I reported earlier this year that the IRS issued IR-2022-183 warning against third parties improperly computing the employee retention credit (ERC). Then, the IRS issued a “renewed warning” in IR-2023-40 warning about promoters who aggressively mislead people and businesses into thinking they can claim these credits.
The IRS is now taking a bigger step. On Sept. 14, the IRS issued IR-2023-169, putting a moratorium on processing new ERC claims through at least the end of the year. But don’t get freaked out! ERC qualifications have not changed, and you can still file.
In fact, the IRS is still encouraging businesses to file legitimate claims, but it is asking businesses to review their claims with a trusted tax professional who actually understands the complex ERC rules, not a promoter or marketer trying to make a quick buck.
This is just being done so that the IRS can combat the “fly-by-night” providers and it will allow the IRS to:
- Add more safeguards to prevent future abuse,
- Protect businesses from predatory tactics, and
- Have time to work with the Justice Department to combat aggressive marketing and incorrect ERC claims.
If you hadn’t heeded the warnings before, take the IRS’ latest initiative as a sign that it’s time to be serious. CPAs have a professional responsibility when they sign a return and that includes doing due diligence on third parties that are providing credit numbers.
ERC Horror Stories
Many promoters that sprung up during the pandemic are doing an ERC evaluation in minutes and claiming quarters without substantiation. Let’s look at a few actual case studies we have had from wary CPAs asking us for guidance before they signed their name on an amended return reflecting a large refund.
Commercial retailer located in Alabama
The retailer entered into an agreement with an ERC provider. After responding to a brief questionnaire followed by a short phone call with the ERC provider, the retailer was told it qualified for all quarters in 2021 and that the ERC would be over $1 million!
The CPA and business owner were skeptical about how little time and effort it took to make this determination. So, they came to us for a second opinion. Below is a synopsis of the analysis that showed that the work product fell far short of what the IRS requires to substantiate an ERC claim. This included the following:
- Gross receipts? There was no significant decline in gross receipts.
- Qualifying quarters? The retailer was located in Alabama and Florida, two states where government orders did not extend into the third quarter of 2021, yet the other ERC provider used claimed Q3 in their calculation. Furthermore, the client had stated that restrictions for them had ended in May 2021.
- Supply chain? There was no reference to the location of the retailer’s suppliers to substantiate any supply chain disruption, but the other provider claimed it under the partial suspension test.
- Qualifying mandates? There was no identification of any specific government order applicable to the retailer.
- More than nominal impact? The retailer estimated the impact in delayed work was 10% but there was no substantiation.
- Substantiation and documentation? None of the information in the questionnaire completed by the retailer was substantiated by the ERC provider.
Thus, there was no $1 million credit here. We engaged an outside law firm that was able to break the contract with this ERC provider so that the company would not be on the hook for over $250,000 in fees. They have now engaged us to conduct a new ERC study the right way.
Tool and equipment manufacturer in Montana
The manufacturer signed an agreement with an ERC provider. After a few phone calls with the ERC provider, the manufacturer was informed it qualified for an ERC claim totaling over $750,000 based on canceled trade shows. The manufacturer contacted their CPA about the windfall. The CPA expressed skepticism and contacted us for our thoughts. We advised the manufacturer and their CPA on a second opinion.
After a review of the ERC study and related documentation, we informed the manufacturer that the ERC study would not withstand IRS scrutiny in the event of an audit. This was due to the following:
- Gross receipts? There was no significant decline in gross receipts.
- Qualifying business disruption? There was no evidence showing the trade shows were cancelled due to government orders, not even evidence showing the trade shows were cancelled.
- More than nominal impact? The analysis did not show a nexus between the closure of trade shows, nor the manufacturer’s supply chain issues and the manufacturer’s more than nominal impact.
- Qualifying mandates? The governmental order referenced was simply the emergency declaration, not a specific governmental order applicable to the manufacturer’s suppliers.
- Substantiation and documentation? The analysis stated that the manufacturer had to wait longer for materials but made no mention as to how long or how much longer they had to wait in comparison to 2019.
As a result, we advised the manufacturer not to file the claim. They were able to disengage the ERC provider and a law firm was able to get the manufacturer’s down payment refunded. Again, the manufacturer subsequently came to us to do a new ERC study correctly.
Moral of the Story
When it comes to the ERC, it’s the wild, wild west. The smell of gold (fast, easy fees) has lured these pop-up ERC providers to promise the world without doing the necessary, exact and meticulous research and documentation to properly qualify and quantify a company for ERC.
The CPA may be stuck in the middle, between a drooling client hungry for a cash refund and their due diligence responsibility before preparing and signing that tax return proposing a huge refund.
Like it or not, the facts are the facts. Sometimes we have good news and sometimes we have bad news. Either way, we must continue to exercise our great CPA trait: using professional skepticism and due diligence to get our clients both the best and the right answer.
Unless you have absolute comfort with your client’s ERC provider, maybe a legal “second opinion” is in order.