Enacted as part of the CARES Act in 2020, the Employee Retention Credit (ERC) provided much-needed relief to employers during the COVID-19 pandemic, particularly those who were on the fence as to whether they would maintain their payroll. However, with the COVID-19 pandemic largely behind us now, the IRS has taken steps to begin to identify whether employers who claimed the ERC on prior year employment tax returns were actually entitled to the credit and, if so, whether they properly reduced their wage expense deductions for the employment periods in which the credit was claimed.
More recently, the IRS has indicated that it is now aware of third-party ERC promoters who may have nudged employers to claim the ERC even when those employers did not qualify for the credit. On October 19, 2022, the IRS issued an announcement in the Internal Revenue Bulletin, warning employers of these schemes. To the extent the IRS identifies an employer who improperly claimed the ERC when it otherwise did not qualify, the IRS has indicated that it intends to reclaim the credits with penalties and interest. In addition, given the warning shot fired at third-party promoters of ERC schemes, such promoters are now on notice that the IRS may attempt to impose civil penalties or criminal sanctions against them as well under various federal statutes that prohibit unscrupulous promoter and tax-return preparation activities. See, e.g., I.R.C. § 6694 (understatement penalty for unreasonable position or willful or reckless conduct); § 6700 (promoting abusive tax shelters); § 6701 (aiding and abetting an understatement of tax liability).
As indicated above, the ERC was enacted originally as part of the CARES Act. Thereafter, it was modified in one form or another through Congress’s passage of the Relief Act of 2020, the Rescue Plan Act of 2021, and the Infrastructure Act of 2021.
Very generally, employers may qualify for the ERC if they meet either a “gross receipts test” or a “full or partial suspension test.” Both of these tests are subject to certain complex rules, including rules related to attribution and, at least with respect to the full or partial suspension test, a careful review of federal and state government orders (which, as many may remember, changed routinely throughout the pandemic).
More on these tests and the ERC may be found here.
On October 19, 2022, the IRS issued its notice styled: “Employers warned to beware of third parties promoting improper Employee Retention Credit claims.” In the notice, the IRS cautioned employers that it was aware of instances in which third-party promoters were:
- Overselling to the employer the employer’s right to claim the ERC;
- Assisting employers take improper positions related to taxpayer eligibility for and computation of the ERC;
- Charging large upfront fees or contingent fees based on the amount of the ERC;
- Not adequately advising employers of all aspects of the ERC laws, including, for example, the requirement that employers reduce their claimed wage deductions when claiming the ERC.
Significantly, the IRS did not stop there. Rather, the notice also specifically advises taxpayers and tax professionals who become aware of fraudulent or mistaken ERC positions, schemes, or promotions to identify the employer and/or third-party promoters anonymously through the filing of an IRS Form 3949-A, Information Referral, or by reporting the activity to the Treasury Inspector General for Tax Administration at 1-800-366-4484. Although not mentioned, taxpayers and tax professionals can also submit in certain instances tax whistleblower claims for monetary awards. None of these developments are overly surprising to many: tax professionals (including the AICPA) have repeatedly warned the IRS and the Treasury about improper ERC claims.
Given the IRS warnings in the notice, the takeaway is clear. First, employers who have not yet claimed the ERC but which are trying to determine whether they qualify should seek a tax opinion from a qualified tax professional. Second, employers who have already claimed the ERC, particularly those employers who claimed the ERC through third-party promoters, should reach out to a qualified tax professional to have an independent determination made as to whether the employer truly qualifies and, if so, whether the employer complied with all parts of the law applicable to the ERC. Third, if an employer has improperly claimed the ERC, the employer should consider taking proactive measures to regain compliance and potentially avoid significant penalties and interest on a later IRS examination. Fourth, employers should recognize that the IRS generally has a longer period of time to reclaim the ERC under section 3134(l) of the Code, which permits the IRS five (5) years rather than the ordinary three (3) years to select an ERC return for examination.