House tax bill proposes major changes to the Employee Retention Tax Credit (ERTC)

Background on the ERTC

The ERTC was created under the CARES Act in March 2020 to encourage employers to retain staff during the COVID-19 pandemic. Initially, it provided a refundable tax credit equal to 50 percent of qualified wages (up to $5,000 per employee) for 2020. Later legislation expanded the credit to 70 percent of wages for the first three quarters of 2021, with a maximum of $10,000 per employee per quarter. Employers could file retroactive claims via amended payroll tax returns, with deadlines of April 15, 2024 for 2020 claims and April 15, 2025 for 2021 claims.

Enforcement History

Concerns about fraudulent and abusive claims led Congress to retroactively eliminate ERTCs for the fourth quarter of 2021 through the Infrastructure Investment and Jobs Act. The IRS then began warning about ERTC promoters that advise businesses and individuals to claim the ERTC when they may not qualify in 2022 and added the ERTC to its “Dirty Dozen” list in 2023. In September 2023, the IRS imposed a moratorium on processing new ERTC claims, which remains in effect today. As of May 2025, over 597,000 ERTC claims remain unprocessed.

Key Proposed Changes

The proposed legislation aims to curb abuse and redirect funds to other tax priorities and expands upon prior enforcement efforts announced on January 17, 2024 in the Tax Relief for American Families and Workers Act of 2024. Major provisions include:

• Retroactive Disallowance: All ERTC claims filed after January 31, 2024, would be invalidated, regardless of the original statutory deadlines (previously April 15, 2024 for 2020 claims and April 15, 2025 for 2021 claims). This could result in retroactive clawbacks or denials for businesses that filed ERTC claims after this date.

• Extended Statute of Limitations: The IRS would have six years (an additional three years from the normal three-year limit) to audit ERTC claims, giving the IRS additional time to audit ERTC claims and make proposed adjustments or denials.

• Promoter Penalties: The bill also targets “COVID-ERTC promoters,” defined as individuals or firms that (1) aid, assist, or advise in filing ERTC claims, (2) charge contingency fees based on the resulting credit or refund, and (3) derive a significant portion of their revenue from such services. Three new penalties are proposed, all of which would apply retroactively to March 12, 2020:

• A penalty equal to the greater of $200,000 per violation for businesses ($10,000 for individuals) or 75 percent of the promoter’s gross income from the claim.

• A $1,000 penalty per violation for failing to meet due diligence requirements in determining ERTC eligibility.

• ERTCs would be treated as listed transactions for promoters, requiring disclosure under Section 6111 and the maintaining of client lists under Section 6112. Failure to comply could result in penalties of up to $200,000 per reporting failure and $10,000 per day for failing to provide client lists upon IRS request.

Legal and Constitutional Concerns

The retroactive nature of the proposed changes has raised serious concerns. Many businesses filed claims in good faith based on existing statutory deadlines. Retroactively invalidating those claims could result in significant financial hardship, especially for businesses that already received or anticipated receiving the credit.

In addition, businesses may have made hiring or financial decisions based on the availability of the ERTC, and a retroactive repeal could penalize those who complied with the law as currently stated. Similar concerns apply to the bill’s retroactive promoter penalty provisions, which would apply enforcement actions and penalties to actions taken since March 12, 2020—more than five years after the changes being made in the proposed legislation. Promoters who advised or assisted in filing ERTC claims under the law as it stood at the time may now face substantial penalties, including monetary fines, based on these new proposed standards introduced after the fact.

Such retroactive tax legislation may undermine the principle of legal certainty and could also violate due process protections under the Fifth Amendment if deemed “harsh and oppressive.” Courts have historically upheld retroactive tax laws, but only when the retroactivity is reasonable in scope and impact. Given the Congressional history of inducing taxpayers to claim the ERTC and the IRS’s large number of unprocessed claims, the proposed legislation appears ripe for constitutional challenge.

Potential Actions for Employers & Promoters

In light of the proposed legislation, employers may want to consider several proactive steps. First, they may want to review the timing of any claims filed after January 31, 2024, to prepare for potential claw backs. Next, employers may want to evaluate relationships with third-party advisors, particularly those who charged contingency fees or made broad claims about eligibility. Employers should consider organizing their documentation and assessing the defensibility of their claims in anticipation of possible audits. If there are doubts about eligibility, voluntarily amending or withdrawing claims may help mitigate penalties. Finally, staying informed about legislative developments is crucial, especially given the bill’s bipartisan support.

Promoters of the ERTC may face considerable legal and financial risks under the proposed legislation. To address these risks, promoters may want to consider conducting a thorough review of all ERTC claims filed on behalf of clients, with particular attention to those based on partial suspension or gross receipts tests. This may include reassessing marketing materials and revising them to remove any guarantees of refunds or implications of automatic eligibility. Promoters may also want to ensure that all client intake processes and eligibility assessments are well documented. Finally, promoters may want to proactively notify clients about the proposed changes and their potential implications, staying aware of updates on enforcement trends and IRS guidance on the subject.