. In all, 37 investigations have resulted in federal charges so far, with 17 investigations resulting in convictions and nine sentencings with an average sentence of 20 months.
■ Promoter investigations: The IRS is gathering information about suspected abusive tax promoters and preparers improperly promoting the ability to claim the ERC. The IRS’s Office of Promoter Investigations has received hundreds of referrals from internal and external sources. The IRS will continue civil and criminal enforcement efforts of these unscrupulous promoters and preparers.
■ Audits: The IRS has thousands of ERC claims currently under audit.
Lastly, and unfortunately, some of the new disallowance letters have mistakenly failed to include rights to appeal or may have been issued in error. IR-2024-203 addressed this issue and reiterated that when businesses receive a denial of an ERC claim they have options available to file an administrative appeal by responding back to the address on the denial letter. IRS.gov also has additional information on administrative appeals with the IRS independent Office of Appeals.
This tsunami of issues regarding ERC has put the IRS behind the eight ball and caught between a rock and a hard place by either issuing thousands of suspected improper credits or, with its limited resources, taking years to distribute legitimate credits to the heartbeat of America’s—small and midsize businesses. These will be difficult choices the IRS will have to make in the months ahead.
III. Tax Administration in the Age of AI
Beyond the difficulties associated with the processing and administration of the above-referenced tax credit, the IRS has waded into another complex area: AI.
Commissioner Werfel announced in April that the IRS will make sure AI has a “growing role” in tax administration. Regarding the agency’s use of AI, the GAO has expressed faith that AI can help IRS in its endeavor to close the “Tax Gap.”11 According to the GAO’s summary of IRS efforts in the AI space, the Service is piloting a new process for sampling tax returns for National Research Program (“NRP”) audits. The new process uses AI to improve the efficiency and selection of audit cases to help identify noncompliance and measure the tax gap. However, the IRS has not completed its documentation of several elements of its AI sample selection models, such as key components and technical specifications. Completing documentation would help the IRS retain organizational knowledge, ensure the models are implemented consistently, and make the process more transparent to future users.
The IRS in May 2024 released a memo for all senior executives regarding AI governance and principles. According to the interim guidance memorandum, “Between 2019 and 2023, legislation and federal guidance drove the need to ensure trustworthy use of advanced analytics and artificial intelligence.” The memorandum will be published as IRM 10.24.1, Artificial Intelligence (AI) Governance and Principles, establishing requirements and recommendations for IRS development, implementation, and use of AI.
Commissioner Werfel has stated that the IRS is considering the use of AI in two specific ways: virtual chatbots to assist taxpayers and AI tools for use by agents in carrying out their compliance activities.
However, AI is not new to the IRS. In December 2020, former Commissioner Rettig noted in the agency’s progress update for FY 2020, titled “Putting Taxpayers First,” that the agency had “expanded use of data analytics and artificial intelligence across all lanes from selection to examination. We are able to now identify issues of noncompliance that would not have been remotely possible just a few years ago.” For example, in 2020 IRS’ Collection Operations initiated its ACS Voice Bot project, leveraging AI, and succeeded in launching the technology in authenticated voice robotics to interact directly with taxpayers in 2022.
In the last couple of years, IRS exam functions have started to use AI in case selection analytics, notably in LB&I’s large partnership model. In reviewing partnership returns, the GAO report issued in July 2023, addressing audit processes for large, complex partnerships, noted IRS statements regarding the use of AI in this space. The report noted that the “IRS considers the Large Partnership Compliance Model to be an artificial intelligence (“AI”) system and included it in an inventory of AI use cases required by Executive Order 13960 Promoting the Use of Trustworthy Artificial Intelligence in the Federal Government.IRS officials told us they also believe the Partnership Model meets the description of an AI system used by the Executive Order.”
Questions that likely will come into play include the following:
■ Do their authenticated voice bots answer lots of calls, avoid errors, and resolve the cases they worked?
■ Are returns selected for audit those with the highest noncompliance risk and are the audit results commensurate with the predicted or identified noncompliance (i.e., is the no-change rate declining)?
Perhaps one of the biggest benefits of using AI is just around the corner and involves Examination programs.
The IRS recently issued a request for information (“RFI”) for assistance in building a system that will interact with a taxpayer at the earliest signs a position, either on a pending or recently filed tax return, is questionable. The system will then give the taxpayer an option to selfcorrect or not.
