The Internal Revenue Service announced on Sept. 14, 2023, an immediate moratorium on the processing of Employee Retention Credit (ERC) claims that is anticipated to last at least through the end of the year.
This unsurprising announcement comes after repeated warnings to taxpayers of aggressive promoters and marketing campaigns targeting ineligible applicants that has resulted in the improper submission of claims for refunds through a pandemic-era relief program that was designed to protect honest small-business owners. These marketing campaigns include targeted emails, phone calls and text messages claiming recipients’ eligibility for large refunds if they apply for the ERC. Taxpayers who submitted ERC refund claims should discuss eligibility with a trusted tax adviser to determine if any remedial action is appropriate, and taxpayers considering filing a claim should ensure they are eligible.
The ERC is a refundable tax credit for businesses and tax-exempt organizations that had employees and were affected during the COVID-19 pandemic. If eligible, a taxpayer may receive up to $5,000 per employee for 2020 and up to $7,000 per employee per quarter for the first three quarters of 2021. The ERC eligibility requirements differ depending on the time period for which the credit is claimed.
Tax Scams. In March 2023, the IRS published its annual dirty dozen list of tax scams, adding ERC abusive promoter claims to the list. Because the ERC is complex and requires careful review before applying, the IRS has repeatedly warned taxpayers to be wary of the following:
- Unsolicited ads, calls, emails or texts from unknown persons.
- Statements that someone can determine ERC eligibility within minutes.
- Large up-front fees for assistance claiming ERC refunds.
- Fees based on a percentage of the refund amount of ERC claimed.
- Statements that a taxpayer qualifies for ERC before any discussion about particular tax situation.
- Statements urging taxpayers to submit the claim because there is nothing to lose.
With more than 3.6 million claims made to date and a backlog exceeding 600,000 claims, the IRS issued the moratorium to address pressing concerns raised over the past few months by multiple tax professionals and the media regarding a substantial number of new ERC claims from ineligible taxpayers who were pressured or scammed into falsely believing they were entitled to significant refunds.
As of July 31, 2023, the Criminal Investigation division of the IRS noted that it had initiated 252 investigations involving over $2.8 billion of potentially fraudulent ERC claims. Of those, 15 investigations have resulted in federal charges. Of the 15 federally charged cases, so far six matters have resulted in convictions, four of which have reached the sentencing phase with an average sentence of 21 months. In addition, the IRS has referred thousands of ERC claims for audit by its civil division. If found ineligible, businesses could be forced to repay the credit, plus interest and penalties, and would need to seek recourse on their own against promoters.
For taxpayers who submitted an ERC claim before Sept. 14, the moratorium does not mean the IRS will not process claims or issue eligible refunds. Instead, the payout for such claims will be at a slower pace due to detailed compliance reviews. The IRS’ standard processing time goal of 90 days is now being pushed out to 180 days and could be much longer if further review or audit is deemed warranted. The IRS also may seek additional documentation from taxpayers who filed claims.
New Initiatives. In addition to announcing the moratorium, the IRS announced that it is in the process of developing new initiatives to help businesses that find themselves victims of aggressive promoters. While taxpayers await further guidance, the IRS has provided several specific recommendations for businesses, depending on where they are in the ERC claim process.
- Currently awaiting processing of an ERC claim. For those who currently have an ERC claim on file and have confirmed with a trusted tax adviser that the business is eligible for the ERC, the IRS recommends no action and to expect additional delays in receiving refunds. Unfortunately, there is no process to expedite review of valid claims.
- Withdrawing an existing claim. For those businesses that have filed and have a pending claim that they now believe was submitted improperly, the IRS indicated that such claims can be withdrawn — even if the case is already under audit or awaiting audit. The IRS was quick to point out, though, that for taxpayers who willfully filed fraudulent claims or conspired to do so, withdrawing a fraudulent claim will not exempt them from potential criminal investigation and prosecution. Taxpayers in this situation may need to consult legal counsel to determine the best course of action.
- Planning to file a claim. For those considering filing a claim, the IRS urges businesses to carefully review the ERC guidelines during the processing moratorium period. The IRS urges businesses to talk to a trusted tax professional. Before submitting a claim, taxpayers should request from the tax adviser assisting on the preparation of the claim a detailed worksheet explaining ERC eligibility and the computations used to determine the ERC amount.
- Waiting for the IRS ERC settlement program to be finalized. If a business has already received an ERC refund that it now believes is in error, the IRS announced that it will provide additional details on the settlement program in fall 2023 that will allow businesses to repay ERC claims. The settlement program will allow the businesses to avoid penalties and future compliance action.
ERC Eligibility Basics. The ERC is available to certain employers, including tax-exempt organizations, that paid qualified wages to some or all employees after March 12, 2020, and before Jan. 1, 2022 (Eligible Employers). Eligibility and credit amount vary depending on when the business impacts occurred. The ERC is not available for self-employed individuals.
