Employee Retention Credits – Issue Spotting

Updated March 21, 2023 

A renewed warning was issued earlier this month as the IRS and tax professionals continue to see third parties aggressively promoting Employee Retention Credit (ERC) to ineligible taxpayers. Similarly, promoters may not inform taxpayers that wage deductions claimed on the business’ federal income tax return must be reduced by the amount of the credit. Improperly claiming the ERC could result in taxpayers being required to repay the credit along with penalties and interest. Per Acting IRS Commissioner Doug O’Donnell, “the IRS is actively auditing and conducting criminal investigations related to these false claims. People need to think twice before claiming this.” 

Updated October 19, 2022

The Internal Revenue Service warned employers to be wary of third parties who are advising them to claim the Employee Retention Credit (ERC) when they may not qualify. Some third parties are taking improper positions related to taxpayer eligibility for and computation of the credit. These third parties often charge large upfront fees or a fee that is contingent on the amount of the refund and may not inform taxpayers that wage deductions claimed on the business’ federal income tax return must be reduced by the amount of the credit. It appears the IRS is finally catching up.

Posted December 6, 2021

Many businesses will benefit from the Employee Retention Credit (ERC), most will not. Although Tax Guard does not prepare returns or directly file for ERCs, we wanted to share some of our clients’ experiences. Tax Guard primarily negotiates installment agreements and subordinations of federal tax lien for businesses that owe money to the IRS and also borrow money from banks, asset-based lenders, and other lenders. If you have an IRS liability and do not qualify for an ERC, give us a call to discuss options for resolving the liability and preserving your funding relationship.

Employee retention credits

Employee Retention Credits: The Background

The ERC was created in March 2020 by the CARES Act, then later modified by the Consolidated Appropriations Act (December 2020), American Rescue Plan Act (March 2021), and Infrastructure Investment and Jobs Act (November 15, 2021). Qualifying businesses can claim these credits on wages and health insurance benefits paid to employees. Properly calculated credits reduce payroll taxes and, depending on the amount, generate cash refunds as well because the credit is “refundable.” As such, it is an extremely valuable tool for some businesses. Every business should consult its CPA or tax professional to determine whether it qualifies for the generous benefits. 

Unfortunately, we’ve seen a number of ERCs through our monitoring service that don’t pass the sniff test. We’ve also seen an explosion in the number of companies offering to prepare tax credits in the past few months. The current situation is a bit like the wild west – businesses are shooting first by filing for credits without considering the rules, which are confusing and cumbersome. The sheriff, the IRS, will ultimately get around to cleaning up the mess, but it will take a few years. Our advice is simple – ask your CPA or tax professional about the ERC, make sure you qualify, and don’t be tempted to overstate the amount of the credit. 

Employee Retention Credit Eligibility

The ERC is available for both for-profit and non-profit employers, but not all businesses are eligible. Businesses must qualify for the credit, and there are two tests for eligibility: (1) a partial or total government-ordered shutdown or (2) an applicable decline in gross receipts.

Shutdown. The credit for a partial or total government shutdown is only applicable to the portion of the quarter business was suspended, not the entire quarter.  

Decline in Gross Receipts. The decline in gross receipts test depends on which quarters a business claims a credit.  

  • For the second, third, and fourth quarters of 2020, gross receipts must be at least 50% less than the same quarter in 2019.  
  • For the first, second, and third quarters of 2021, gross receipts must be at least 20% less than the same quarter in 2019.  
  • Businesses also have the option of determining eligibility based on gross receipts in the immediately preceding calendar quarter (compared with the corresponding quarter in 2019). 

Amount of the Credit

Assuming a business qualifies for the ERC, the amount of the credit also depends on the quarter in which the business claims the credit.  