If the IRS were to fully develop and deploy this system, then imagine this option and how many audits and “no-change” results would be avoided. This technology may allow the IRS to use limited resources to audit more productive returns and taxpayers who really need to be audited, and it is arguably not far off.
Tax practitioners should also not lose sight of what the IRS can do with all of its collected digitized return information. It appears the IRS may be adding emphasis on research and development issues (“R&D”) and will likely use advanced analytics with machine learning. The added documentation requests from the IRS for R&D, and digitization of all those new forms, will help them expand the data sets. This will greatly facilitate the integral machine learning component of any AI effort.
Practitioners can also expect to see a very thoughtful and careful use of AI at IRS. The tax laws have grown increasingly complex and the amount of work for the IRS has grown in both size and variety. There will always be more work for the IRS than it has people to get it done. The predictive and decision analytics, along with machine learning systems, will continue to help the IRS pick the best work to be done through the most efficient treatment options and streams available. This process includes humans; however, with the integration of AI and other tools, responsibilities will likely change.
This technology will continue to play a role in the IRS’ growing array of self-help and other digital options for taxpayers to obtain answers on their own and potentially even resolve their own cases. These are possibilities given funding provided through the Inflation Reduction Act (“IRA”) remains available.
Featured Leadership
Kathy Petronchak is the Director of IRS Practices and Procedure at alliantgroup and is part of the alliantnational group in Washington, DC. In this role, she serves as an invaluable resource on a wide range of issues related to IRS procedures, such as foreign bank account reporting, alternative dispute resolution; statute of limitations; account problems, collection issues, and penalty issues. She is currently the Chair of the AICPA IRS Advocacy & Relations Committee and has served on various committees the past 11 years.
Eric Hylton held several prominent positions at the IRS, including serving as Deputy Chief of the Criminal Investigation Division and as CI’s head of International Operations. As National Director of Compliance, Eric employs his years of experience at the IRS to assist alliantgroup’s clients as an ambassador for U.S. small and medium sized businesses (SMBs) and in helping others become tax compliant.
Donald Sniezek joined alliantgroup from the IRS, where he spent more than 34 years of his career, holding a number of Senior Executive Service positions culminating in appointment as Director of Examination Headquarters for the Small Business and Self-Employed (SBSE) Division. He uses his years of experience at the IRS to assist alliantgroup’s clients as a technical advisor and ambassador for U.S. small and medium sized businesses (SMBs).
Darren Guillot recently retired from IRS after 36 years with the agency. His roles included serving as Commissioner of the IRS’ Small Business/Self Employed Division, overseeing all IRS domestic and international Collection Operations and its Operations Support functions. In his role as Commissioner, SBSE (2021 – 2022) he led IRS’ groundbreaking, successful effort using authenticated voice robotics, eliminating phone hold times for over 14 million taxpayers in less than two years. He also led the creation and oversight of IRS’ Fraud Enforcement Office, providing support and coordination for all IRS efforts in detecting and deterring tax fraud – including leading the most expansive and innovative use of data and systems analytics to address virtual currency by the civil functions of the IRS.
Matthew Beddingfield is a Senior Associate in ZMF’s Washington, D.C. office who specializes in representing whistleblowers from their initial filing through any necessary appeals process. He has experience representing clients before several government entities, including the Internal Revenue Service and the U.S. Securities and Exchange Commission, as well as the U.S. Tax Court.
Prior to joining ZMF Law, Matthew was a legal editor at Bloomberg, where he reported on a variety of tax cases and legislative updates.
Matthew graduated from the Duquesne University School of Law, where he was the Editor-in-Chief of Juris, the law school’s primary magazine. During that time he worked for Senior District Judge Nora Barry Fischer of the U.S. District Court for the Western District of Pennsylvania. He holds a B.A. from the Ohio University Scripps School of Journalism.
Featured Leadership
Rick Lazio is a former U.S. Representative from New York serving in Congress from 1993-2001. While there, he became a strong advocate for small businesses by sponsoring the successful Small Business Tax Fairness Act. After Congress, Rick moved to the private sector working for JP Morgan Chase as a Managing Director and then Executive Vice President. Rick is committed to his continued interest and support of small to mid-sized businesses by brokering his insight and experience in the public and private sectors to provide strong incentives for job growth. This interest has extended into his civic and philanthropic work in New York with the Committee for Economic Development and the Association for a Better New York.
