Enacted as part of the CARES Act in April 2020 and expanded as part of the Taxpayer Certainty and Disaster Tax Relief Act, American Rescue Plan Act (ARPA) and the Infrastructure Investment and Jobs Act, the Employee Retention Tax Credit (ERC or ERTC) has been a valuable and necessary lifeline for many businesses and non-profit organizations. While the credit did not have much traction at the onset (given the limitation of either doing a Paycheck Protection Program (PPP) loan or the ERC) the expansion in December 2020 and subsequent has led to many employers claiming the credit in 2021, 2022, and even 2023.
Despite being a nearly 3-year-old program, there are still employers who have yet to determine if they are eligible for this credit, the IRS continues to distribute additional news and guidance regarding the credit, and there is still confusion surrounding the program.
Deadline for Amended Returns
Most employers and taxpayers are aware that the deadline for filing an amended return is 3 years from the date the return is due. In the case of Form 941-X for ERC Claims, this would make the deadline for amending 2nd Q 2020 (originally due July 31, 2020) July 31, 2023. However, in the case of payroll returns, the Form 941 for a calendar year is considered to be filed on April 15 of the succeeding year – meaning that for 2nd Q 2020, 3rd Q 2020 and 4th Q 2020 the deadline for amending these returns is April 15, 2024. While that may sound far away, its closer than you may think, especially considering that many tax professionals have tax season to contend with during the 1st Q 2024.
IRS Legal Advice Memorandum
On July 20, 2023, the IRS released a legal advice memorandum which specifically discusses shutdowns related to supply chain disruptions. The memo lists 5 scenarios regarding supply chains and if the impact as described in the scenario would qualify as a disruption as a result of a government order and therefore make the employer eligible for the ERC.
Scenario 1 – an employer that was otherwise not subject to any government orders experienced delays in receiving critical goods in 2020 and 2021 but had a surplus of goods. The employer inquired and received a vague response the delay was COVID-19 related, but the supplier did not provide a government order.
The memo states this employer does NOT qualify under a supply chain disruption because it cannot provide a government order. Further, the surplus of goods would have made it so the employer could continue, and therefore, even if there was an order, the specific employer was not suspended.
Scenario 2 – an employer that was otherwise not subject to any government orders had critical goods stuck in a port. The employer cannot identify any specific government order that caused the bottleneck and the employer had information that stated it was due to COVID-19, increases in consumer spending, aging infrastructure, and lack of drivers.
The memo states that this employer does NOT qualify under a supply chain disruption because it cannot identify a relevant government order. While COVID-19 may be a contributing factor, there was no government order applicable to the bottleneck and it is incumbent on the employer to demonstrate that a government order lead to the bottleneck.
Scenario 3 – an employer and supplier were both suspended in April 2020 by government orders which were lifted in May 2020. There is a delay of critical goods throughout 2020 and 2021 assumed to be as a result of the order in April 2020.
The memo states that this employer is eligible for the 2nd Q 2020 because it was fully or partially suspended for that quarter but only for wages paid during that suspension period. The residual delays as a result of the order do NOT qualify as a government order once it has been lifted.
Scenario 4 – an employer was not subject to any government orders and couldn’t obtain critical goods from a certain supplier but was able to obtain these goods from a different supplier at a higher cost and lower profit to the employer.
The memo states that this employer does NOT qualify under a supply chain disruption because the employer could continue its operations, albeit at a higher cost.
Scenario 5 – an employer (large retail business) was not subject to any government orders, but experienced supply chain disruptions leaving them unable to stock a limited number of products and requiring them to raise prices on others; however at no time did it prevent the employer from fully operating as a retail business.
The memo states that this employer does NOT qualify under a supply chain disruption because the employer could continue its operations and cannot demonstrate a government order that prevented the employer from obtaining critical goods and the limited stock on a few items did not rise to the level of a partial suspension of operations.
Taken as a whole, the memo demonstrates a “narrow” interpretation by the IRS of the supply chain disruption as a qualification to be an eligible employer. The guidance clarifies that in order for there to be a qualified disruption, it needs to be a direct result of a government order related to COVID-19, not just because of COVID-19 itself.
New IRS FAQ
During the initial stages of the CARES Act and ERC in order to get information to taxpayers rapidly the IRS issued FAQs related to the ERC. These FAQs do not hold the same weight of law as notices or regulations (although the original FAQs became, in practice at least, Notice 2021-20), however, they do provide taxpayers with guidance. The IRS has issued a new FAQ in July 2023. The FAQ is somewhat targeted at employers and promoters who are making “weaker” ERC claims and provides a great summary of the program and limitations. The FAQ does not provide much in terms of new guidance, but does highlight:
- Not all employers will qualify and there are specific eligibility criteria.