  • For wages paid between March 13, 2020, and December 31, 2020 (the second, third, and fourth quarter 2020 941 returns), the ERC is 50% of qualified wages paid, up to $10,000 per employee annually. The maximum is $10,000 per employee for the year.  
  • Initially PPP recipients were not eligible for the ERC. However, credits can now be taken on wages so long as they are not forgiven or expected to be forgiven under PPP. 
  • For wages paid between January 1, and September 30, 2021 (first, second, and third quarter 2021 941 returns), the ERC is 70% of qualified wages paid, up to $10,000 per employee per quarter. The maximum is $21,000 for the year, which means the 2021 credits are much more robust than the 2020 credits. 
  • Note: the description of the ERC in this blog post applies to small employers (less than 500 employees). There are different and/or additional rules that apply to large employers, recovery startup businesses, etc. Again, before filing for the credit, check with your CPA or tax professional. 

Nature of the Credit 

Businesses claim the ERC on the quarterly Form 941 payroll tax returns. There are two parts to the credit – non-refundable and refundable.  

  • First, the non-refundable portion of the credit is used to offset the Social Security or Medicare portion of the taxes, depending on the quarter in question. The nonrefundable portion of the ERC reduces either (a) Social Security taxes for the 2020 quarters as well as the first and second quarters of 2021, or (b) Medicare taxes for the third quarter of 2021.  
  • Second, if the credit exceeds the employer’s total liability of the portion of the Social Security taxes (or Medicare taxes for the third quarter 2021), the excess credit is refunded to the employer/business. 

Issues with Filing for the ERC

Again, the ERC is potentially an awesome tool, but make sure the business qualifies and the calculations are correct. There are some common issues. 

First, ERC rules are confusing. Four pieces of legislation created and modified the ERC. The rules are complex, and as recently as early August the program looked like a failure. However, in the past few months we’ve seen a surge in the number of claimed credits. Unfortunately, many of these credits may not be legitimate. The IRS does not require proof of eligibility or the calculations when a business claims the ERC on the quarterly 941 return. As such, it’s easy to play fast and loose with the numbers up front (the IRS will eventually reconcile the credits and ask for the money back with penalties and interest, if applicable). 

For example, we recently came across a $1.5 million ERC for the second quarter 2021, which raised a few questions. First, the 941 return indicates there are approximately 80 employees, which should result in a maximum credit of $560,000 ($7,000 * 80; note: this crude calculation does not account for the non-refundable Medicare tax offset). Second, there were only approximately 40 employees in the same quarter in 2019, which would seem to indicate the business’s receipts or revenues probably increased in 2021 compared to 2019 (double the employees likely means more work; more work means more revenue). If so, the business would not qualify for the ERC (no decline in gross receipts). 

  •  Takeaway – if you file an ERC, make sure it is prepared by a reputable and knowledgeable CPA or tax professional. Also, don’t be tempted to overstate the credit because the IRS does not require proof up front; the IRS will reconcile the credits within two or three years and, at a minimum, pursue collection any erroneous credits or refunds. 

Second, businesses can retroactively claim the ERC using amended returns (941-X). So, if they missed claiming the credit the first time around, there is a second bite of the apple available. Many businesses are now filing amended 941 returns. Not surprisingly, the IRS, who has not recovered from its collection moratorium in 2020, is behind in processing the returns. Per the National Taxpayer Advocate (NTA), as of October 30, 2021, the IRS has a backlog of 2.7 million unprocessed amended returns. Although the IRS says its current processing time is 20 weeks, the NTA data indicates the processing time is considerably longer than 20 weeks. Additionally, the NTA indicates it will not provide any assistance relative to the amended returns (hurry up and wait). 

  • Takeaway – if you are file an ERC, you should expect to wait 9 months or more from the date the amended return was filed for the refund check to be mailed to you. 

Conclusion 

Many businesses will benefit from the ERC. However, if not calculated properly, the ERC can create problems for the business. Proceed with caution and use a trusted professional. If you don’t qualify for the ERC and have an IRS liability, give us a call to discuss some options for resolving your debt.