There has been a substantial amount of advertising of the benefits to employers of the Employee Retention Credit (ERC). The credit is beneficial if an employer qualifies, but many of the advertisers are promoters pushing well beyond a reasonable interpretation of the rules. In some cases, these are merely fronts for scams to obtain information that can be used for identity theft. These promoters often charge large up-front fees or a fee that is contingent on the amount of refund which gives them an incentive to push the bounds of reasonableness when applying for the credit.
In order to illustrate how serious, the IRS considers the potential tax scams associated with these promoters, it has recently issued multiple warnings. The frequency of the warnings reveals how serious the IRS is about stopping and uncovering Forms 941 and Forms 941X improperly claiming the ERC. Below you will find warnings dated April 25th, April 4th, March 20th, March 7th of 2023, and October 19th of 2022. Additionally, on April 5, 2023, in IR-2023-71, the IRS included illegitimate ERC claims as the first item on its list of the Dirty Dozen tax scams. Obviously, this is a priority for the IRS. The IRS has stated that it is actively auditing and conducting criminal investigations related to false claims.
The issue has apparently surfaced at the White House because the Administration’s 2024 Budget has a proposal to extend the statute of limitations from three (3) years to five (5) years for the ERC credit.
There are many employers that legitimately qualify for the credit. There is a mechanical test based on reduced gross receipts and one based on whether the employer sustained a full or partial suspension of operations due to a government order. The gross receipts test, if properly administered, provides an objective test for qualifications. The suspension of operations test is subjective and more open to abusive interpretation of the rules by promoters of tax scams. Even the objective gross receipts test can be difficult to apply because of aggregation rules for common ownership of businesses and who qualifies as an employee, etc.
As a rule of thumb, in order to get an idea if a company qualifies under the more objective decline in gross receipts test, a quarter-by-quarter comparison of gross receipts is required. Assuming a calendar year-end business, the base year is each of the four quarters of 2019 ending March 31, June 30, September 30, and December 31. For 2020, the business must have gross receipts of less than 50% of the respective 2019 quarter. For the first three quarters of 2021, the gross receipts must be less than 80% of the respective 2019 quarter. The percentage test outlined in this paragraph are only an indication that a business might qualify for the ERC not a guaranty of qualification.
If an outside third party has approached your business promoting the ERC, we recommend that you consult with us or another qualified tax professional before proceeding with filing a Form 941-X to claim the ERC. It is important to know that when the ERC is taken the wage expense must be reduced for the year the credit was generated. That means that the business income tax return for that year must be amended. If the business is a pass-through entity, the owners’ individual tax returns must also be amended.
Caution: This explanation is general in nature and should not be used for specific planning. Contact a tax professional for your specific planning needs.