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Over the past year, television and radio commercials have touted the benefits of making a refund claim for Employee Retention Credits (ERC). While many business owners have received significant refunds and more business owners are contemplating making claims, the IRS has cautioned taxpayers to be wary of ERC promoters. Because the IRS sees this as an issue with significant risk of abuse and fraud, experts believe that ERC claims will be a focus of IRS audits in the near future.

Summary of Employee Retention Credits

The ERC program was a key component of the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act). These credits were created to assist certain employers with continuing payroll during a shutdown due to the COVID-19 pandemic, businesses that experienced pandemic-related declines in gross receipts and certain recovery startup businesses. Eligible businesses were those that employed no more than 100 FTEs in 2020 or 500 FTEs in 2021.

A business that sustained a full or partial suspension of its business operations in compliance with orders from an appropriate governmental authority limiting commerce, travel, or group meetings due to COVID-19 during the period starting in 2020 through the first three quarters of 2021 is eligible for ERC. A business can claim ERC if it experienced a significant decline in gross receipts, as defined by the IRS, during 2020 or a decline in gross receipts, as defined by the IRS, during the first three quarters of 2021, provided that the decline was related to the pandemic. Also, a qualified recovery startup can claim the ERC up to $50,000 for the third and fourth quarters of 2021. This applies to businesses that began after Feb. 15, 2020, with average annual receipts under $1 million.

Complex calculations of the amounts were included in the CARES Act and subsequent IRS guidance. However, with refundable credits of up to $26,000 per employee, reviewing eligibility and calculating amounts quickly became a cottage industry.

ERC consultants

Determining eligibility for, and amounts of, the credit can be complicated and confusing. Because the eligibility rules were not particularly clear at the time the returns for 2020 and 2021 were due, many tax return preparers advised clients not to claim these credits. With tens of billions of dollars at stake, the market was flooded with consultants offering businesses the opportunity to recoup tens of thousands, even a million dollars or more, many working on contingency fees.

As a general rule, tax return preparers and those engaged in practice before the IRS cannot work on a contingency for credit refund claims. This means that an ERC consultant working on contingency is likely not a tax professional. However, many businesses prefer to pay a portion of the refund rather than the upfront cost of professional fees.

Many ERC consultants are competent and thoughtful professionals. However, many ERC consultants are also making overly aggressive claims. Because of the latter, the IRS has issued warnings about ERC promoters.

IRS warnings

In its Information Release 2022-183, the IRS issued a formal warning to businesses, advising that they be cautious of advertised schemes and direct solicitations promising tax savings that may be too good to be true. The IRS reminded businesses that each business, not the promoter, is always responsible for the information reported on its tax returns.

In April, the IRS listed Employee Retention Credit claims as one of its “Dirty Dozen” schemes, along with phishing, fake charities, and Offer in Compromise mills. This annual list contains the “schemes and scams” that the IRS is most wary of for the year. In this notice, the IRS stated its intention to increase enforcement action of ERC claims. This means a focus on auditing refund claims.

Red flags

If a business is considering engaging an ERC consultant, it should perform its due diligence in choosing the consultant. Red flags for an ERC consultant should include pressure tactics to act quickly, excessive contingency fees, or contingency fees payable before a refund is received. ERC consultants should be willing to stand behind their findings and defend the refund claim in an audit. These consultants should carefully review the facts and circumstances before determining eligibility. If an ERC consultant does not perform proper due diligence, this is another red flag.

Before engaging an ERC consultant, a business should have the engagement agreement reviewed by counsel. After an ERC consultant has completed its findings, the business should have its accountant or tax return preparer review the amended returns before submitting the returns to the IRS.

IRS audit

The claim for refund extends the time for the IRS to review the periods for which a credit was claimed. This means that the refunds could be spent and forgotten before an audit is even begun. If the IRS audits a claim for refund, it will carefully review the eligibility and the credit amounts. This means that the IRS will review whether there was a governmental shutdown, and it will calculate the declines in revenue. Also, the IRS will review payroll, calculating the number of employees and the amounts paid. If the IRS determines that the business was not eligible or that the amounts claimed exceed the proper amount, the business will be required to repay the credits with penalties and interest. For these reasons, any business that is audited should have experienced representation in addition to the ERC consultant to work through the audit and any appeal.

Conclusion

If a business was affected by the pandemic and did not already claim the Employee Retention Credit, it should review its eligibility because it could lead to a cash windfall. However, that business should carefully choose its advisors and should clearly document its eligibility and calculations. Due diligence and proper documentation are the keys to successful credit refund claims.

If you have questions regarding refund credits or the ERC consultants, please reach out to Scott Shimick at Whiteman Osterman & Hanna.

Whiteman Osterman & Hanna, the Capital Region’s largest law firm with over 100 attorneys, has developed a reputation for innovative solutions and professional leadership. For almost 50 years, the firm has served the legal needs of business, government, non-for-profits, and individuals in the Capital Region and across New York State.

This update is intended to be a general summary of the law and does not constitute legal advice. If you have concerns about the impact and effect on your business, you should consult with counsel to determine applicable legal requirements for a specific factual situation before acting or relying upon any information in this article.

As seen in the Albany Business Review - view here.