Is There Anything Besides the ERC Happening in Washington?

By:  William E. Sigler, Esq.

With the gridlock in Congress, an argument could be made that the only things happening in Washington these days involve the Employee Retention Credit (ERC). 

True, in late January the House passed a $79 billion collection of business and family tax breaks.  The bill would allow taxpayers to deduct research expenses for 2022 through 2025, but only for domestic research; delay the tightening of the interest deduction limitation until 2026; and substitute the 80%, 60%, and 40% bonus depreciation for tax years 2023 through 2025 with 100% bonus depreciation, and then revert to 20% bonus depreciation for 2026.

The bill would also change the calculation of the refundable child tax credit to a per-child basis, meaning that once the earned income amount in excess of $2,500 is multiplied by 15%, that amount would then be multiplied by the total number of children, resulting in the total refundable amount. This change would apply to the 2023, 2024, and 2025 tax years.  In addition, the maximum amount of the refundable credit would be increased to $1,800 for 2023, $1,900 for 2024, and $2,000 for 2025. The credit would then be adjusted for inflation from the $2,000 amount for 2024 and 2025. 

However, that bill stalled in the Senate which, now that it has returned from its recess, must address the March 1^st and March 8^th partial governmental shutdown deadlines previously created by Congress.  The tax package could be added to that legislation, possibly along with an extension of the passenger and aviation taxes that otherwise expire on March 8^th. 

But, incredibly, even this tax package has not escaped the reach of the ERC.  It includes provisions that would make penalties applicable to ERC promoters, and extend the statute of limitations on assessment for the ERC to six years.  Most alarming to those who have not yet filed their ERC claims is a provision that would deny an ERC, unless the claim for the refund or credit was filed on or before January 31, 2024. 

Endless Tinkering

The ERC largely only applies to 2020 and, unless you are a “recovery start-up business,” the first three quarters of 2021.  However, besides the countless FAQs and other guidance issued by the IRS, if you want to figure out how the ERC works, you have to consult the Coronavirus Aid, Relief and Economic Security Act enacted on March 27, 2020, the Taxpayer Certainty and Disaster Tax Relief Act enacted on December 27, 2020, the American Rescue Plan Act enacted on March 11, 2021, and the Infrastructure Investment and Jobs Act enacted on November 15, 2021 (and, maybe, the tax bill passed by the House if it ever gets through the Senate). 

Generally speaking, in order to be eligible for the ERC, an employer must qualify in one of the following three ways:

1. Experience a full or partial suspension of operations due to orders from an appropriate government authority during 2020 or the first three quarters of 2021.
   
2. Experience a significant decline in gross receipts during 2020 or a decline in gross receipts in the first three quarters of 2021.  For 2020, gross receipts needed to be 50% less than gross receipts in the same calendar quarter in 2019.  For 2021, gross receipts needed to be less than 80% of gross receipts in the same calendar quarter of 2019.  Thus, it became easier to meet the test in 2021. 
   
3. Qualify as a “recovery startup business” in the third or fourth quarters of 2021. 

For 2020, the ERC was based on 50% of qualified wages with wages limited to $10,000 per employee for the year, including health care expenses.  For 2021, the ERC was based on 70% of qualified wages with wages limited to $10,000 per employee per calendar quarter, including health care expenses.  Thus, the amount of the ERC was potentially much greater in 2021.  The credit was claimed by amending the applicable Forms 941. 

Early Rumblings

Almost right from the beginning there were problems.  One area of particular concern was the governmental order test.  Soon after Congress enacted the CARES Act, the IRS posted a list of FAQs on its website.  Several of them concerned the governmental order test.  These were later incorporated into Notice 2021-20. 

Additional concerns have arisen, and more guidance has been issued, since the release of Notice 2021-20.  For example, the IRS issued GLAM 2023-005 on July 21, 2023, and then some new FAQs on July 28, 2023. This guidance is intended to address the interplay between the governmental order test and supply chain issues.  In the FAQs, the IRS established the following test for ERC claims based on supply chain issues:

1. The governmental order must have caused the supplier to suspend operations;
   
2. The employer could not obtain the supplier’s goods or materials elsewhere regardless of cost; and
   
3. The foregoing resulted in a full or partial suspension of the employer’s business operations. 

Second Thoughts?

