M“ERC”h Madness: The Latest Developments of the Employee Retention Credit (ERC)

Those of you following basketball know that March Madness is here, and basketball has taken center stage. But for us, at Sikich, our heads are more in the game of tax. We’re following the Employee Retention Credit (ERC) as it continues to have a madness of its own. What started out four years ago as a COVID-19 relief effort for employers, today, has continued to inundate employers and the IRS. The following items are the latest developments of the credit and how the ERC can impact your business:

Full Court Press: The IRS continues to combat abuse of the ERC. This effort is two-fold: the IRS previously suspended processing new ERC claims, while also allowing companies to repay the credit they received at a discount. Second, the IRS is investigating alleged ERC mills and communicating key findings about ERC abuses and aggressive marketing tactics.

Three-Pointer: IRS investigations related to the ERC are active on at least three fronts. It has initiated (1) criminal investigations; (2) civil examinations; and (3) enhanced compliance reviews of unpaid claims.

Slam Dunk: The IRS is looking to pursue individuals and companies involved in fraudulent or abusive ERC activity. At the end of 2023, the IRS had 352 open criminal investigations covering $2.9 billion worth of claims (an average of over $8.2 million in credits per investigation).

Turnover: While the Statute of Limitations (SOL) will soon expire on Forms 941 and 941X filed for 2020, the statute can be extended if the IRS asserts fraud. For 2021 claims, the SOL will begin to expire in 2025 (for ERC claims filed for Q1 and Q2 of 2021) or 2027 (for ERC claims filed for the third quarter of 2021). While employers may expect the SOL to run and their ERC claim to be preserved, there are some possible “turnovers” that could change that assumption.

Double Dribble: The IRS has two opportunities to review an employer’s tax returns. First, it can determine whether an employer properly filed their ERC on an original or amended payroll tax return. Second, the IRS can evaluate if the employer correctly reported their ERC wage adjustment on their corresponding income tax return.

Recruiting Violations: Few things can derail a trip to the tournament faster than running afoul of the NCAA recruiting rules, even when those violations are committed by a third-party booster outside of the program. Similarly, a company’s ERC claim may face increased scrutiny and risk based on who prepared it. In December 2023, the IRS initiated civil examinations of aggressive promoters, which included interviewing affected credit recipients. These examinations are ongoing and could impact vendors and customers of aggressive promoters.

At least one class action lawsuit (MB Automotive Specialists, Inc. v. ERC Specialist, LLC. Case No. 2024CH01110) was filed by ERC recipients against one of these alleged ERC mills. It’s important that employers take stock of who prepared their ERC claim and the support that was prepared as part of that process. In many cases, getting a review of the basis for the claim and the support from a qualified, reputable firm before the IRS starts its review could go a long way towards ensuring that your “season” isn’t cut short.

While these items mostly relate to steps the IRS is taking to enforce eligibility for the ERC, there are actions that employers should take to prepare for a potential IRS audit.

Time Out: One of the most important steps you can take is to review the work previously performed that supported your ERC claim. For all claims paid and unpaid, it is possible that the IRS will request further documentation to support it. If the claim has not yet been paid, it is more likely an employer will be asked by the IRS to produce additional ERC support.

Currently, the IRS is working through the list of employers that filed for an ERC refund to provide notice of businesses’ obligations. Within this notice, the IRS states that employers must provide the required documentation to the IRS within 30 days. The notice states that failure to comply timely with the request will result in disallowance of an employer’s ERC claim.

The documentation requested includes detailed narratives specifically addressing how and why an employer was eligible, as well as business and payroll records that support the claim. It may, in fact, take more than 30 days to compile this documentation if it isn’t already organized. We can assist in thoroughly reviewing an employer’s filed claims and the documentation that supports the claim to prepare for further IRS enforcement action.

