Employers: Beware of Employee Retention Credit Schemes From Third-Party Promoters
You’ve almost certainly heard of the Employee Retention Tax Credit (ERC) since it was introduced on March 27, 2020, as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. It has been mentioned countless times in the news, in commercials and in third-party email blasts. Likely, you have also discussed the ERC with other colleagues.
The IRS and tax professionals continue to see third parties aggressively promoting ERC schemes on both the radio and online. You have probably heard the phrase, “Did you know your business may be eligible for up to $26,000 in payroll tax credits per employee?” A hook like this would undoubtedly make you question whether this is something that you are missing out on. And, while you want to make sure that you are seizing your piece of the pie, taxpayers should carefully review the ERC guidelines before trying to claim the credit and be wary of offers promising tax savings that are too good to be true.
These third-party promoters push businesses to file a claim for the credit even though they may not be eligible to do so while typically charging the filer either large upfront fees or a fee that is contingent on the amount of their refund. In addition, the promoters may not inform taxpayers that they must reduce the wage deductions reported on the federal income tax return by the amount of the credit, essentially creating additional federal income tax or reducing any net operating loss (NOL) carryforwards.
The ERC is a valuable credit for those who qualify. However, claiming the credit improperly could result in taxpayers having to repay the credit along with potential penalties and interest.
Qualifying for ERC
The ERC is a refundable tax credit for businesses that continued to pay employees while being forced to shut down due to the pandemic or who had significant declines in gross receipts.
Currently, eligible taxpayers can claim the ERC on an amended employment tax return during a qualifying period.
To be eligible for the ERC, employers must have:
- Sustained a full or partial suspension of operations due to orders from an appropriate governmental authority due to COVID-19 during 2020 or the first three quarters of 2021;
- Experienced a significant decline in gross receipts during 2020 or the first three quarters of 2021; or
- Qualified as a recovery startup business for the third or fourth quarters of 2021.
Eligible employers can’t claim the ERC on wages that were reported as payroll costs in obtaining Paycheck Protection Program (PPP) loan forgiveness or that they used to claim certain other tax credits.
The significant decline in the gross receipts test is a strictly objective calculation, whereas the suspension of operations qualification is quite the opposite. You may think, couldn’t an argument be made that almost all businesses were impacted by COVID-19 in some way, shape or form? That is exactly what third-party promoters for the ERC are asserting. The promoters often take improper, overly aggressive positions related to the taxpayer to gain eligibility for the ERC. One of these improper, overly aggressive positions is claiming that a business had operations partially suspended due to supply chain issues. They may argue that a business could not obtain the materials it needed for its operations. Although this may be legitimate, given the circumstances, if a business’s revenue grew or did not experience a significant decline, one is hard-pressed to argue that the supply chain issue suspended operations, as clearly the business persevered through this time.
The IRS has also been clear that they have made it a priority to audit ERC claims. A specific issue related to the IRS audits is the discrepancy in the IRS statute of limitations for auditing ERC (five years) compared to the statute of limitations for amending business tax returns (three years). To avoid entities from obtaining a double benefit, the IRS requires that wage deductions are reduced in the year associated with the ERC claim. This means taxpayers claiming ERC for a 2020 period will need to amend the corresponding 2020 tax return (2021 tax return for 2021 ERC claims) to make this wage reduction adjustment and either adjust NOL carryforwards or pay the additional tax resulting from this adjustment. Based on the current statutes, in the event of an IRS disallowance of an ERC claim in year four or five of the IRS audit statute, a taxpayer may not only have to pay back the credits but may have also lost the opportunity to amend 2020 and/or 2021 tax returns (with expired three-year statutes) to reclaim the lost wage deductions that resulted in NOL carryforward adjustments and/or additional tax paid.
However, businesses that can document their eligibility shouldn’t hesitate to file a claim for an ERC refund. The credits are claimed on amended payroll tax returns, and claimants will be issued a check from the U.S. Department of the Treasury if their returns are accepted by the IRS. The IRS has provided some clarification on the deadline to apply for the ERC, and instead of the ERC filing window closing each quarter, relative to the quarter the credit is claimed, the filing window closes only once for each year of the ERC. For all quarters in 2020 that the ERC eligibility is determined, the deadline to apply for the ERC is April 15, 2024. For all quarters in 2021 that the ERC eligibility is determined, the deadline to apply for the ERC is April 15, 2025.
Given the prevalence of abuse and potential fraud in this area, employers should do their due diligence in determining eligibility for the ERC and work with a trusted professional to do so.
Contributing Author: Shawn T. Layo, CPA, is a tax partner at Dannible & McKee, LLP with over 20 years of experience in taxation and planning for individuals and closely-held companies. He is responsible for overseeing tax engagements for a variety of clientele with a focus on manufacturing, construction, retail automotive, multi-state corporations and high-net-worth individuals. For more information on this topic, you may contact Shawn at email@example.com or (315) 472-9127.