Recently, the IRS has begun issuing “clawback letters” on Letter 6577C to businesses that previously received Employee Retention Credit (ERC) refunds, indicating proposed adjustments to specific quarters. These letters inform businesses that they may need to repay a portion of their ERC refund. In many cases, these clawback letters are issued in error or in connection with a resolvable situation (e.g., errors on the original W-2/W-3s or 941s).
Receiving a clawback letter - typically indicated by Code 741 (Notice Issued) on your transcript- can be both alarming and confusing. However, understanding what it means, what to look out for, and the steps you need to take can make the process easier. Let’s walk through what these letters entail and how to respond effectively.
These IRS "clawback letters" serve as official notice that the IRS is proposing to reduce the ERC amount your business previously received for a specific quarter. The letter will specify the affected quarter, the IRS’s reasoning for the adjustment, and instructions on how to proceed if you agree or disagree with the proposed change.
If you agree with the adjustment, you’ll sign the statement included with the letter and arrange to return the specified amount. If you disagree, you have the option to respond by submitting a detailed explanation or documentation supporting your original claim.
In the recent wave of Letters 6577C, the IRS has been using mathematical filters to validate the total ERC your business claimed for a given quarter against a hypothetical "Maximum ERC" inferred from your original Form 941 filing.
The IRS is using the following formula to calculate “Maximum ERC”:
For the purpose of determining the W-2 Employee count, it appears as though the IRS is assuming this number based Line 1 of the originally filed Form 941.
Per the Form 941, the following amount should be reported on Line 1:
Thus, while Line 1 may provide a snapshot of the number of employees receiving W-2 wages on the 12th of the operative month, it is not an accurate representation of all employees who might have been paid during the entire calendar month. As a result, Line 1 will always be equal to or less than the actual W-2 count.
Employers with a high number of part-time employees, high turnover, or seasonal staff will typically see more significant differences between the Line 1 amount and the actual W-2 count for the quarter. Consequently, due to the IRS’s flawed analytics, many of these employers are erroneously receiving clawback letters, which will require prompt and careful responses to demonstrate to the IRS the actual versus assumed W-2 count.
In other cases, we are seeing instances where taxpayers had errors on, or completely omitted, the Line 1 amount on their original 941. In these cases, taxpayers may still have the opportunity to present the true facts to the IRS to prevent enforcement of the proposed clawback. TaxNow recommends working closely with a trusted tax professional to assist in addressing these situations.
1. Carefully review the Details
Start by thoroughly reviewing the letter to understand which quarter(s) are being adjusted and why. Understanding the IRS’s reasoning will help you decide on your next steps. If you disagree with the IRS’s assumed “W-2 Employee” count, you should recalculate the Maximum ERC amount using the correct number to ensure that this figure is still greater than or equal to your actual ERC claim.
2. Decide Whether to Accept or Deny
3. Respond Promptly
The IRS typically provides a limited window to reply, so acting quickly is essential. In some cases, you may have three weeks or less to respond. Missing the deadline could limit your options and make resolving the issue more complicated, or even worse, impossible.
For those who have claimed the ERC, staying updated on your IRS filings and transcripts is essential. Monitoring for IRS codes or flags, particularly Code 941 (Notice Issued) and Code 290 (Disallowed Claim), can help you get ahead of any unexpected issues. With the IRS taking a closer look at ERC claims, even straightforward filings may face unexpected scrutiny—advanced knowledge allows you to respond proactively.
With TaxNow, you don’t have to wait for surprises in the mail. Our service provides real-time alerts on IRS activity, ensuring you’re informed about any updates or actions related to your ERC claims. From tracking IRS codes to monitoring your filings, TaxNow equips you with the insights needed to respond effectively.
Stay ahead of your ERC claims with TaxNow. Sign up today to keep your business prepared for any IRS developments.
