Employee Retention Credit audits and enforcement: the OBBBA retroactive disallowance of late 2021 claims, the closed Voluntary Disclosure Programs, the still-open claim withdrawal process, and the five-year audit window

The Employee Retention Credit (ERC) was one of the largest pandemic-relief programs in the tax code, and it has become one of the largest enforcement problems. The IRS has called it the most complex credit it has ever administered. After processing roughly 5 million claims and paying out approximately $235 billion, the agency is now in the cleanup phase: auditing historic claims, challenging aggressive filings, disallowing claims it considers ineligible, and pursuing the promoters who pushed businesses into the program.

For business owners, the practical reality in 2026 is that the ERC is no longer about applying for refunds. New claims are effectively foreclosed. What remains is audits, repayments, appeals, and enforcement. If your business claimed the ERC, particularly if you used a third-party "ERC mill" that marketed the credit aggressively, you need to understand the current enforcement landscape and your options.

The One Big Beautiful Bill Act (OBBBA), enacted July 4, 2025, substantially sharpened the IRS's enforcement tools and retroactively foreclosed a large category of claims. Combined with the closure of the Voluntary Disclosure Programs, the landscape has shifted decisively toward enforcement.

What the ERC was

The ERC, created by the CARES Act in 2020, was a refundable payroll tax credit designed to encourage employers to keep workers on payroll during the pandemic. The credit applied to qualifying wages paid in 2020 and 2021. For 2020, the credit was up to $5,000 per employee for the year; for 2021, it was up to $7,000 per employee per quarter.

To qualify, a business generally had to meet one of these tests for the relevant period:

A full or partial suspension of operations due to a government order related to COVID-19; OR

A significant decline in gross receipts (a 50% decline in 2020, or a 20% decline in 2021, compared to the same quarter in 2019); OR

Status as a recovery startup business (for the third and fourth quarters of 2021).

The credit was claimed on Form 941-X (the adjusted employer's quarterly federal tax return), typically filed as an amended return after the fact.

The eligibility requirements were specific and fact-dependent. The problem that drove the enforcement wave: aggressive third-party firms marketed the ERC to businesses that did not qualify, often claiming that nearly any business affected by the pandemic was eligible, and taking a percentage of the credit as their fee. This produced a flood of improper claims.

The OBBBA changes: retroactive disallowance and sharper tools

The OBBBA made several changes that fundamentally altered the ERC landscape:

Retroactive disallowance of late 2021 claims. This is the most significant change. The OBBBA disallows ERC claims for the third and fourth quarters of 2021 that were filed after January 31, 2024, even if the business actually satisfied the eligibility criteria. The provision (Section 70605 of the OBBBA) took effect July 4, 2025 and locks the filing deadline retroactively. A business that filed a legitimate Q3 or Q4 2021 ERC claim after January 31, 2024 will not receive the refund, regardless of eligibility.

Extended assessment statute. The OBBBA extended the statute of limitations for the IRS to assess and pursue ERC claims to roughly five years. This significantly increases the audit risk window, extending the IRS's ability to challenge claims through approximately 2029 for credits claimed in 2024 or earlier.

Increased penalties and promoter enforcement. The OBBBA increased penalties associated with improper ERC claims and strengthened the IRS's tools to pursue the promoters who marketed the credit, including due-diligence requirements and penalties aimed at the ERC mills.

The combined effect: a large category of late-filed 2021 claims is foreclosed, the audit window is longer, and the penalties are higher. The OBBBA shifted the ERC firmly into enforcement territory.

The closed Voluntary Disclosure Programs

The IRS offered two Voluntary Disclosure Programs (VDPs) to let businesses that received improper ERC payments come forward, repay a portion, and avoid penalties and interest. Both are now closed:

The first ERC-VDP (Announcement 2024-3) closed March 22, 2024. It allowed participants to repay 80% of the credit received and avoid penalties and interest.

The second ERC-VDP (Announcement 2024-30) closed November 22, 2024. It allowed participants to repay 85% of the credit (for 2021 periods) and avoid penalties and interest.

Both programs required that the business not already be under criminal investigation or employment tax examination, and neither protected against criminal prosecution for willfully fraudulent claims. Participants received a closing agreement resolving the matter.

The closure of both VDPs is significant. The favorable terms (repaying 80% or 85% and keeping the rest, with no penalties) are no longer available. A business that received an improper ERC payment and missed the VDP windows now faces the full repayment plus potential penalties and interest if the claim is disallowed on audit.

The still-open option: claim withdrawal

For businesses that filed an ERC claim but have NOT yet been paid, the ERC Claim Withdrawal Program remains available. The IRS ERC withdrawal process lets a business ask the IRS to treat its Form 941-X as if it had never been submitted.

The advantages of withdrawal:

Approved withdrawals are not subject to the 20% accuracy penalty.

Interest does not accrue on amounts the business never received (because the claim is treated as never filed).

The withdrawal removes the claim entirely, ending the exposure.

Withdrawal is generally the best route for a business that filed a claim, has not yet been paid, and is unsure about its eligibility. Rather than wait for the IRS to scrutinize the claim (and potentially pay it and then claw it back with penalties), the business can withdraw the claim cleanly.

