During a payroll conference in Washington D.C. on March 20, a director at the IRS warned taxpayers to “think twice” about claiming the expired COVID-19 employee retention credit (ERC) as the Service is “actively auditing and conducting criminal investigations” relating to claims that are more frequently turning out to be false.
ERC tax relief for certain employers.
The ERC was made available during the COVID-19 pandemic to encourage businesses to retain workers by offering a refundable tax credit against certain employment taxes equal to a certain percentage of the qualified wages (including allocable qualified health expenses) that an eligible employer paid to employees after March 12, 2020 and before October 1, 2021 (before January 1, 2022 for recovery start-up businesses) (see Payroll Guide ¶20,905).
Basics for qualifying.
To qualify for the ERC, an employer must have had its operations subject to a full or partial suspension of operations due to governmental orders or experienced a significant decline in gross receipts during the pandemic. Additional federal legislation changed and extended this credit, which included adding a recovery startup business.
Possible to claim ERC and Paycheck Protection loan.
First Draw and Second Draw Paycheck Protection Program (PPP) loan takers are allowed to claim the ERC if the employer is eligible for the ERC. However, payroll costs that are qualified wages for the ERC are not eligible for loan forgiveness if the employer elects to claim the credit for those amounts.
Eligible employers may still claim the credit.
Employers used Form 941 to claim the COVID-19 tax credits and may currently use Form 941 -X to make adjustments or corrections to these credits, which may include using this form to claim the ERC tax credit if eligibility was not initially determined (see Payroll Guide ¶4275).
IRS continues to sound alarm on ERC scams.
On March 20, the IRS began its 2023 list of “Dirty Dozen” tax scams with the ERC after “blatant attempts by promoters to con ineligible people to claim the credit.” This action renewed a number of earlier alerts from the Service about promoters “touting refunds involving Employee Retention Credits” (IR 2023-49; IRS Kicks Off 2023 Version of Dirty Dozen Tax Scams With Employee Retention Credit Claims, 03/22/23; IRS Sounds the Alarm Again on Employee Retention Credit Scams, 03/08/2023).
Proceed with caution if claiming the ERC.
“Anyone who’s considering claiming [the ERC] needs to carefully review the guidelines,” Daniel Lauer, IRS Director of the Small Business/Self-Employed Examination – Specialty, who kicked off the American Payroll Association’s (APA) Capital Summit on Monday, cautioned. He also explained that the IRS’s Office of Professional Responsibility is currently working on additional ERC guidance for the tax professional community that Lauer “hopes will be available in the near future.”
Biggest ERC examination issues.
Not surprisingly, some of the more frequent issues that arise during an IRS examination is ERC fraud. Lauer exclaimed how “fraud is very prominent with the Form 941-X.” As of March 17, 2023, the IRS had a backlog of 788,000 unprocessed Forms 941-X, some of which cannot be addressed until the corresponding Form 941 is processed. The number of unprocessed Forms 941 is down to 655,000, notably lower than the 1.7 million unprocessed forms as of March 3, 2023.
The U.S. Treasury Department’s fiscal year 2024 revenue proposals include increasing the statute of limitations on the assessment of ERC credits from three to five years (for the remaining six quarters the ERC may be claimed that is not covered by the extension provided under the American Rescue Plan Act of 2021, see Payroll Guide ¶20,906), giving the Service more time to conduct audits, as well as taxpayers more time to amend previously filed Forms 941 relating to certain COVID-19 tax credits.
Other prominent ERC examination issues discussed in Lauer’s presentation involve verifying the qualified wages and health plan expenses, whether the business’s shutdown was a government order or a “voluntary” cessation, and PPP loan forgiveness.
ERC audit procedures.
Around three-quarters of the way through his presentation, Lauer, who has been with the IRS for 41 years, began discussing COVID-19 tax credit examinations and audit procedures for the ERC to illustrate what the Service’s more than 300 employment tax examiners trained on these credits are “looking at to make sure [the tax credits] are appropriate.” As Lauer went through his slides, he noted that the evidence the IRS will be focusing on regarding ERC credit examinations is “quite comprehensive.”
What the examiners want from employers?
Among the copious amounts of information that may be requested, Lauer said that examiners will ask for a copy of the worksheets from the Form 941 instructions that employers or third-party providers used to compute the ERC. Worksheet 2 and Worksheet 4 were included in the Form 941 instructions to determine the ERC for wages paid before July 1, 2021 and before October 1, 2021 (before January 1, 2022 for recovery start-up businesses), respectively. The current version of the Form 941-X instructions continues to include both Worksheets 2 and 4 for claiming the credit for the above periods of time.
Information Document Request.
If there is an information document request (IDR) from the Service, the taxpayer will also need to provide: a list of employees paid wages for ERC claimed, if any employees who received wages included in the ERC are related individuals, and the amount of wages paid to each employee for the ERC. IDR’s are authorized by Code Sec. 7601 and issued by the IRS with Form 4564 during a tax audit to request information from the taxpayer. An IDR may be issued at the beginning of the audit but may issue additional IDRs as the audit continues.
Other documentation requests.
Other documentation the IRS may request during an ERC tax credit examination, if applicable, may include: how the taxpayer determined qualified health plan expenses that the employer allocated to the ERC, the application for the PPP loan forgiveness, a copy of the employer’s forgiveness letter, received from the loan provider or the Small Business Administration (SBA). Lauer added that examiners may need to ask for additional information based on the specific issue or as a follow up to the information provided by the taxpayer.
Resources to help.
Lauer noted that while an ERC audit can be quite involved, there are resources for taxpayers and he encouraged consulting the IRS’s COVID-19 webpage for all related notices, revenue procedures, instructions, and publications before meeting with an IRS examiner.
ERC examinations will be a focus for some time.
Before answering questions, Lauer concluded his presentation by explaining that he and the SB/SE specialty examiners will be “primarily focused” on ERC credits and working their way through the unprocessed Forms 941, which could be over the course of the next “year and a half.”
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