Since its inception, the Employee Retention Credit has been both a boon to employers and a cautionary risk for preparers.
The Internal Revenue Service has done its best to prepare practitioners for the questionable practices of third-party marketers affecting their clients, with a rising level of warnings urging a careful review of the ERC guidelines before claiming the credit.
Third parties continue aggressively promoting these ERC schemes on radio and online. The promoters charge large upfront fees or a fee that is contingent on the amount of the refund. And the 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.
There continue to be attempts to claim the ERC during the 2023 filling season, the IRS noted. The Office of Professional Responsibility is currently working on additional guidance for the tax professional community that will be available in the near future.
"We certainly see risk associated with the ERC," said Deb Rood, CPA, risk control consulting director at CNA Accountants Professional Liability, the underwriter for the AICPA Professional Liability Program. "We are receiving numerous phone calls from CPAs who are quite concerned about ERC calculations made by third parties, as well as the potential for claims against the accountant. CPAs are looking for strategies they can implement now to help manage their risk."
CPAs may face a future professional liability claim if a client's ERC is disallowed by the IRS, even if they only prepared the business income tax return and did not calculate the ERC or amend the payroll tax return, she observed.
"In some cases, the IRS has up to five years to audit payroll tax returns claiming ERC, longer than the typical three-year statute of limitations for income tax returns," she cautioned. "This two-year difference can create a 'whipsaw effect' for taxpayers whereby otherwise available income tax wage deductions in years closed under the statute of limitations may be lost, along with the disallowed ERC and related penalties and interest being assessed on underpaid employment taxes. A triple whammy if you will."
Who's responsible?
Arguably, the third party that calculated the erroneous credit should be responsible for any errors, rather than the CPA who prepared the related tax returns. However, because positions taken on tax returns prepared now may not be overturned until several years down the road, the third party that performed the calculation may no longer be in business.
Furthermore, even if the third party remains an ongoing enterprise, it may lack assets or insurance coverage, leaving the CPA to respond to client assertions of improper advice. Defending these assertions may be challenging if the CPA failed to abide by professional standards or did not maintain documentation to demonstrate that they did, warned Rood.
Given the magnitude of the risk, practitioners should protect themselves by obtaining a signed engagement letter from the client that defines the federal and state tax returns to be prepared or amended, she cautioned.
"They should also consider including a provision that discusses the CPA's responsibilities related to the review of work performed by third parties," she added.
Next, the practitioner should evaluate the client's information, including the ERC calculation provided by the third party, in accordance with professional standards.
"Those standards state that the tax practitioner may rely on information furnished by the client in good faith and without verification," Rood said. "However, the practitioner may not ignore the implications of information furnished to, or actually known by, the practitioner. Moreover, if the information as furnished appears to be incorrect, inconsistent with an important fact or another factual assumption, or incomplete, it is incumbent upon the practitioner to make reasonable inquiries of the client."
Rood recommends that practitioners give it a "sniff test" for credibility. "But depending on the third party, be prepared for a skunk smell," she cautioned.
Was there a full or partial suspension of the business in compliance with orders from an appropriate government body limiting commerce, travel, or group meetings during the claimed periods? Did the client experience a significant decline in gross receipts during the applicable periods?
"If not, the client may have an uphill battle to prove that it qualifies for the credit," she said.
If the CPA is comfortable that the client qualifies for the credit, there are still some questions to consider: Is the credit calculated based upon the appropriate wages? Is the client or third party taking a blanket approach, saying that all wages are eligible for the ERC? Does the calculation take into account Paycheck Protection Program payments? Related parties?
"My understanding is that some third-party providers are not asking these questions, which may result in problems for the client and, in turn, the CPA," she said.
After completing the sniff test, the CPA should determine if they can sign the income tax return.
"If the CPA's analysis indicates that there is a 'realistic possibility' of the tax return position being upheld on audit, sign away," she said. "'Realistic possibility' is generally considered to be a 33% chance of being upheld. If the likelihood is lower, what's referred to as a 'reasonable basis,' or a 20-25% chance of being upheld, the CPA may sign the tax return if the position is disclosed in the return."
"Unfortunately, in some cases the CPA will be unable to prepare the returns, she indicated.
Regardless of whether the CPA believes the client qualifies for ERC and whether the CPA believes the calculation is correct, all clients should be advised, in writing, that:
- The IRS may disagree with the ERC calculation reflected on the client's payroll tax returns;
- If the client's ERC claim is disallowed after the statute of limitations to amend the business tax return has passed, the client will be unable to deduct wages upon which the ERC was calculated, resulting in a lost deduction and overpayment of federal income tax;
- If the client's ERC claims is disallowed, the client may owe additional payroll taxes, interest and penalties for which the client will be responsible; and,
- The client may be unable to obtain refunds for fees paid to a third party or recoup other losses from them for incorrect ERC calculations.
"Nothing is guaranteed, but informing the client of the risks related to ERC and having documentation of such notice and warning deflect a client's assertion of 'You should have told me,'" said Rood.
If the preparer suspects the taxpayer is not eligible for the credit, they should comply with the AICPA Statements on Standards for Tax Services, Rood indicated.
To do so, the CPA should inform the client, in writing, of:
- The nature of the error on the client's previously filed returns;
- How the client may correct the error; and,
- The potential consequences to the client of not correcting the error.
The CPA should also inform the client, in writing, that, as of the date of the writing, statutory provisions require the client's income tax returns to reflect a wage deduction in line with the ERC claim. "My understanding is that not all third parties are telling taxpayers about the income tax ramifications," Rood noted.
In addition to any upcoming guidance, the IRS has already issued the following guidance on the ERC:
- OPR Issue Number 2023-02 (March 7, 2023);
- IRS IR 2023-40 (March 7, 2023);
- IRS IR 2022-182 (Oct. 19, 2022); and,
- COVID Tax Tip 2022-170 (Nov. 7, 2022).
"My understanding is that IRS Criminal Investigations has already pressed charges against at least 10 firms calculating ERC and has indicted at least one for tax conspiracy, wire fraud, and on false tax return charges," she said. "In my opinion, any further guidance the IRS issues will depend upon the results of those investigations and others. If the IRS continues to find that the ERC is being abused, I would not be surprised if it issued additional warnings to taxpayers, third parties, and other tax preparers."
