Refundable tax credits have long been an area for potential abuses of the tax system, given the opportunity to get money back from the government in excess of the federal income taxes owed. There have been abuses associated with the Earned Income Tax Credit for many years, for instance.
During COVID, several tax relief provisions were enacted that included refundable tax breaks to provide help to individuals and businesses suffering from COVID as soon as possible. The government has been pursuing significant abuses in the Paycheck Protection Program, and as the Internal Revenue Service continues to audit submissions requesting Employee Retention Credit claims, it has stated that it is finding abuses in 2022 tax return filings and is now starting to see continuing abuses in 2023 tax return filings.
The IRS seems to primarily be blaming third-party promoters aggressively promoting schemes on the radio and online to businesses that may not be eligible for the ERC. When the IRS discovers that the claimed credit is inconsistent with the tax return filed on their behalf by their regular tax return preparer, the taxpayer could be required to repay the credit along with penalties and interest.
Who's entitled to the ERC?
An employer is eligible for the ERC if it has:
1. Sustained a full or partial suspension of operations limiting commerce, travel or group meetings due to COVID-19 under an order from an appropriate governmental authority;
2. Experienced a significant decline in gross receipts during 2020 or a decline in gross receipts during the first three quarters of 2021, as compared to the same quarter in 2019; or,
3. Qualified in the third or fourth quarters of 2021 as a "recovery startup business" — a new business started during COVID. (Notice 2021-20, Notice 2021-49, Notice 2021-65 and Revenue Procedure 2021-33 further define these terms.)
There are also complicating rules as to which employees qualify for the credit, what wages qualify for the credit, and how the ERC interacts with PPP payments, credits related to paid family sick leave, the Work Opportunity Tax Credit, the Shuttered Venue Operators Grant, and the Restaurant Revitalization Fund.
Obviously, these are very fact-dependent eligibility requirements. The IRS has been receiving a very large number of requests for ERC relief and is in the process of auditing those requests. Those audits require time to verify eligibility. The IRS has been given five years rather than the normal three years to complete these audits. The agency states that its audits are indicating many submissions by taxpayers that do not qualify and that are inconsistent with the tax returns filed, suggesting that the ERC submission was prepared with a promoter rather than the regular tax return preparer of the taxpayer.
To claim the ERC, eligible employers must file Form 941 by the end of the month following the end of each quarter and file Form 5884, "Employee Retention Credit," with their annual tax return. The deadline for submissions claiming the ERC is April 15, 2024, for the second, third and fourth quarters of 2020 and April 15, 2025, for all the quarters of 2021.
How much is the ERC?
While there had been retention credits enacted in the past associated with natural disasters such as Hurricane Katrina, the ERC with respect to COVID was first enacted in the CARES Act for the period commencing March 12, 2020, and continuing through the end of 2020. It is a 50% credit against wages paid between March 13 and Dec. 31, 2020, to a maximum of $10,000 in wages, or a maximum $5,000 credit.
The Consolidated Appropriations Act-2021 extended the credit through June 30, 2021, at a level of 70% of qualified wages up to a maximum of $10,000 in wages, or a maximum of $7,000 per quarter. The American Rescue Plan Act extended the ERC qualification period through the end of 2021 at the same level per quarter, except that the fourth quarter of 2021 only applied to recovery startup businesses. The ERC was retroactively terminated by the Infrastructure Investment and Jobs Act in 2021. Some of the promoters of ERC claims have been citing a figure of a credit of up to $26,000 per employee — $5,000 for 2020 and $7,000 for each of the first three quarters of 2021.
IRS alert
In Information Release 2023-40, the IRS states that tax professionals continue to be pressured by people wanting to claim the ERC credits improperly.
The service states that, if a business filed an income tax return deducting qualified wages before it filed an employment tax return claiming the ERC, the business should file an amended income tax return to correct any overstated wage deduction.
The IRS encourages the reporting of tax-related illegal activities relating to ERC claims by submitting by mail a complete Form 14242, "Report Suspected Abusive Tax Promotions or Preparers," and any supporting materials to the IRS Lead Development Center in the Office of Promoter Investigations, Stop MS5040, 24000 Avila Road, Laguna Niguel, California 92677-3405, or faxing it to (877) 477-9135.
The agency also encourages anyone who is considering claiming an ERC to carefully review the eligibility guidelines for themselves. If a tax professional raises questions about the accuracy of an ERC claim, the IRS encourages the business to pay attention, and it warns that it is actively auditing and conducting criminal investigations related to false ERC claims.
The IRS Office of Professional Responsibility has also reminded tax practitioners of their responsibilities under Circular 230:
- Diligence as to accuracy. Under Circular 230 Sec. 10.22(a), practitioners who prepare tax returns have a duty of due diligence to inquire of their clients with sufficient detail to ascertain the information necessary to determine clients' eligibility for the ERC and to claim the proper amount of the ERC on the clints' tax returns.
- Standards for tax return and other documents. Under Circular 230 Sec. 10.34, a practitioner acting as a preparer or advisor may determine that the client had previously claimed an excessive ERC. In addition to informing the client under Sec. 10.21 of the "noncompliance, error or omission" and any penalty or penalties that may apply, the practitioner should consider advising the client of the option of filing an amended return. The practitioner is not obligated to prepare the amended ERC claim unless asked by the client, and then only if the practitioner feels competent to do so.
- Written advice. Under Circular 230 Sec. 10.37(a)(3), the practitioner is allowed to advise a client to rely on the advice of others only if reliance is reasonable under all the facts and circumstances. If the other adviser, who may have advised the client to claim the ERC, has a conflict because of the amount or character of the fee the advisor charged for the advice at the time, then the practitioner's reliance on that advice may not be reasonable. Practitioners should note that Sec. 10.27 separately limits the circumstances in which an advisor, if a practitioner, may charge a contingent fee.
Summary
Tax practitioners should carefully consider ERC claims made by a client where the practitioner was not involved in making the claim and where there is a possible inconsistency with a tax return that has been filed by the practitioner.
