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Employee Retention Credit — Eyes Open

MARCH 24, 2023
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by Dean Zerbe, Former Senior Counsel to the U.S. Senate Finance Committee; alliantgroup National Managing Director

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The IRS recently announced that scams from promoters pitching the Employee Retention Credit (ERC) to unwary business owners is the top of the “dirty dozen” list of tax cons this year. As I’ve written about previously, business owners need to be eyes open about the ERC – and work closely with their CPA/trusted tax advisor about whether they may qualify for the ERC.

The new IRS Commissioner’s statement about the ERC and tax scammers – captures well the tightrope here for businesses – on the one hand the ERC is a good benefit for small and medium businesses that qualify – on the other hand – qualifying is not a walk in the park (at all).

“The aggressive marketing of these credits is deeply troubling and a major concern for the IRS,” said IRS Commissioner Danny Werfel. “Businesses need to think twice before filing a claim for these credits. While the credit has provided a financial lifeline to millions of businesses, there are promoters misleading people and businesses into thinking they can claim these credits. There are very specific guidelines around these pandemic-era credits; they are not available to just anyone. People should remember the IRS is actively auditing and conducting criminal investigations related to these false claims. We urge honest taxpayers not to be caught up in these schemes.”

While my shop – alliantgroup — has helped many companies qualify for the ERC – we’ve also had to tell many companies that they don’t qualify for the ERC. Most concerning – we’ve seen scores of companies referred to us by their CPA – companies that have listened to promoters and that clearly don’t qualify for the ERC. These business owners have been sold a bill of goods by here-today- gone-tomorrow promoters.

What is particularly stunning is the promotional pitches and material that are out there for the ERC. I’ve never seen anything like it—the radio ads, the TV ads, internet – even billboards – all singing the siren song of ERC. Ms. Phillips at Forbes wrote a first-rate article on the IRS announcement on ERC being the top of the dirty dozen list – and provided some examples of solicitations for ERC that she has received. I see a continuous run of ERC pitches. Let’s be honest – when they are doing TV ads for a tax benefit – hochimama – watch out.

Most troubling – we have clients that are coming to us with forms they receive in the mail – forms that walk, talk, quack like an IRS form letter. The form letters are directing the company to apply for the ERC. Let me be clear – there is not a “Department of Employee Retention Credit” at the IRS. Eyes open.

Fraud In ERC — Examples

For business owners and CPA/tax advisors – I thought it useful to go through some of the frauds/errors we are seeing – so they may be better aware. This article focuses on the second test for qualifying for ERC – the covid-related government order having a more than nominal impact on business operations – since that is where we are seeing the most problems from scammers. The reduction in revenue test to qualify for ERC is more straightforward – and while not immune to mischief – is not seen as often.

For the covid-related test, commonly, there is no effort by the ERC promoter to tie the impact to a business to a specific government order related to covid (a covid order that actually impacts the business). Further, the promoters do not provide detailed analysis of the impact of a covid order showing that the covid order had a more than nominal impact (for each quarter) on the operations of the business. For example, we will often see a blanket statement covering all quarters that the company was impacted by covid – ex. “had to close the breakroom.” If you think you can mail it in and qualify for the ERC – you are doing it wrong.

We continually see promoters making ERC claims on behalf of the business and the government covid “order” being pointed to is not an “order” but merely an advisory or guidance. For example, I have repeatedly seen statements from promoters that CDC guidance is a government order (it’s not). Also, for example, my colleagues have seen where a company based their entire analysis based on a Nebraska State of Emergency declaration (the IRS guidance specifically states that state of emergency declarations do not constitute government orders). No, no, no. You need an actual government covid-related order; that covid order has to have a more than nominal impact on your business for that specific quarter. You need to document and substantiate how that government covid order had a more than nominal impact on your business for that quarter.

As an example, on government covid orders, one Midwest company we reviewed was hornswoggled into claiming a $2 million ERC credit for certain quarters – quarters in which no government covid orders even existed. Leading to the client having to amend their returns and give the money back.

As we have reviewed proposed ERC claims done by promoters — commonly provided to us by our CPA-partners on behalf of their clients to verify that the client qualifies for the ERC – other issues we see include missing or misapplying issues such as: misapplying tests for controlled group; interaction with Paycheck Protection Program (PPP); and interaction with other tax credit, incentives and grants.

