The Employee Retention Credit: The latest scrutiny
By Randy Crabtree, CPA and Nick Pantaleo
August 31, 2023
The IRS issued
two important notices this summer governing the much-discussed Employee Retention Credit (ERC). First, the agency notes that it is doubling down on its efforts to flag dubious supply chain qualifications. Second, it has put additional procedures in place to combat fraud, including closer scrutiny of false and misleading public advertisements and scams taking advantage of taxpayers.
More than 2.5 million ERC claims have been submitted since the program was introduced during the pandemic. IRS processing of claims slowed due to the complexity of the amended returns. But the IRS has made substantial progress on processing claims this year, asserting that 99% of claims were only three months old as of mid-July. Now that the backlog is clearing, the IRS is shifting resources from processing to compliance.
Considering how much fraud is occurring, you can’t fault the IRS for taking its time on larger claims. In fact, the IRS has called on the Treasury and Congress to help. IRS Commissioner Danny Werfel called the “amount of misleading marketing around [the ERC] staggering,” which he said creates problems for tax professionals, businesses, and the IRS. "A terrible scenario is unfolding that hurts everyone involved -- except the promoters," Werfel asserted.
How do you protect yourself and your clients?
You have to stay vigilant and sign off only on amendments that you feel are justified. The IRS has made it clear that preparers — not just their clients — could face penalties for preparing amendments with fraudulent or overly misstated ERC claims.
We’ve all seen or heard the ads claiming a business can qualify for up to $26,000 in ERC credits per employee if it remained open during the pandemic. Many third-party promoters use vague claims or broad arguments to justify being qualified for the credit without knowing a business’s specific circumstances.
To have a viable ERC claim, businesses and their accountants should be able to answer the following:
- How are you qualified? Revenue drop or government mandate? Ask for details of the analysis.
- If a mandate, which specific mandate? The business should be able to point to a specific state or local mandate and explain how that mandate impacted it. For instance, Occupational Safety and Health Administration guidance and recommendations are not considered mandated unless adopted as such by your locality.
- How did you account for PPP or other CARES Act grants in the calculation? These, among others, can reduce the amount of eligible expenses if being used in conjunction with other programs.
- Is it a small or large employer for purposes of the ERC? You need to know the average number of full-time employees during 2019 and if that number was over or under the 100- or 500-employee threshold for 2020 and 2021 respectively.
However, a proper analysis for ERC qualification should contain much more information than above. If your provider can’t answer these questions — at bare minimum — then they likely are not properly investigating or determining qualification.
Even if they can answer most questions, but are relying on the supply chain argument, how do you know if that argument is legitimate? In the
IRS memo am-2023-005, the IRS laid out five sample scenarios (below) which did not qualify as per the supply chain argument:
- A company had enough supplies to continue operating despite a supplier delay disruption that forced it to use reserves. The IRS said that was not considered sufficient impact to qualify for ERC. Additionally, there wasn’t a specific mandate referenced that applied to the supplier.
- Having critical goods stuck at a port is not a qualification unless the business can specifically identify a governmental order that caused the delay at the port.
- Residual delays caused by a governmental order in prior calendar quarters — that are no longer in effect — does not constitute a qualified period in the subsequent quarters.
- Incurring a higher cost for critical goods does not result in a full or partial suspension of operations and, thus, the business doesn’t qualify.
- A retailer that’s able to continue operating, despite not being able to keep stock in a limited number of products due to supply chain disruptions, does not qualify.
How many of these situations sound like your clients? It turns out there are very few situations in which a supply chain disruption qualifies for the ERC credit. And even when it does, it’s usually for a very short period of time, not for six full quarters as we’ve seen on some claims.
Staying vigilant
After conducting ERC analysis for thousands of clients, our firm is yet to identify a single client able to qualify for the ERC due to supply chain disruption.
In the end, make sure you are doing your due diligence on these claims as the IRS is allocating significant resources toward compliance. Don’t go it alone. Make sure you work with a provider that has your best interests in mind — one that will be around to assist you three to five years down the road.
Nick Pantaleo is a Partner and the Chief Financial Officer at Tri-Merit.
Randy Crabtree, co-founder and partner of Tri-Merit Specialty Tax Professionals,
is a widely followed author, lecturer and host of “The Unique CPA” podcast.
