By Kevin F. Sweeney and Olivia Y. Klein
The Employee Retention Credit (ERC) was created as part of the CARES Act to provide support money to businesses experiencing disruptions during the COVID-19 pandemic. By most accounts, the ERC accomplished Congress’s objectives. However, an unintended consequence of the credit is that it gave rise to a cottage industry of ERC advisers, some of whom have been accused by the IRS of misleading businesses into filing claims when not eligible.
Over the past year, through press releases IR-2022-183 and IR-2023-40, the IRS repeatedly warned businesses about filing improper ERCs and the threat of unscrupulous ERC advisers. Despite the warnings, the IRS has noted that questionable ERC claims have continued to be filed faster than the IRS can keep up.
To give itself more time to analyze these claims, the IRS issued press release IR-2023-169 on Sept. 14, 2023, placing a moratorium on its processing of new ERCs until at least Dec. 31, 2023. Claims that have already been submitted will be processed at a slower rate so the IRS can conduct detailed compliance reviews, which are likely to include requests for additional documentation in many instances. The IRS anticipates existing claims will take about 180 days, with claims selected for audit taking considerably longer.
In addition, the IRS announced that it would provide guidance for businesses to withdraw erroneous ERCs. The goal is to give businesses that were misled about ERC eligibility a path to remediate improper claims in a manner that could avoid potential penalties and interest.
On Oct. 19, 2023, the IRS issued IR-2023-193, which set forth withdrawal procedures for businesses that were pressured or misled by ERC advisers into filing ineligible claims. Pursuant to these procedures, a withdrawn claim will be treated as if it was never filed. To qualify, a business must:
To withdraw an ERC claim, eligible businesses and their advisers must follow the specific instructions in FS-2023-24. Businesses that filed ERC claims through a professional payroll company should consult with that company, which may need to submit the withdrawal request. Other businesses and their tax professionals can simply fax the withdrawal request to the IRS using its dedicated fax line. Although it may take longer for the IRS to process, requests can be mailed in too. Those businesses that are already under audit can send the withdrawal request to the assigned examiner or reply to the audit notice if an examiner has not yet been assigned.
Businesses that attempt to withdraw a claim will get a letter from the IRS indicating whether the request was accepted or rejected. An approved request is not effective until the taxpayer receives the acceptance letter. Even where the withdrawal is accepted, businesses may need to amend their income tax returns.
Although the IRS is contemplating a settlement initiative for businesses that have already received ERC payments, such businesses cannot currently take advantage of the above procedures. Despite this, they can still proactively help themselves. It is still possible for businesses that received ERC checks to reduce or eliminate their ERC claims by filing amended returns, as outlined in the IRS's frequently asked questions about the ERC.
For businesses, CPAs, or business advisers with concerns about the ERCs they or their clients claimed, now is the time to have an attorney with ERC and sensitive tax controversy experience conduct an independent compliance review. If a claim is determined to be problematic, withdrawal may be the best chance of escaping costly interest and penalties, where available. If a claim is potentially problematic but withdrawal is not an option, businesses may consider filing amended tax returns. For claims that appear valid and defensible, it is advisable for businesses to organize the supporting documentation for a future audit and assemble a team capable of litigating the matter, if it becomes necessary. For claims that take longer than six months or are erroneously rejected by the IRS’s new processing procedures, you may want to consider bringing an appeal or filing a refund lawsuit against the IRS.
In most cases, criminal exposure may be minimal. Nonetheless, given the IRS’s warnings of widespread ERC fraud, any internal compliance review must analyze whether the particular claim at issue could be viewed as fraudulently filed. Although the IRS’s focus has been on ERC advisers in this regard, that does not mean other individuals and businesses at fault for filing fraudulent claims are off the hook. To that end, the IRS does warn that a withdrawal will not offer automatic protection from potential criminal investigation.
A review should pay particular attention to typical areas of confusion, such as the affiliation, aggregation, and full-time employee calculation rules (which are similar to, but not the same as, those applicable to Paycheck Protection Program loan eligibility), and the partial suspension requirement (which is a subjective standard open to reasonable interpretation). To that end, businesses and their advisors should be mindful of recent IRS scrutiny and guidance in addition to the applicable statutes and regulations.
One particular type of claim likely to draw scrutiny is a full or partial suspension claim based on supply chain disruption. In Q&A No. 12 of Notice 2021-20, the IRS recognizes that such a disruption may effectively shut down a business sufficient to qualify for the ERC, so long as the supplier was unable to deliver critical goods or materials due to a full or partial suspension of its business due to a government order; the employer was unable to obtain critical goods or materials from a supplier or an alternative supplier; and the employer suffered a full or partial suspension of its business due to the government order related to the supply side disruption.
As a follow up to Q&A No. 12, the IRS released a general legal advice memorandum (GLAM) on July 21, 2023, which applied the above analysis to five different scenarios involving various types of supply chain disruptions. Taken as a whole, the IRS’s analysis of these scenarios appears to indicate that its application of the principles of Q&A No. 12 is quite narrow. In particular, the GLAM can be read to impose the following restrictions on claims based on a full or partial shutdown linked to a supply chain disruption:
The IRS guidance and procedures discussed above make future ERC claims more difficult and have given businesses an opportunity to remediate erroneously filed claims, sometimes without paying penalties or interest. It would be wise for many to take the IRS up on this offer. Others will need to begin preparing a defense. A wrong move could be very costly. Accordingly, it is important that any business that claimed the credit consider enlisting an attorney with ERC and sensitive tax controversy experience to conduct an independent review of its claim and advise on the most advantageous path forward. It is equally important for CPAs and business advisers to discuss these issues with any client that filed an ERC claim.
Kevin F. Sweeney is a former federal tax prosecutor and currently a shareholder in the Philadelphia office of Chamberlain Hrdlicka, where he focuses on IRS audits, civil and criminal tax litigation, white-collar criminal defense, and IRS whistleblower matters. He can be reached at firstname.lastname@example.org.
Olivia Y. Klein is an associate in the tax controversy section of Chamberlain Hrdlicka, practicing primarily on federal, state, and local tax. She can be reached at email@example.com.
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Statements of fact and opinion are the authors’ responsibility alone and do not imply an opinion on the part of the PICPA's officers or members. The information contained herein does not constitute accounting, legal, or professional advice. For actionable advice, you must engage or consult with a qualified professional.