As the summer winds down, Employee Retention Credit (ERC) compliance activity and new guidance from the IRS are heating up. From IRS’s release of a Generic Legal Advice Memorandum (GLAM) to a new set of FAQs and notable ERC remarks from key officials, these recent developments are top of mind for many businesses and advisors. We’ll break them down for you.
Generic legal advice memorandum (GLAM)
While “supply chain disruption” is often used to explain why supplies are delayed or business volume is different from forecast, it is also used as a reason to qualify for an ERC refund. Recognizing this, the IRS documented their official position in the form of a Generic Legal Advice Memorandum (GLAM) for taxpayers and their advisors.
GLAM Number AM 2023-005 was released on July 21, 2023. The GLAM addresses five different scenarios, each detailing whether the employer would or would not have experienced a Full or Partial Suspension Due to a Government Order from an Appropriate Government Authority (the “Suspension Test”) for ERC purposes under IRC Section 2301 or IRC Section 3134. These scenarios address supply chain disruptions of a trade or business and whether each scenario allows an employer to meet the definition of an “eligible employer,” which would allow the employer to receive ERC for the period of eligibility.
The GLAM reminds us that neither the statutory language of IRC 2301 nor IRC 3134 includes “supply chain disruption.” The only reference to eligibility under the Suspension Test related to suppliers is found in IRS Notice 2021-20, Question 12. There is also no use of the term “supply chain disruption” in IRS Notices 2021-20; 2021-23; 2021-49; or 2021-65. Click here to view Question 12 of IRS Notice 2021-20 in full.
Of the five scenarios reviewed by the GLAM, only one scenario finds that the employer is eligible for an ERC under a supply chain disruption argument. In Scenario 3, both the employer and their supplier have operations suspended due to a specific government order that shut down the employer and the supplier for a month. The scenario also finds that the eligibility is limited to only one month in quarter two of 2020, at the height of the COVID-19 pandemic and government shutdowns. The IRS further asserts that businesses should not rely on eligibility in subsequent quarters due to residual effects that may carry over. If the government order is not in effect and the impact is less than nominal, the employer would not qualify.
The IRS position is clarified in this GLAM and taxpayers should take note that a supply chain disruption is not a qualifying government order. While an employer may in fact experience a disruption that impairs their business, the employer must still fulfill the specific statutory requirements which includes a government order that impacted the business.
In addition to producing the exact governmental order that affected the supplier, the employer must substantiate its eligibility for the credit by providing records or documentation demonstrating that:
a. the governmental order caused the supplier to suspend operations;
b. the inability to obtain the supplier’s goods or materials caused a full or partial suspension of the employer’s business operations; and
c. the employer was not able to obtain these critical goods or materials from an alternate supplier.
Note that it’s important to recognize that a particular supplier may have been considered an essential business under its state’s executive order (i.e., essential infrastructure, food distribution, transportation, etc.). Under this scenario, the supplier often falls under an exception that allowed them to remain open and continue operations. This results in item “a” above not being met. If a business was impacted by a supply chain disruption but cannot fulfill all other ERC eligibility requirements, the employer can only qualify if the gross receipts requirements are met.
New Frequently Asked Questions (FAQs)
The IRS released further ERC guidance in the form of a new set of FAQs on its website on July 28, 2023. Prior to IRS Notice 2021-20, taxpayers relied on an initial set of FAQs that were incorporated into IRS Notice 2021-20, which was published in the spring of 2021. This further demonstrates the IRS’s intent to provide new and clarifying guidance to taxpayers.
These FAQs focus on the misleading messages from ERC promotors and ERC mills that the IRS started issuing warnings about in the fall of 2022.
The FAQs address the following issues:
- Eligibility: These FAQs cover what is and what is not an eligible employer.
- Qualifying orders: These FAQs further define what is not a qualifying order under the full or partial suspension rules for a qualifying government order for ERC eligibility, as well as what additional evidence must exist to qualify, including how the employer was specifically impacted by the qualifying order. Lastly, there is some reiteration of what qualifies as a full or partial suspension from IRS Notice 2021-20.
- Significant decline in gross receipts: These FAQs provide a summary of the rules for 2020 and 2021 that allow an employer to qualify for ERC under the significant decline in gross receipts test.
- Recovery startup business: These FAQs review the rules for claiming ERC if the employer qualifies as a business that began operations after February 15, 2020, defined as a recovery startup business. The FAQs also clarify that a recovery startup business must first determine if it qualifies under the full or partial suspension rules or the significant decline in gross receipts rules before it can qualify as a recovery startup business.
- Claiming the ERC: These FAQs cover rules on how to claim the ERC, as well as who should sign the IRS Form on which a claim for refund is requested. One of the FAQs states that if an employer determines they received ERC refunds improperly, they are required to repay the funds and may be subject to additional interest and penalties.
- ERC scams: These FAQs address what the IRS considers a scam or unscrupulous promoter, and further identifies the warning signs that employers should look for to identify scams. One of the FAQs addresses ways employers can protect themselves against scammers.
- Recordkeeping: This FAQ provides a general list of documents that businesses should retain. This list is shorter than those that are requested upon selection for audit.
- Timing: This FAQ addresses the IRS’s timeline for processing claims for refund.
