Since its introduction three years ago under the CARES Act, the Employee Retention Credit (ERC) has had a significant impact on many for-profit and not-for-profit employers, large and small. The ERC got off to a slow start, as most employers opted for a Paycheck Protection Program (PPP) loan instead. Following the enhancement of the ERC under the CARES Act 2.0, the ERC became available to employers even if they had obtained a PPP loan, although the same wages could not be used for both the ERC and PPP. The floodgates opened as employers wanted to learn about their eligibility for the ERC incentive.
We address the ERC in a number of articles and resources. The latest can be found below:
The Latest Developments of the Employee Retention Credit Part 1
As employers searched for direction on the technicalities of the ERC, opportunistic ERC brokers sprang up, seeking to aid employers with hopes of obtaining a refund. Some of these brokers were professional and diligent in following IRS guidance to assist. However, other brokers were often aggressive in their search for business owners and pushed the envelope in their interpretations of the IRS’s ERC guidance. ERC brokers also received a percentage – often 10-35% – of an employer’s ERC refund.
As brokers increased their outreach to businesses, the IRS cautioned employers about aggressive ERC brokers contacting unsuspecting taxpayers (many of whom did not qualify for the ERC). The IRS has recently issued announcements related to this topic:
- IRS warning on ERC mills
- IRS alert to tax practitioners about concerns of professionals not following IRS standards
In this, the IRS cautions practitioners about their responsibility in working with ERC situations. The IRS notes that “to fulfill their professional obligations to clients and to tax administration, practitioners (attorneys, CPAs, and enrolled agents) must meet the applicable provisions in Circular 230.” A key aspect of Circular 230 involves a practitioner exercising “Diligence as to Accuracy” (Section 10.22(a) of Circular 230). The IRS notes the following:
- If the practitioner cannot reasonably conclude (consistent with the standards discussed in this guidance) that the client is or was eligible to claim the ERC, then the practitioner should not prepare an original or amended return that claims or perpetuates a potentially improper credit.
- Additionally, if a practitioner learns that a current client did not comply with the ERC requirements in a prior tax year, the practitioner must, under Section 10.21, promptly inform the client of the “noncompliance, error, or omission” and any penalty or penalties that may apply.
Therefore, not only must employers be cautious in pursuing ERC claims, but tax practitioners must also exercise diligence in working with the ERC.
- On March 20, 2023, the IRS embarked on its annual “Dirty Dozen” campaign of tax scams. At the top of the list in 2023 was abuse of the ERC.
ERC Audits
IRS audits of the ERC have started, and in some cases, will involve an onsite visit by an auditor and/or a corresponding audit. Employers should expect increased IRS scrutiny of these claims. It is predicted that audit activity will increase as this year progresses, with many practitioners saying that by the end of 2023, professionals will have a better understanding of the types of ERC claims that are being disallowed.
During an examination, the IRS will request documentation from employers concerning its ERC funds and whether they comply with IRS guidance. Some disputed cases will eventually find their way to the courts, as legal arguments supporting ERC eligibility due to a suspension will be tested.
If an employer has their ERC claims disallowed, they will be forced to pay back the ERC amounts they claimed, possibly with interest and penalties tacked on. If an ERC claim is disallowed and has to be repaid, one challenge for employers that worked with an ERC broker will be to obtain a refund of fees paid. The ability to recover these fees may largely depend on the terms of the contract signed.
More resources are being considered to address CARES Act-related fraud. On March 2, President Biden announced a $1.6 billion plan to combat pandemic aid fraud (inclusive of multiple programs, such as the ERC). Total fraud, according to the Department of Labor Office of Inspector General, stands at $191 billion. President Biden proposed these additional resources as a part of a package expected to enter Congress in June.
What does an employer do now with the ERC?
Be Diligent. Review your situation in relation to the IRS rules on the ERC. As the employer signing the ERC refund claim, you bear the responsibility for it to be thorough and diligent in determining your eligibility, ERC calculations, and support of your files. If you engage a consultant or ERC broker to assist you, consider the terms of the contract for payment. Will you be required to pay the fees even before the ERC refunds are received? In the event the ERC claim is disallowed in an audit, will the broker or consultant refund their fees?
Lastly, make sure you understand the net amount you will receive after all fees and additional taxes on amended tax returns are paid.
Don’t Rush. Don’t rush the filing of your claim. As noted above, take the time to be diligent and don’t feel any pressure to file the ERC claim until you are comfortable with it. The statute of limitations does not start to run until 2024 for claims from 2020 and 2025 for claims from 2021.
Retain Documentation Supporting the Claim. Assume that the IRS will examine your ERC claims. Gather and retain all the applicable documentation now as you file. If you have already filed your claim, go back through the ERC filings and make sure to collect your documentation, even if the IRS has not contacted you for an exam.
If you had a consultant or ERC broker prepare your claim, request all documentation from them to retain in your file – don’t assume the third-party has these materials. To aid you in this documentation process, we prepared a checklist of items you and your advisors should expect to provide during the audit process.
Pay Now; Refund Later. One reminder with the ERC: if you obtain a refund, it needs to be included in your taxable income for the period the wages were earned that generated the ERC. For example, if you filed an ERC claim in 2021 and didn’t receive your refund until late 2023, you still need to include the ERC amount in your taxable income for the year of the claim (2021). Amended income tax returns will likely be needed to include this ERC in taxable income. Thus, an employer must pay the income tax cost now, for the amount of the ERC to be received later.
Red Flag with Government Orders. There are generally two methods a business or not-for-profit can follow to be eligible for the ERC. The first method involves a significant decline in the employer’s gross receipts in a calendar quarter compared to the same quarter in 2019. This is objective and generally straight-forward in calculating eligibility.
The other method of eligibility involves a full or partial shutdown of the business or not-for-profit due to a government order. This is a much more subjective determination. Many of the ERC brokers are presenting the opportunity to generate refund claims under this method. In some cases, they use aggressive and seemingly unsupportable legal positions to help employers qualify for the ERC. It is anticipated that these aggressive positions will cause impacted employers to be subject to audits that will consume time and resources and may ultimately be overturned.
Proceed with caution if you are filing an ERC claim in which you are relying on a government order. We would recommend obtaining a legal opinion from your independent legal counsel before doing so to gather their review of (1) the applicable government orders, (2) that these orders apply to your business, and (3) that the order satisfies the IRS guidance issued on government orders.
For businesses or not-for-profits that started during the pandemic (generally defined as after February 15, 2020), those businesses may qualify for ERC in the third and fourth quarter of 2021 if they are below $1 million in annual gross receipts and meet other eligibility requirements.
Consult With Advisors. If you take these steps and are diligent in your work, you should also contact and review your ERC claim with your outside advisors. An advisor should be independent from an ERC broker and use the IRS guidance as their justification for claiming or not claiming the ERC. You may also need to obtain a legal opinion on the ERC, as noted above.
The ERC continues to present a significant opportunity for employers. It also poses a critical exposure area for others. Caution should be adhered to, whether an employer is considering an ERC now or has previously filed an ERC claim. Take a closer look at your documentation now, as the IRS will likely review it. Employers should apply ERC (“Employers Respond Cautiously”) in dealing with the credit.
Please contact your Sikich advisor with any questions:
About our authors
Jim Brandenburg
Jim Brandenburg, CPA, has 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.
Tom Bayer
Thomas Bayer, CPA, CExP, has 30 years of experience providing a broad range of accounting, tax and business advisory services to commercial clients across various industries. Tom has specialized expertise in the areas of tax planning and compliance, business advisory services, and business succession planning.
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.