For example, with one particular company that we were asked to double check the work – received the unfortunate news from us that the $7 million ERC they claimed was actually a complete zero. The provider, with clearly no tax experience, did not understand the aggregation rules for controlled groups which equated to a company that was well in excess of the employee threshold.

One (scam) provider claimed that since one person in a company got covid at one location, that was tantamount to a more than nominal impact across the organization and therefore claimed in excess of 300k in credits.

Separately, in an example reported by the Treasury Inspector General for Tax Administration (Semiannual Report page 16) of extreme abuse included a Utah return preparer that plead guilty of filing false returns by submitting $11 million in ERC claims. The return preparer actively solicited single-member, limited liability companies (LLCs) to apply for the covid-related tax credits, including the ERC and sick and family leave wages. He also actively solicited independent contractors involved in door-to-door sales, rideshare drivers, sole proprietors, and other Form 1099-MISC, Miscellaneous Income, workers to convert their “businesses” into LLCs, to allow the independent contractors to qualify for COVID-related tax credits. He sought ERC credits for LLCs regardless of whether the LLC was statutorily eligible to receive the ERC, resulting in false and fraudulent claims.

Signs That You Might Be In River City

Signs of trouble are if the company promoting the ERC is indemnifying themselves – ie having the client sign documents stating that they (the client) bear all risk and that the promoter is simply calculating the credit amounts – based on the client’s self-qualification. You want your tax advisor to stand by their work and will stand with you if the IRS calls.

If the company promoting the ERC is advertising qualification for ERC in minutes and blanket qualifying regardless of the specific situation or impacts to the business — be extremely wary. Ensuring and documenting that a business qualifies for the ERC – and will pass IRS scrutiny – is a significant lift.

We had one CPA partner ask us to review a small business client’s proposed ERC filing. In this case, the business’ payroll company had put together the ERC filing – claiming the business was going to get $2 million dollars. When we reviewed the claim for the ERC there was no government covid-related order that served as the basis for the claim; there was no analysis of how the business was subject to a more than nominal impact due to covid. We determined that the business was eligible for zero under the ERC. While not a happy result, a far happier result then making an erroneous filing and then being subject to a full audit by the IRS with taxes, penalties and interest at the end of the day (not to mention the time, cost and grind of the exam). As important, a happy result for the CPA who could easily be in a bad way as well for making an ERC filing on behalf of their client.

Important for tax advisors to bear in mind that the IRS Office of Professional Responsibility (OPR) made clear in a recent bulletin that as the tax advisor to the business claiming the ERC on the return, they have important responsibilities – for which the IRS will look to hold them accountable.

The IRS Man Cometh

As the IRS announcement and bulletin makes clear – the IRS is heavily focused on the scam artists pushing the ERC – and the businesses that are falling for their carnival barker pitch. Business owners are kidding themselves if they think they can point the finger to the scam artist (who will have skipped town long ago) and say, “he told me it was ok.”

The IRS will have a fish-meets-barrel moment auditing these ERC scam filings. In most cases, these audits are going to be straightforward and simple for the IRS to find that the business owner doesn’t qualify for the ERC. To be clear, it will be the business owner – not the scammer – who will owe the tax, penalties and interest.

Good for business owners to embrace clean living now. Don’t listen to the radio and tv ads, the internet pitches, the billboards. Business owners need to have their eyes wide open and talk closely with their CPA and trusted tax advisor on whether they qualify for the ERC.

About the Author

Dean Zerbe is alliantgroup’s National Managing Director based in the firm’s Washington D.C. office. Prior to joining alliantgroup, Mr. Zerbe was Senior Counsel and Tax Counsel to the U.S. Senate Committee on Finance. He worked closely with then-Chairman and current Ranking Member of the Finance Committee, Senator Charles Grassley (R-IA), on tax legislation. During his tenure on the Finance Committee, Mr. Zerbe was intimately involved with nearly every major piece of tax legislation that was signed into law – including the 2001 and 2003 tax reconciliation bills, the JOBS bill in 2004 (corporate tax reform), and the Pension Protection Act. Mr. Zerbe is a frequent speaker and author on the outlook for short-term and long-term changes in tax policy, as well as ways accounting firms can help their clients lower their tax bill. He holds an LL.M. in Taxation from NYU and a J.D. from George Mason University.