Defense: The defense an employer has for determining their qualification for the ERC can be the deciding factor in this exercise. Employers who qualify for the ERC under the full or partial suspension rules (where an employer’s operations were limited due to a government order) must offer adequate evidence of eligibility. The IRS will require detailed records that quantify the adverse impact of a government order on the employer. It is not enough to simply refer to the somewhat vague impact of a supply chain disruption or OSHA/CDC guidance, as this will not meet the standards outlined in the IRS’s Generic Legal Advice Memorandums. Without proper documentation, a recipient’s claim will likely be disallowed if additional evidence is not compiled.

Lay-up: The other method to qualify for the ERC may present itself as a lay-up for many employers. We are referring to the method in which an employer experienced a significant decline in gross receipts. There is certainly less subjectivity with this method; however, there are some often overlooked complexities. The aggregation and related party rules may apply and limit eligibility or reduce the claim amount.

Further, the claim could have been underreported if the “Alternative Quarter Test” was not included in the gross receipts analysis. Employers must also consider wages that are used for other tax credits to see if they should be included in the ERC claim computation. Depending on the employer and their facts and circumstances, this claim may not be a lay-up. Make sure to have the claim reviewed to ensure all rules were followed, and the amount of the claim was accurate.

Technical Foul: The definition of “government orders” that makes an employer eligible for the ERC has gotten difficult to interpret. While there were formal government orders when the ERC was first enforced, many government officials’ statements were construed as orders, despite not being so. To help clarify this, the IRS issued guidance on how to determine what is or is not a government order. The IRS guidance differed from advice offered by many third-party ERC mills. This, unfortunately, still faults the employer, and we again emphasize the need for accurate, complete documentation to substantiate a claim.

“Buzzer Beater:” The IRS introduced the Voluntary Disclosure Program (VDP) for those employers hoping to repay ERC refunds they shouldn’t have received. Please note, employers must pay back 80% of the claim, and they must register and make payment to the IRS by March 22, 2024. Carefully review IRS Announcement 2024-3 with legal counsel before completing this step.

Final Four: On par with the time of year, the ERC already has its final four set. It’ll come down to: (1) the IRS; (2) taxpayers/employers; (3) third-party providers; and (4) CPAs/attorneys. Each party provides a different view of the ERC, but regardless, we strongly encourage caution in all cases dealing with the credit. Of the utmost importance is seeking solid, professional advice as the IRS continues to closely review ERC claims.

Employers that received or are waiting to receive ERC funds should review their situation. The IRS is clearly focused on ineligible claims and recovering funds that were improperly disbursed. We can assist you with reviewing documentation that the IRS may request in order to determine where you might face challenges.

Lack of preparation may find employers with a more serious matter on their hands, such as an assessment to repay an ERC claim or a pending claim that the IRS has disallowed. While basketball fans are closely following March Madness, the tax consulting experts at Sikich are lacing up our sneakers to identity the various implications of the ERC on your business. We’re ready to review the detailed documentation that is required to support your claim to better help you to understand where you might have gaps or opportunities. Please get in touch with our team here.

About our Authors

Kellie Fedkenheuer, CPA/CFF, CFE, oversees and manages litigation support, forensic accounting and consulting engagements. She has assisted government agencies, government contractors, and commercial clients with claims related to both public and private projects.

Jason Boberg, CPA, CFE, has in-depth experience conducting and managing litigation support services, expert witness testimony, forensic accounting, fraud/investigation services, financial consulting, and performance audits for commercial clients and federal and state government entities.

Tom Bayer, CPA, CExP, has specialized expertise in the areas of business succession planning, tax planning and compliance, and business advisory. He has deep experience providing a range of accounting, tax, and business advisory services to commercial clients across industries.

Jim Brandenburg, CPA, MST, possesses extensive experience and knowledge in corporate and partnership tax law, mergers and acquisitions, and tax legislation. His expertise includes working with owners of closely held businesses to identify tax planning opportunities and assist them in implementing these strategies.