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ERC audits: Be prepared

  • September 7, 2023

By   Roger Russell September 05, 2023, 5:06 p.m. EDT4 Min Read

Despite the numerous warnings from the Internal Revenue Service, the American Institute of CPAs and various tax practitioner groups, advertisements for employers to take advantage of the Employee Retention Credit continue to proliferate.

Unscrupulous promoters advertise that just about anybody qualifies. Stories abound of employers “ERC shopping” where, after a business’ accountant or financial advisor tells them they don’t qualify, they simply go to an ERC mill, which happily tells them that they do, indeed, qualify for the credit.

Employers who have filed for a refund should know that the IRS has a set period of time to challenge the refund and recoup the money, according to tax attorney Barbara Weltman, author of “J.K. Lasser’s Small Business Taxes 2024.”

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“For the credit related to the third quarter of 2021, the IRS usually has until April 15, 2025, to act. But the IRS can file a lawsuit within two years of payment, even if later than the usual three-year statute of limitations,” she advised. “As of June 14, 2023, there were about 537,000 unprocessed Form 941s, and there are IRS employees in the Cincinnati and Ogden [Utah] service centers trained to work possible ERC refunds. And the Treasury’s 2024 Greenbook proposed that Congress extend the period to give the IRS more time to challenge erroneous refund claims.”

The aggressive marketing of the ERC continues to prey on innocent businesses and others, according to the IRS.

“Aggressive promoters present wildly misleading claims about this credit. They can pocket handsome fees while leaving those claiming the credit at risk of having the claims denied or facing scenarios where they need to repay the credit,” warned Commissioner Danny Werfel.

And CPAs may face a malpractice claim when preparing tax returns that reflect the ERC, even if they didn’t calculate it.

That’s one of the problems with the ERC, according to James Creech, senior manager with the tax advocacy and controversy group at Top 10 Firm Baker Tilly.

In terms of whether or not a taxpayer qualifies, it’s a binary test, Creech suggested. But “the binary test has a lot of gray in it. If you use the suspension criteria, there are a lot of taxpayers who very clearly qualify under that test. But I think that, for the most part, those taxpayers knew they qualified and have probably already claimed the credit contemporaneously with the pandemic.”

“Now we’re moving past the pandemic and there’s an incentive to get this money under more and more questionable circumstances,” he continued. “So, I think people are stretching a bit and that there is a significant risk. People are going to look at getting the money, as opposed to doing the rigorous analysis required to get to a comfortable position that you do qualify. And I think there’s a lot of taxpayers who are going to realize too late that they probably didn’t qualify after they’ve already claimed the credit. This is true especially now, if they use people that advertise on the radio, that probably charge a contingency fee.”

A number of promoters have a clause in their agreement that promises that if the taxpayer gets audited, they will pay for the audit defense and will pay back any credits that the government reclaims.

“They’re just making a calculated risk when they put that in the agreement,” he said. “If they’re still operating and you get audited, they’ll have made so much money from other people that it’s cheap marketing. And if they’re still in business when the claims come in, they’re still way ahead of the game. It’s a crowded space full of greedy people.”

The mills are jumping all over this program to make money while it’s available. Once it’s over, many will disappear without paying, according to Creech.

We’re starting to see a shift in the audits, he remarked. “When you get audited for an ERC claim, one of the things the government wants is to speak to the taxpayers themselves. They want to speak to somebody with firsthand knowledge of the business operations, and most likely that’s the owner. One of the things they’re really focusing on in this interview is, ‘How did you learn about the credit? Who do you know who did the credit eligibility calculation?’ If the response is that they were at the Mets game and called the phone number they saw on the Jumbotron, it’s not the same as having a qualified CPA firm involved.”

“During these exams we’re seeing a significant amount of time and effort that lead up to filing for the credit independent of the facts and circumstances related to the government orders and the shutdown that your business had to go through,” he added. “That’s a shift, because normally it doesn’t matter who did the work. Here, who did the return matters greatly. But other than that, if you’re eligible and you can prove it, you’re OK.”

Many times, these are audits of refund claims, so there has not been any cash paid for the particular quarter that is under exam, which means the onus is on the taxpayer to prove that they’re eligible. They’re quick audits, according to Creech.

“They’re very intensive, very fast where the auditor comes in and says, ‘You know, I’m giving you a limited amount of time to demonstrate to me that you are entitled to this,'” he explained. “So, the taxpayer who finds they’re under audit should reach out to a professional within a matter of hours. No response means no credit, because you didn’t justify it.”

Roger Russell

Senior Editor, Accounting Today

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