If you are a client of Insight Accounting Group and own a business, we have very likely discussed the applicability of the federal Employee Retention Credit (ERC) with you sometime in the past two years. In the past six months you have also likely been contacted in some fashion by a third party claiming that your business is eligible for a $26,000 per employee credit and offering to help you claim the credit.
The IRS has repeatedly warned employers to be wary of wary of these claims by third parties who are advising them to claim the ERC when they may not qualify. Many of these third parties are taking improper positions related to taxpayer eligibility for and computation of the credit. These newly formed ERC companies charge large upfront fees or a fee that is contingent on the amount of the refund and may not fully inform you of the risks of improperly claiming the credit. They may also fail to mention the additional tax compliance work that is involved when the credit is claimed. We echo the IRS’s concern about the radical claims by these fly-by-night operations and caution you to thoroughly investigate any company you are considering hiring.
What is ERC?
The ERC is a refundable federal tax credit designed for businesses who continued paying employees while their operations were restricted or shutdown due to the COVID-19 pandemic or had significant declines in gross receipts from March 13, 2020, to December 31, 2021.
To be eligible for the ERC, employers must have met one of these three criteria:
• Experienced a significant decline in gross receipts in 2020 (more than 50% decline when compared to 2019) or a decline in gross receipts during the first three quarters 2021 (gross receipts must be less than 80% of those in same quarter 2019) , or
• Sustained a full or partial suspension of operations due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings due to COVID-19 during 2020 or the first three quarters of 2021, or
• Qualified as a recovery start up business for the third or fourth quarters of 2021
Eligible taxpayers claim the ERC for these periods by preparing an amended employment tax return for a period within those dates. If ERC is claimed, wage deductions on the business’ federal income tax return must be reduced by the amount of the credit. This means the business must also amend their business income tax return to correct any overstated wage deduction. In addition, shareholders of a pass- through business claiming the credit must also amend their personal tax filings and pay the additional income tax due immediately.
Also be aware, eligible employers cannot claim the ERC on wages that were reported as payroll costs in obtaining PPP loan forgiveness or that were used to claim other tax credits. Qualifying for a PPP loan does not automatically qualify you for ERC.
Should I consider claiming ERC due to partial suspension of operations?
Claiming ERC using the gross receipt tests are straight forward and relatively easy to calculate. The focus of many claims the ERC companies relate to “full or partial suspension” provisions. A “full suspension” of operations during COVID would likely result in a business qualifying for the ERC under the gross receipts test alone. There is a clear lack of authoritative guidance related to what qualifies as a “partial suspension” which makes it difficult to determine eligibility with any degree of certainty. While this uncertainty may be perceived as an opportunity by some, improperly claiming the credit comes with risks.
The IRS is promising to focus on auditing ERC claims in the next few years and the statute of limitations on unpaid federal payroll taxes is 10 years. If it is later determined that you improperly claimed ERC, your company will be required to pay back the credits plus penalty and interest. The company preparing your ERC calculation may very likely not be around years from now when these audits are conducted, and the back taxes and penalties are assessed. Carefully read any contracts you sign with and ERC company to make sure you understand how fully and thoroughly they will support you during an audit of their work.
Although we understand the decision to move forward with “suspension of operations” ERC refund claims is ultimately up to each business owner. Our firm’s position is to provide no specific opinion or recommendation, one way or the other, relative to partial suspension claims. If you do choose to proceed with one of these claims, we encourage you to do so with a healthy level of caution, taking into consideration the potential risk associated with the filing of a tax refund claim based on an eligibility position that could possibly be difficult to successfully defend under audit.
If you decide to move forward with the filing of one of these refund claims, Insight can assist you with the preparation of required amended business and individual income tax returns to report the income tax impact resulting from the filing of the ERC claim. However, Insight will not prepare any of the necessary amended payroll tax returns (Form 941-X) to report ERC refunds calculated using partial suspension of operations. Filing the amended payroll reports will be the responsibility of your company, your outside payroll service company or the third party providing the ERC consulting services.
Please contact your Insight team member if you have any questions.