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Voices: Clients who claim a questionable ERC could mean trouble


Byline from Darren Guillot, Former IRS Commissioner of the Small Business/Self Employed Division; alliantgroup National Director and
Eric Hylton, Former IRS Commissioner of the Small Business/Self Employed Division; alliantgroup National Director

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The Internal Revenue Service announced in March that its compliance efforts related to the Employee Retention Credit had exceeded $1 billion, with the agency specifying that “more than 12,000 entities filed over 22,000 claims that were improper and resulted in $572 million in assessments.”

According to the IRS, which as of the end of February 2024 had initiated more than 386 criminal cases in the ERC space, enforcement efforts will only continue to expand. IRS Commissioner Danny Werfel has also made it clear that the IRS is taking erroneous ERC claims seriously, recently commenting that the agency remains “concerned about widespread abuse involving these claims that have harmed small businesses.”

In the face of these eye-popping statistics, and the IRS adding ERC fraud to its “Dirty Dozen” list of abusive tax schemes, the question for accountants across the U.S. becomes: “What is my responsibility if my client presents me with a questionable ERC claim?” More importantly, accountants need to ask themselves what personal risks they take on if they push through an ERC calculation they suspect could be inaccurate.

The IRS Office of Professional Responsibility released guidance on March 7 regarding how tax professionals can ensure they are meeting their Circular 230 professional responsibilities when dealing with a potentially erroneous claim from a third party.

Citing Section 10.22(a) of Circular 230, the IRS OPR stated that if “the practitioner cannot reasonably conclude … that the client is or was eligible to claim the ERC then the practitioner should not prepare an original or amended return that claims or perpetuates a potentially improper credit.”

The IRS OPR went on to state that, as a best practice, tax practitioners should consider advising their clients of the option to file an amended return, as well as penalties for noncompliance.

In short, Section 10.22(a) cited in the guidance binds accountants to diligence as to the accuracy of the claim and requires a reasonable inquiry to confirm the client’s ERC eligibility, as well as further inquiry into the credit calculation if it appears to be incorrect, incomplete, or inconsistent.

IRS OPR Director Sharyn Fisk has been on record cautioning that the agency is more frequently auditing taxpayers who claim credits that they are not entitled to and that the IRS “can’t ignore information that’s inconsistent, incomplete or incorrect.”

Fisk has gone on to say that accountants aren’t exercising due diligence if they fail to ask the question of a client or a third party who calculated an ERC, while noting that documentation is critical for tax practitioners to protect themselves.

The American Institute of CPAs has also issued warnings to accountants reviewing ERC calculations from third-party providers. The AICPA stated in Risk Alert 2.1.23 that if a “client’s ERC claim is later denied, the client may allege the CPA, through its preparation of the tax return reflecting the ERC claimed, tacitly agreed with it, thus negating all prior written warnings provided to the client.”

The AICPA added that, if asked by a client to prepare a return using information from a third party, including ERC calculations, accountants “should first obtain a signed engagement letter defining which federal and state tax returns require preparation or amendment and then evaluate the information in accordance with professional standards.”

In terms of factors to consider when an accountant is vetting an ERC calculation, the IRS has provided a list of “red flags” for taxpayers and tax practitioners to look out for, which include a third party being able to determine ERC eligibility “within minutes” and large upfront fees to claim the credit.

In short, accountants who are seeing a noticeable lack of documentation to support a credit, or excessively high ERC calculation based on what they know of their client, should take steps to validate the figure, including consulting with those firms that specialized in tax credits prior to the COVID-19 pandemic, before moving forward.

Return preparers who fail to take note of these red flags and either proceed with ERC calculations they know aren’t reasonable, or fail to amend an existing claim, might face consequences themselves, including possible disciplinary proceedings from IRS OPR for those who have ignored Circular 230, as well as possible preparer penalties under Section 6694 or 6701 of the Internal Revenue Code.

As stated, the IRS’s ERC enforcement campaign is far from over. And although the agency’s Voluntary Disclosure Program for ERC ended on March 22, there are still some options available. Tax practitioners should inform their client of the option to withdraw a questionable ERC if monies have not yet been received.

American CPAs cannot, and should not, accept ERC calculations they feel lack a reasonable basis. As a result, it is incumbent upon accountants faced with questionable ERC figures to ask the right questions and consult established tax consulting firms in order to validate the ERC figure at issue.

