IRS Director comments on Employee Retention Tax Credit (ERTC) claims
On March 20, 2023, at a payroll tax conference in Washington D.C., a director with the IRS warned taxpayers to “think twice” about claiming the ERTC, as the service is “actively auditing and conducting criminal investigations” relating to the claims and is finding many false claims.
The IRS has previously sounded the alarm on this credit, claiming that there are fraudulent claims and further “promoters” out there claiming all Organizations are eligible for the credit.
For a refresher on what the ERTC is read more here.
Interestingly of note is that in a news release by the IRS on January 26, 2021 (attached here), the IRS urged employers to take advantage of such credit. At the time, most organizations were focused on keeping themselves afloat and keeping their employees on payroll. So, what’s changed?
How to qualify for ERTC
There are two distinct ways to qualify for the ERTC, this is explained further in the refresher above but is important to note.
- Experienced a significant decline in gross receipts (note: the definition of significant changes from 2020 to 2021), OR
- Experienced a full or partial suspension of the operation of their trade or business during the period because of governmental orders limiting commerce, travel, or group meetings due to COVID-19.
What’s Changed?
As you can probably see by looking at these, the second qualifier has significant gray area to understand if your organization experienced this partial suspension. This in turn has become a significant pain point for the IRS, as there is no current case law that outlines this “test”, and further there are barely any regulations on point. What we have thus far is made up of the legislation itself and IRS notices on the topic, some of which are in the form of FAQs. An IRS notice is binding on the IRS, but not on a court which may or may not interpret this “test” differently.
Further, because of this facts and circumstances test that has not yet been through courts, this makes it ripe for abuse. Over the last couple months, the “ERTC Experts” have come out of the woodwork, groups looking to capitalize on the lucrative credit. This unfortunately has created a lot of warnings by the IRS which in certain cases serves to scare away legitimate organizations from claiming a credit they may be eligible for.
So what does this mean for your organization?
If you have not claimed the ERTC, you should contact your tax and legal advisers to see if this credit is something worth pursuing for your business. Any organization that guarantees your eligibility or promises that ALL entities are eligible, are just not correct. There are legitimate steps to take to talk with your trusted advisors on your eligibility, but no one, and I repeat, no one can guarantee the position the IRS will take on your specific claim under audit. If you are planning to work with someone on a new claim, read the fine print carefully. Read that engagement letter and trust your gut in the process.
If you have claimed the ERTC, and receive a tax notice, notice of audit, or an information document request (IDR) from the IRS, you should contact your tax and legal advisers immediately. Having representation during an audit is incredibly important for many reasons, including making the process efficient and preserving your rights.
Likely areas of focus
There are likely to be three areas that the IRS may focus on during an ERTC examination.
- Eligibility – How did your organization substantiate that you were eligible for the credit?
- Calculation of Amount Claimed – Do you have an employee by employee calculation that supports the number, did you properly exclude any PPP, other government grants, owner wages, and other noneligible wages?
- Proper and Complete Filing – Did you properly file the claim and also amend or prepare an AAR to correct the overstated wage deduction?
Importantly, the IRS Director of the Small Business/Self-Employed Examination group, Daniel Lauer, spoke about the issues they have seen thus far. As with all audits documentation is key, and it is expected that the ERTC audits will be no different. Of importance, as part of the American Rescue Plan Act Congress extended the normal 3-year statute of limitations for auditing (non-fraud related) ERTC claims for the 3rd and 4th quarter of 2021 is extended to five years.
On the calculation side, verifying the qualified health plan expenses is likely an important area of focus.
On the eligibility side, the organization should really point to a specific covid-19 order that limited commerce, travel, or group meetings. These may consist of quarantine orders that caused your organization to suspend operations for 14 days for a potential breakout. This may also be travel orders that required quarantining when entering or leaving a new state, if your organization has a significant travel based business. As you can likely tell this is a facts and circumstances test that highly depends on the states you operate in, and your specific business. Which is why it is important to involve trusted advisors in this discussion.
What is at Stake?
If an employer is audited and the amount of ERTC is reduced by the service there could be penalties and interest associated with the overstated credit. Those penalties could range from 20% (accuracy related penalties) to 75% (civil fraud penalties). Further, in egregious cases, the IRS may assert criminal fraud resulting in significant penalties or even imprisonment.
In December the IRS also released the training guide they now have to training new agents on how to review and audit these claims.
What can you do?
Focus on documentation! The best way to face an IRS audit is with significant proof or documentation that confirms your position. Obtaining a professional opinion on your claim and ensuring you save any emails/files/purchase orders/vendor notices/etc.
You should retain all this documentation for at least 5 years.
If you have already filed a ERTC Claim you should review the documentation you have on file with a tax professional. Conducting your own pre-audit assessment of your claim can provide you some comfort and may avoid penalties in the future. Based on that pre-audit assessment you may amend your return again, for a more accurate credit, or review your files again to see if there are additional pieces of information you originally left out.
Now is the time to take action, prior to an audit or review. Most importantly, do not go at this alone. It is important to take consult your trusted advisors. Contact us today if you have any questions or have received any notice from the IRS in relation to your ERTC Claim.