Eligible employers are eligible for the credit if they operated a trade or business during calendar year 2020 and/or 2021, and experienced either: (1) the full or partial suspension of the operation of their trade or business because of governmental orders limiting commerce, travel or group meetings due to COVID-19 (the “suspension test”); or (2) a significant decline in gross receipts (the “gross receipts test”). For the first three quarters of 2021, eligible employers also included certain governmental employers that were (1) organizations described in section 501(c)(1) and exempt from tax under section 501(a); and (2) colleges or universities whose principal purpose is to provide medical or hospital care. For the fourth quarter of 2021, only certain startup businesses qualified for the ERC.
Fully or Partially Suspended by Government Order. Under the suspension test, a business is considered fully or partially suspended if an appropriate government order limited travel, commerce or group meetings due to COVID-19 and such order had more than a nominal impact on the operations of the business. Recommendations or statements from governmental authorities encouraging taxpayers to take certain actions do not constitute orders that would qualify a taxpayer for the ERC. Further, even if a governmental order limiting travel, commerce or group meetings applied to a particular taxpayer, if all of the taxpayer’s employees were able to telework during the pandemic and the business continued to operate with no more than a nominal impact, the business is not deemed suspended. Further, a taxpayer who voluntarily closed its business or reduced hours of operation does not qualify under the suspension test. However, a taxpayer could still qualify for ERC based on a decline in gross receipts (described below) even if the taxpayer does not otherwise qualify under the suspension test.
Significant decline in gross receipts. Under the gross receipts test, an employer is considered to have a significant decline in gross receipts for the period beginning with the first calendar quarter in 2020 for which its gross receipts are less than 50% of its gross receipts from the same calendar quarter in 2019, and ending with the earlier of Jan. 1, 2021, or the first calendar quarter after the quarter for which gross receipts are greater than 80% of gross receipts for the same calendar quarter in 2019. For calendar quarters in 2021, the eligibility requirements were amended for employers attempting to qualify due to a decline in gross receipts. For 2021, the ERC is allowed beginning with the quarter where gross receipts are less than 80% of the same quarter in 2019.
Also, the change added an alternative quarter election rule giving employers the ability to look at a prior calendar quarter and compare it to the same calendar quarter in 2019 to determine whether there was a decline in gross receipts. Further, if an employer was not in existence in 2019, the employer could determine whether it experienced a decline in gross receipts by comparing its gross receipts for the calendar quarter in 2021 to its gross receipts in the same calendar quarter in 2020.
ERC Calculations and Limitations. The credit amount for 2020 is 50% of up to $10,000 of qualifying wages per employee for the 2020 ERC period of March 13, 2020, through Dec. 31, 2020. In other words, the maximum credit for 2020 is $5,000 per employee. For 2021, the credit amount is 70% of up to $10,000 of qualifying wages per employee for each eligible quarter. In other words, the maximum credit per employee is $7,000 per quarter. Qualifying wages include not only cash compensation paid to each employee, but the allocable portion of their healthcare costs as well. Severance payments do not qualify for the ERC.
For the 2020 ERC period, while there is no company size restriction to qualifying for the ERC, special rules apply if the number of full-time employees in 2019, on average, exceeds 100. Those businesses may compute the credit based only on wages and healthcare paid to employees not providing services during an eligible 2020 period. If the 2019 average full-time employee count is 100 or fewer, the company is deemed a small employer and the credit is based on wages paid to all employees, whether they were working or not. Similar rules apply to the 2021 ERC period; however, the number of full-time employees was raised to 500 or fewer to be deemed a small employer, still based on 2019 average full-time employees.
Importantly, employers cannot claim the ERC on wages that were reported as payroll costs for Paycheck Protection Program loan forgiveness.
How to Claim the ERC. The ERC is claimed by amending the organization’s payroll tax returns for the eligible quarters. For example, businesses that file quarterly employment tax returns can file Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund, to claim the credit for prior 2020 and 2021 quarters. Importantly, the ERC differs from some other COVID-19 incentives in that the credit is taxable — meaning the organization taking the credit must reduce its wage deduction on its income tax return for the year for which the ERC was claimed. For example, if an organization claimed ERC for 2020, the organization may need to amend its tax return for a reduction of the wage deduction in the amount of the credit if such reduction was not captured on an originally filed income tax return.
ERC Filing Deadlines. Given the issuance of the moratorium, taxpayers need to be mindful of the following statutory deadlines to file ERC claims and should monitor for additional guidance on the status of the moratorium:
- April 15, 2024, to file a claim for any eligible 2020 quarter.
- April 15, 2025, to file a claim for any eligible 2021 quarter.
McGuireWoods lawyers are experienced in evaluating ERC claims and eligibility requirements. Please do not hesitate to reach out if you have questions regarding a previously filed ERC claim or are considering filing an ERC claim.