Whether the software gets a second year, former IRS commissioner Mark Everson predicted, “depends 100 percent on who the treasury secretary is come January.

A second-term Biden administration would likely run Direct File again, perhaps even expanding the parameters the software can handle and offering it in more states. If former president Donald Trump wins the election, on the other hand, its prospects are less secure. While Trump’s own views on Direct File are not known (his campaign declined to respond to questions), Republicans at the national and state levels have been critical of government-run tax filing.

But some proponents argue that Direct File might live on, even under a president who didn’t support it, since the IRS has wide discretion in how to spend its own budget.

“I don’t think they built it to shut it down,” said Adam Ruben, whose organization, the Economic Security Project, has been promoting the website to taxpayers. “I’ll be surprised if we don’t see it expand to more states and more tax situations next year.”

David Kautter, a former assistant secretary of the Treasury for tax policy, said the IRS won’t equate user numbers with success or failure.

“The IRS would say … we didn’t set our sights real high. We tried to make this a controlled pilot program,” he said. “If the IRS can develop a user-friendly interface, then it has the possibility to become very popular” in the future.

One unexpected twist was that publicity around Direct File drew attention to other long-standing government-supported options. The Free File Alliance, a group of private companies that offer free versions of their software to eligible taxpayers, said that as of April 5, more than 1.7 million households had used Free File software, an increase of 16 percent compared to the same time last year.

Meanwhile, IRS-supported Volunteer Income Tax Assistance programs had prepared 2.3 million free returns, an increase of 200,000 compared to last year, Treasury Secretary Janet L. Yellen told reporters on a call Friday.

The IRS has also touted its hiring of more than 5,000 customer service workers since receiving tens of billions of dollars of additional funding from Congress in 2022. This year, its workers answered more than 85 percent of phone calls from taxpayers, compared to 15 percent before the new funding, the IRS said.

Overall, it was “one of the best tax filing seasons the nation has seen in years,” said IRS commissioner Danny Werfel on the call Friday.

Hits and misses

Four taxpayers agreed to let a Washington Post reporter observe while they tried using Direct File.

In California, Tristan Brown, a state teachers union lobbyist, spent 15 minutes filling in his information before realizing that he had received a $140 dividend, a form of income that Direct File wouldn’t allow him to report.

“I guess I’m stuck. Which is lame. I feel like a lot of people are going to have [an investment] account that would have that,” he said. “Now I’m back to letting TurboTax take my money.”

Mia Francis, a barista, ran into similar trouble. Eight minutes in, she learned the site wouldn’t allow her to file since she had lived and earned income during the year in a nonparticipating state before moving to Massachusetts. “I do a lot of moving around. Unless they have it where … you can use it if you lived in more than one state, it will be unlikely that I’ll be able to do it,” she said as she stared at the screen.

But two of the taxpayers made it all the way through.

Havilah Fowler, an 18-year-old barista, was nervous about filing her first-ever tax return. The identity verification process was cumbersome and took her more than an hour, including a wait for a video call. Then she read and reread some of the prompts.

She wasn’t sure, for example, what “standard deduction” meant. “What is going on? Google will explain this better,” she said.

Still, when she got to the final page and saw her refund was on its way, she cheered and clapped.

Describing herself as “an inexperienced taxpayer,” Natalie Comerford, 20, clicked several times when the site offered buttons to explain or clarify tax concepts. She read explanations about how to correctly type in information from her W-2s from her part-time jobs, what “estimated tax payments” are, and whether she was entitled to any tax credits. Less than an hour after she began, she submitted her return.

“Normally government sites are really clunky,” she said. “That was really easy.”

Featured Leadership

As an alliantgroup trusted tax advisor and consultant, Mr. Guillot assists small and medium-sized businesses navigate America’s tax system to secure incentives and credits that stimulate innovation and improve products and services. He also serves them as an expert resource resolving complex compliance and appellate controversies.

Eric Hylton held several prominent positions at the IRS, including serving as Deputy Chief of the Criminal Investigation Division and as CI’s head of International Operations. As National Director of Compliance, Eric employs his years of experience at the IRS to assist alliantgroup’s clients as an ambassador for U.S. small and medium sized businesses (SMBs) and in helping others become tax compliant.