On September 14, 2023, the IRS announced a moratorium on processing ERC claims at least through the end of 2023.  And then on October 19, 2023, the IRS announced a special withdrawal process to help those who filed an ERC claim and are having second thoughts about its accuracy.  This program allows certain employers that filed an ERC claim, but have not yet received a refund, to withdraw their submission and avoid future repayment, interest and penalties.  However, the IRS was quick to note that withdrawing a fraudulent claim will not protect against potential criminal investigation and prosecution. 

The announcement also indicated that, with stricter compliance reviews in place, existing ERC claims would go from a standard processing goal of 90 days to 180 days – or longer if the claim faces further review or audit.  This part of the announcement came as no surprise, since most employers found that it took longer for ERC claims to be processed anyway.  However, the announcement also indicated that the IRS would be seeking additional documentation from taxpayers in circumstances where it felt that it was necessary to ensure that the claim filed was legitimate.

To use the ERC claim withdrawal process, all of the following must apply:

1. The claim must have been made on an adjusted employment tax return (Forms 941-X, 943-X, 944-X, or CT-1X);
   
2. The adjusted return must have been filed only to claim the ERC, i.e., there must have been no other adjustments;
   
3. The entire amount of the ERC claim must be withdrawn; and
   
4. The IRS must not have paid the claim or, if the IRS has paid the claim, the taxpayer must not have cashed or deposited the refund check.

Taxpayers who have received a refund check, but haven’t cashed or deposited it, are still able to withdraw their claim by voiding the check and mailing it with their withdrawal request pursuant to the instructions on the IRS’ website.  Taxpayers who are not eligible to use the withdrawal process may be able to reduce or eliminate future repayment, interest and penalties by filing an amended return. 

Paybacks!

The IRS next announced an ERC voluntary disclosure program on December 21, 2023.  This program allows employers who erroneously claimed an ERC to repay 80% of the credit they received.  Implicit in the 80% is the thought that 20% was likely paid to a promoter – which gives you a good idea as to whom this program is being targeted.  Interested employers must apply to the ERC voluntary disclosure program by March 22, 2024.

In order to take advantage of this program, the employer must identify any advisors or tax preparers who helped them with their claim to qualify for the program.  The IRS will not charge interest or penalties, provided the 80% is repaid.  If an employer is unable to repay the 80%, interest or penalties will not be avoided, but the employer may be considered for an installment agreement. 

Other requirements for the ERC voluntary disclosure program include the following:

• The employer must not be under a criminal investigation. 

• The employer must not be under an IRS employment examination for the period they are applying.

• The employer must not have received an IRS notice and demand for repayment of any part of the ERC. 

• The IRS must not have received information from a third-party that the taxpayer is not in compliance nor acquired information directly related to the noncompliance from an enforcement action.

Form 15434 is used to apply for the ERC voluntary disclosure program.  Employers who outsource their payroll must apply through the third party. 

Your Adjustment is in the Mail

About the same time as the ERC voluntary disclosure program was rolled out, the IRS announced that it had started sending up to 20,000 letters with proposed tax adjustments recapturing what they view as erroneously claimed ERCs.  These mailings, which are on top of another 20,000 denial letters announced earlier in December, are just for tax year 2020.  Thus, more adjustments should be expected for ERC claims filed for 2021. 

Danger, Will Robinson!

On February 13, 2024, the IRS issued a list of seven red flags which to them suggest that an ERC claim might be incorrect:

1. Some promoters have urged employers to claim the ERC for all quarters that the credit was available.  The IRS finds that qualifying for all quarters is uncommon.  Thus, claiming for all quarters signals a potentially incorrect claim. 
   