In summary, these FAQs provide further clarification to previous IRS notices and news releases regarding ERC scams. They are a helpful resource for taxpayers who are subject to aggressive marketing tactics as we approach the April 15, 2024, and April 15, 2025, deadlines for submitting ERC claims for refunds for calendars years 2020 and 2021, respectively.
Click here for the full list of FAQs.
Comments from Congressional Officials and Treasury Officials
Recently, there have been many notable ERC comments from various levels of government officials. These comments give us insight into future actions that may be taken on a regulatory or legislative basis.
IRS Commissioner Werfel recently spoke to a group of tax professionals in Atlanta and made the following statement:
“The further we get from the pandemic, we believe the percentage of legitimate claims coming in is declining,” Werfel told attendees at the IRS Nationwide Tax Forum in Atlanta. “Instead, we continue to see more and more questionable claims coming in following the onslaught of misleading marketing from promoters pushing businesses to apply. To address this, the IRS continues to intensify our compliance work in this area.”
When we consider this comment against the backdrop of additional guidance and final regulations being issued, it appears that employers submitting claims going forward may be subject to a higher level of scrutiny. Further, the IRS could assert that the additional guidance and warnings issued should have given employers additional clarification to prevent them from being subject to these unscrupulous promoters.
Werfel made the following additional comment in Atlanta:
“Under the current law, businesses can typically continue to file claims for the credit until April 15, 2025. That raises future concerns,” Werfel said.
Based on this comment, there is some speculation that the Department of Treasury might submit a proposal to Congress to shorten the current deadlines in an effort to reduce the number of fraudulent claims for refunds. House Oversight Committee Chair David Schweikert, R-Arizona, has already publicly commented they would consider this suggestion to move up the deadlines for applying for the credit. Schweikert further stated that his committee might consider an amnesty program where businesses would come forward voluntarily to correct improper claims for refund. In return for amnesty, these employers would be asked to assist the government in pursuing ERC promoters that are perpetrating fraud.
Lastly, at the same event in Atlanta, Werfel made the following blanket statement about the ongoing misinformation campaigns:
“The amount of misleading marketing around this credit is staggering, and it is creating an array of problems for tax professionals and the IRS while adding risk for businesses improperly claiming the credit,” Werfel said. “A terrible scenario is unfolding that hurts everyone involved — except the promoters.”
For the full script of Werfel’s comments, click here.
On July 25, 2023, the IRS conducted a webinar that outlined eligibility as well as compliance efforts. Carolyn Schenck, IRS National Fraud Counsel, discussed the fact that the erroneous refund constituted an underpayment of employment taxes, which could also include fraud penalties. Fraud penalties can be 30% of the total erroneous refund.
Lastly, on July 27, 2023, a House Oversight Subcommittee hearing was held. Committee members heard testimony from practitioners and associations which further supported the IRS’s published comments about aggressive marketing tactics and scams.
Collectively, these statements by government officials indicate their keen awareness of the current activity and ongoing discussion about new laws and regulations that are being considered.
ERC Enforcement Actions
While a significant portion of the enforcement activity relating to the pandemic focuses on instances of incorrect utilization of PPP loans and improper claims for unemployment benefits, there has been some activity that involves ERC claims.
As of April 20, 2023, the IRS reported over 120 ongoing criminal investigations with an estimated total of $1.2 billion in improper ERC claims. Commissioner Werfel continues to mention ERC activity involving the Criminal Investigation division of the IRS. To date, no ERC promoters or mills have been publicly identified.
A July 31, 2023, press release from the Office of Public Affairs of the U.S. Department of Justice reported the arrest of a New Jersey tax preparer who prepared an estimated 1,387 false tax returns for his clients and himself. Total refund amounts for these false returns were estimated at $124 million. In this case, the preparer was inaccurately telling clients that simply having a business qualified them for ERC.
In February 2023, a Utah tax preparer was indicted for conspiracy to defraud the United States. This firm allegedly filed over 1,000 false tax returns claiming more than $11 million in ERC refund claims. In this case, the firm was soliciting sole proprietors and single member LLCs, converting them to other businesses, then claiming eligibility.
Even though specially trained IRS agents are conducting audits, the extent of audit activity remains limited at present.
What's Next for ERC
The IRS is continuing to impose more restrictive rules as it solidifies its position on employers trying to qualify under the partial shutdown. As a result, there could be some policy changes coming. Additionally, more public announcements could be forthcoming on IRS criminal activity. We will continue to monitor new guidance and enforcement activity. Please contact your Sikich tax advisor with any questions or issues related to ERC.
About our Authors
Debbie Warden
Debbie Warden, CPA, is a tax director with more than 25 years of experience providing tax and accounting services to businesses and individuals with special attention to minimizing tax liabilities through tax planning, including tax credits and other incentives. Her background in both public accounting and industry gives her insight into the challenges faced by businesses and the strategies available to overcome them.
Tom Bayer
Thomas Bayer, CPA, CExP, is the market lead for the Indianapolis, Indiana region. He has 30 years of experience providing a broad range of accounting, tax and business advisory services to commercial clients across various industries.
Jim Brandenburg
Jim Brandenburg, CPA, MST, is a partner with extensive experience and knowledge in corporate and partnership tax law, mergers and acquisitions and tax legislation. His expertise includes working with owners of closely held businesses to identify tax planning opportunities and assist them in implementing these strategies.
