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ERC Promoter Claims: Too Good To Be True?

July 18, 2023

More than three years after the Employee Retention Credit (ERC) was launched, U.S. businesses are still being bombarded with plugs to take advantage of the program: Commercials, radio ads, pop-ups on the Internet, even billboards are claiming nearly anyone can claim the credit. And with a potential credit of up to $26,000 per employee, these messages are hard to ignore. However, if these claims seem too good to be true, it might be because they are.

A plethora of niche service providers have jumped on the bandwagon in the past couple of years to “help” businesses claim ERC-related refunds. These providers are charging fees as high as 25% of the earned credit. What’s worse, many of these providers do not vet whether a business actually qualifies. They may claim qualification based on extremely aggressive interpretations or on an outright inaccurate basis. Equally as bad, they often calculate the credit incorrectly. All of these have potentially severe consequences for businesses that fall victim to these activities.

While these providers might seem professional and well-versed in the ERC – even offering “audit support” with a promise to pay back the fee should you lose – they are often a scheme.

The bottom line is this: The ERC is an extremely lucrative credit, and every taxpayer needs to carefully consider whether they qualify and the strength of their claim.

IRS Scrutiny

As the IRS has processed ERC claims over the past few years, certain patterns have arisen, and claims have been identified as erroneous or even fraudulent. Many of these claims have been prepared and filed by opportunists who saw “easy money.” Until recently, ERC checks have been mailed as soon as claims were processed. That has now changed. The IRS has issued numerous warnings and added the ERC to its “Dirty Dozen” list of tax scams.

The IRS stated that it is “actively auditing and conducting criminal investigations.” While the audits have been slow to start, information requests are coming out from the IRS and asking for detailed information such as:

  • Paycheck Protection Program (PPP) information to ensure that wages were not used towards both programs
  • Worksheets detailing the computations of the credit by employee
  • Eligibility for the credit, including:
    • Copy of the governmental order limiting commerce, travel, group meetings (such as social, commercial, religious, or other)
    • Documentation of the dates the business or operations were fully or partially suspended due to said order
    • Documentation of a significant decline in gross receipts during the calendar quarters at issue
  • Copies of business income tax returns for 2020 and 2021
  • Copies of all employment returns for 2020 and 2021
  • Copies of form 1040 of all principals, partners, or shareholders

The documentation requests help the IRS determine ERC eligibility and ferret out questionable, aggressive, or fraudulent claims. The area that will likely be most contested is eligibility – i.e., whether a business has suffered a partial suspension due to a government order. To claim the ERC under this premise it is imperative that businesses have the following:

  1. Copies of the government order(s) that they were impacted by
  2. Documentation that demonstrates how the specific government order(s) had a more than “nominal” impact on business operations.

Broad claims based on CDC guidance or minimal impacts due to supply chain, work from home, and other similar issues will be subject to extensive review and additional scrutiny.

What’s the Risk?

Where the documentation cannot be produced or is insufficient, the IRS will disallow the credit. This results in dire consequences for the business and the related principals involved. First, any refund erroneously received by the business would need to be returned to the IRS with additions for penalties and interest. With recent interest rates rising sharply, the imposition of penalties and interest can become very expensive very fast. While a service provider may offer to pay back their fees if a business loses, the business has to be able to find the provider. Even if a business can find the provider and get fees refunded, the refund will not cover the penalties and interest that the business will have to pay.

For flow through entities such as partnerships and S Corporations, the owners would be affected as well. The payroll deduction for the year the ERC relates needs to be reduced by the amount of the of the ERC credit for that year. If this was not done on the originally filed return, the 2020 and/or 2021 business returns were likely recently amended to increase income by the applied for credit. Owners are typically happy to pay additional income tax for the business to receive a lucrative credit. However, if the credit is disallowed, the entire process becomes an expensive and futile exercise. If the exam is not completed in time, the statute of limitation may run out. This will prevent the business from once again amending its returns to recoup the disallowed deduction. This result is the worst possible outcome. The business and its owners would forgo a valid and allowable deduction, no credit, and pay a fee to the firm for creating the mess. It would be insult on top of injury.

Next Steps

If a business has already claimed the ERC credit and has concerns about qualification or the sufficiency of its documentation, it is better to get ahead of this now. Being proactive before an audit allows businesses to either a) enhance documentation outside the scrutiny of an audit, or b) file a new Form 941-X to claim the proper amount of credit. The service provider that a business originally used to calculate and file the credits should be able to provide its documentation and calculations, which the business can review and/or share with a different service provider to review.

If you haven’t considered the ERC yet or have questions about eligibility, there is still time. A timely filed payroll tax return has a three-year statute of limitation. Treas. Reg. 301.6501(b)-1 provides a special rule for payroll tax returns that states if quarterly filings are required, the statute does not begin until April 15 of the following year. For example, a Q2 2020 941 statute would be considered as having been filed on April 15, 2021. This means that the statute is open until April 15, 2024.

Whether you need help analyzing eligibility and preparing the calculations or you need a second set of eyes on a previously filed claim, KSM can help. Reach out to your KSM advisor or complete this form.

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