- A government order must be an order; a recommendation or statement encouraging actions will not qualify.
- Just being subject to an order is not sufficient; you must demonstrate the order has impacted your operations.
- A supply chain issue alone will not make an employer eligible.
- A summary of the gross receipts decline testing.
- Confirmation the deadline is April 15, 2024 for 2020 year claims.
- A statement that for improper claims the IRS will be providing more information.
- For any claims to be repaid we advise to amend the 941-x as to limit interest and return the funds
- For businesses, the ERC must be claimed as a reduction of wages in the year the wages are paid, not when the funds are received.
- Information related to “ERC Scams”:
- Unsolicited calls with an “easy application process”
- The promoter can determine eligibility within minutes.
- Large upfront fees
- Fees based on a percentage of the credit.
- Preparers that won’t sign the amended 941-X.
- Aggressive claims from the promoter stating the entity qualifies before any discussion of the tax situation.
- Marketing claiming the employer has “nothing to lose” when submitting the claim.
- The IRS Suggests for any employer claiming a credit, they should:
- Work with a trusted tax professional.
- Request a detailed worksheet explaining the eligibility and computations of the credit.
- Don’t accept a generic document about government orders; ask for a copy of the government order.
- Don’t apply unless you believe you qualify.
The FAQ also provides a great listing of documentation to support eligibility, including records to show:
- The business operations were suspended, including the specific government order
- The decline in gross receipts
- Which employees received wages and in what amounts
- If a large employer, you paid wages to employees not providing services.
- Allocation, if any, of qualified health plan expenses
- Relationship to other businesses, if any
- Copies of returns and Form 7200, if any
IRS Statement at special roundtable of tax professionals
IRS commissioner Danny Werful spoke on Tuesday, July 25th at a special roundtable of tax professionals. Highlights from this included:
- The IRS claims to have cleared the backlog of valid ERC claims.
- For the IRS, this increase in claims and other COVID-19 related impacts lead to delays in processing claims, some up to 18 months in our experience.
- With the backlog cleared, the IRS will be shifting to increased scrutiny on dubious submissions and aggressive marketing from ERC providers.
- The IRS will be intensifying compliance and looking to put in place additional procedures to deal with fraud in the program.
- As the pandemic gets further away, the IRS believes that there are less “legitimate” claims coming in and more questionable claims due to the onslaught of marketing from ERC providers.
- The IRS wants to work with congress to explore legislative solutions, including potentially increased oversight of preparers and putting an earlier ending date on claims.
- The IRS is very concerned with scams and potential fraud given the increase in “false and misleading” public advertising and scams taking advantage of taxpayers.
Congressional Hearings with Tax Professionals
On Friday, July 28th, the House Ways and Means Committee had a hearing with tax professionals to discuss the IRS’ handling of the ERC and the issues they are experiencing. The tax professionals and other witnesses highlighted the following:
- Growing concern of ERC Mills (providers with aggressive marketing and claims) and potential for fraud.
- The advertisements which state that tax professionals may not know about this or what they are doing in regard to this undercut the confidence of businesses and organizations of their preparers.
- The IRS lack of enforcement to date on these providers has made more appear.
- The lack of guidance from the IRS and that a separate ERC implementation team should have been formed from the start to provide guidance and education
- The requirement to file amended returns on paper, rather than electronic, which lead to the backlog.
- The witnesses questioned the IRS Claim (above) that 99% of claims are less than 3 months old.
After nearly 2 years of aggressive providers making claims, the IRS and congress finally appear to be turning their attention toward these so-called ERC Mills and to providing clear guidance that many of the claims of these providers, which were dubious to begin with, are in fact not allowed under the ERC Program. The most recent guidance shows a narrow interpretation of any supply chain related disruptions and further shows that employers must have a government order that directly impacts them and suspended their operations – it is likely that over the next few weeks the IRS will provide more guidance related to government orders which have been a form of shutdown used by ERC Mills for potentially dubious claims.
For any employer (either business or tax-exempt organization) that has not yet looked, it is still possible to claim these credits if you are in fact eligible – either under a decline in gross receipts or under restrictions from a government order. For any employer that may have claimed these credits incorrectly, the IRS stated they will be putting more information out about returning these credits, but for now, it is advisable to file Form 941-X for any quarters and return the funds as soon as possible.
If you have any questions about the ERC, please feel free to reach out.
Edward McWilliams, CPA
Ed is a Partner in the firm’s tax and business advisory practice focusing on providing services to middle market private companies across different industries as well as to early stage startups. Ed has over a decade of experience providing tax and business consulting services to these companies of different sizes and across different industries, bringing a broad and diverse knowledge base and strategic solutions to the many complex issues that businesses face.