Withdrawal is available if the business filed the claim on an adjusted employment tax return (Form 941-X), filed it only to claim the ERC, wants to withdraw the entire amount, and the IRS has not paid the claim (or the business has not cashed or deposited the refund check).

Options for paid claims under audit

For businesses that already received the ERC and now face scrutiny, the VDP option is gone, but several avenues remain:

Amending the return. A business that concludes it was not eligible can file another Form 941-X to reduce or reverse the ERC claim and repay the credit. This does not provide the penalty protection the VDP offered, but proactively correcting the error (before an audit) demonstrates good faith and may support penalty relief.

Defending the audit. ERC examinations are document-heavy. Auditors test two things: whether the business was actually eligible (the government-order suspension or the gross-receipts decline), and whether the wages claimed were correctly calculated. A business with solid documentation of its eligibility can defend the claim on audit. The documentation is the defense.

Appealing a disallowance. If the IRS disallows the claim, the business can request review by the IRS Independent Office of Appeals. The Appeals process provides an administrative avenue to contest the disallowance. Some cases can ultimately proceed to court (a refund suit) if the administrative process does not resolve them.

Penalty relief. Even where the credit is disallowed, penalty abatement and reasonable cause arguments remain available case-by-case. A business that relied in good faith on a tax professional and took prompt corrective action has a basis to argue against penalties. The reasonable-cause analysis turns on the facts: who the business relied on, what information it provided, and how it responded once the issue surfaced.

The documentation that determines the outcome

The single most important factor in defending an ERC claim is contemporaneous documentation of eligibility. The IRS guidance has identified warning signs of incorrect claims, including: claiming too many quarters, citing government orders that do not actually qualify, miscalculating the employee count or wages, improperly claiming supply-chain disruptions, claiming for too much of a tax period, and claiming for periods when the business did not pay wages or did not exist.

The documentation that supports a legitimate claim:

For the government-order test: the specific government orders that suspended or partially suspended the business's operations, and evidence of how those orders affected the business.

For the gross-receipts test: the quarterly gross receipts figures showing the required decline compared to 2019.

For the wage calculation: the payroll records establishing the qualifying wages, and evidence that the same wages were not also used for PPP loan forgiveness (which would be double-dipping).

The wage-deduction interaction also matters: a business that claimed the ERC must reduce its wage deduction on its income tax return by the ERC amount. Businesses that claimed the credit but did not make this adjustment have an income tax exposure separate from the ERC itself.

How ERC enforcement fits the broader tax-debt landscape

The ERC enforcement framework connects to several other Halstonberg tax-debt provisions:

IRS audit defense is the core skill for defending an ERC examination; the document-heavy nature of ERC audits makes thorough preparation essential.

The voluntary disclosure practice is the general framework for coming forward on tax issues; while the ERC-specific VDPs have closed, the general voluntary disclosure principles inform how to approach the IRS on an improper claim.

Reasonable cause penalty defense is the primary avenue for avoiding penalties on a disallowed claim, particularly for businesses that relied on a promoter or professional.

The IRS Appeals process provides the administrative review of a disallowance.

For businesses that cannot repay a disallowed ERC immediately, the standard collection alternatives apply: installment agreements, currently not collectible status, and offers in compromise.

Practical guidance

For businesses navigating the ERC enforcement landscape:

If you filed a claim that has not yet been paid and you are unsure about eligibility, strongly consider the withdrawal process. It treats the claim as never filed, with no penalty and no interest. It is the cleanest exit for an uncertain unpaid claim.

If you received the ERC and now doubt your eligibility, do not ignore the issue. The VDP windows have closed, but proactively amending the return before an audit demonstrates good faith and supports penalty relief. Waiting for the IRS to find the problem is the worst option.

If you are confident in your eligibility, build and preserve your documentation. The government-order evidence or the gross-receipts decline, the wage calculations, and the PPP coordination are the audit defense. Keep these records for at least five years given the extended assessment window.

If you receive a disallowance notice, you have appeal rights. Request review by the IRS Independent Office of Appeals, and consider whether a refund suit is warranted if the administrative process does not resolve it. Do not simply accept a disallowance you believe is wrong.

If you used an ERC mill, scrutinize the claim independently. The promoters that marketed the credit aggressively often filed claims that do not withstand scrutiny. An independent review by a qualified professional (not the promoter) can identify whether the claim is defensible or should be withdrawn or amended.

For the Q3 and Q4 2021 claims filed after January 31, 2024, understand that the OBBBA has retroactively disallowed them. If your refund for those quarters has not arrived and was filed after that date, it will not be paid, regardless of eligibility.

Account for the wage-deduction adjustment. If you claimed the ERC, you must reduce your wage deduction by the credit amount. Confirm this adjustment was made; if not, you have a separate income tax exposure to address.

The ERC enforcement wave will continue through the extended assessment window, which runs to approximately 2029 for many claims. For businesses that claimed the credit, the prudent approach is to confirm eligibility now, document it thoroughly, and address any problems proactively. The favorable voluntary disclosure terms are gone; the remaining options reward businesses that act early and defend their claims with solid documentation.