2. Some promoters have told employers that they can claim the ERC if any governmental order was in place in their area, even if their operations were not affected or the employer chose to suspend their business operations voluntarily.  Other promoters have suggested that employers qualify based on communications from OSHA, or they supply the employer with a generic narrative about a governmental order.  All of these premises for filing an ERC claim are, in the view of the IRS, likely to be misguided.  To claim the ERC under the governmental order test, the IRS requires the following:

• The government order must have been in effect and the employer’s operations must have been fully or partially suspended by the government order during the period for which they are claiming the credit;
• The government order must be due to the COVID-19 pandemic; and
• The order must be a government order, not guidance, a recommendation or a statement. 

3. Employers should be cautious about claiming the ERC for all wages paid to every employee on their payroll.  There are dollar limits and varying credit amounts, and rules for wages that are considered “qualifying wages,” depending on the tax period. 
   
4. Qualifying for the ERC based on a supply chain disruption is very uncommon in the view of the IRS.  A supply chain disruption by itself is not enough to qualify.  For example, the employer still needs to make sure that their supplier’s governmental order satisfies the requirements. 
   
5. It is possible, but uncommon for an employer to qualify for the ERC for the entire calendar quarter if their business operations were fully or partially suspended due to a government order during only a portion of a calendar quarter.  Generally, a business in that situation can claim an ERC only for wages paid during the suspension period, not for the entire quarter. 
   
6. Employers can only claim the ERC for tax periods when they paid wages to employees.  Some taxpayers have claimed the ERC, but records available to the IRS show they didn’t have any employees.  Others have claimed the ERC for tax periods before they even had an EIN, suggesting that the business didn’t exist during the eligibility period. 
   
7. Any ERC promoter that urged an employer to file a claim because they “have nothing to lose” should certainly send up a red flag! 

PEOs and Promoters Beware

The IRS released generic legal advice on February 15, 2024, advising third-party payers, such as professional employer organizations, that handle payroll administration and tax reporting for businesses that they may be liable for underpayments of employment tax if the ERC was improperly claimed. 

The advice describes three different types of third-party payers:  a Section 3504 agent, a non-certified professional employer organization (PEO), and a PEO certified by the IRS.  The IRS concludes that a third-party payer that is a Section 3504 agent, PEO, or IRS-certified PEO is liable for any underpayment resulting from an improperly claimed ERC that the third-party payer claimed for a client on the third-party payer’s employment tax return filed under the third-party payer’s EIN when the credit was claimed based on wages paid by the third-party payer to the client’s employees. 

The tax bill passed by the House would include the following provisions for ERC promoters:

• The penalty for aiding and abetting the understatement of a tax liability would be increased  to the greater of $200,000 ($10,000 in a case of an ERC promoter that is a natural person) or 75% of the gross income of the ERC promoter from providing aid, assistance or advice with respect to a return or claim for an ERC refund or a document relating to the return or claim. 

• For purposes of present-law disclosure and other requirements, as well as penalties relating to reportable and listed transactions, an ERC would be treated as a listed transaction as well as a reportable transaction with respect to an ERC promoter that provides any aid, assistance or advice with respect to an ERC, and the ERC promoter is treated as a material advisor.

• An ERC promoter would be required to comply with due diligence requirements with respect to an employer’s eligibility for, or the amount of, an ERC and would be subject to a $1,000 penalty for each failure to comply.  In addition, if the ERC promoter does not comply with these due diligence requirements, then the knowledge requirement would be treated as being satisfied for purposes of imposing the penalty for aiding and abetting an understatement of a tax liability. 

In addition, the statute of limitations on assessment for the ERC would be extended to six years after the latest of:  (i) the date on which the original return for the relevant calendar quarter is filed; (ii) the date on which the return is treated as filed under present-law statute of limitations rules; or (iii) the date on which the credit or refund with respect to the ERC is made. 

Not the End!

It’s clear that reining in claims for the ERC is a top priority of the IRS.  The ERC has likewise caught the imagination of Congress, although it remains to be seen whether Congress can act on any of its concerns.  But, even besides Congress and the IRS, lawsuits are beginning to appear between employers, promoters and other tax professionals.  This suggests that issues involving ERC claims are likely to be front page news for the foreseeable future. 

If you have any questions or need assistance, please visit our Tax Practice Group page or contact one of our tax attorneys.