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By Randy Crabtree January 24, 2023, 10:15 a.m. EST6 Min Read
I’m sure you’ve heard the radio ads telling business owners: “If you were impacted by COVID, you could be entitled to up to $26,000 per employee in refunds from the IRS. Call today! Don’t delay!” The breathless announcer is of course referring to the Employee Retention Credit, aka the Employee Retention Tax Credit , even though neither acronym is mentioned by name. The nice folks answering the toll-free phone number won’t require upfront fees from you and that you can get the IRS money whether or not you received a Paycheck Protection Program loan.
What’s not to like? Plenty.
As with the PPP and other pandemic relief programs, there’s a slew of misinformation about the ERC program, much of which has been pushed by pop-up ERC “shops” and “mills” looking to profit from the opportunity and confusion surrounding the program which admittedly didn’t have the smoothest rollout, as I explained over the summer.
First there’s the manufactured sense of urgency. Many believe that since the ERC program sunsetted in Q4 of 2021, it’s too late to file or you could be running out of time if you don’t “act today!” Not so. You have plenty of time to amend your returns. Contrary to what you might have heard, ERC money is not going to expire soon. Take the time to get your study done right and see how the potential court cases play out. Let’s see if any rulings come out that change the current IRS guidance.
Second, the radio ads don’t tell you how long you’ll wait to receive your refund if you legitimately qualify for them. This isn’t a Scratch-Off game. As my colleague Nick Pantaleo, mentioned on a recent podcast we did together, any credit over $100,000 per quarter is subject to extra review, and you should expect a delay of at least nine to twelve months for your refund to arrive. Another podcast panelist, Dan Chodan, a partner at Trout CPA, said, “We’re in a ‘holding pattern’ while all the IRS agents are being trained to do ERC audits.”
One size doesn’t fit all
Chris Wittich, a partner at Boyum Barenscheer, reminded listeners that every company’s situation is different, but said pop-up shops tend to use generic arguments for each of their clients such as “supply chain disruption.” Using a one-size-fits all solution is less work on the provider’s part and they know if they use the claim enough, eventually it will stick, lamented Wittich. The Occupational Safety and Health Administration argument is another one-size-fits-all approach they like to take. As we’ll see in a minute, it often doesn’t work.
Pantaleo said he is constantly reminding shipping and manufacturing clients that the supply chain argument can be misleading. Supply chain disruption was a worldwide bottleneck, but the ERC program was specifically designed to address shutdowns at the state and local level.
Since most manufacturers were deemed essential during the pandemic, they weren’t shut down and didn’t suffer significant revenue falloff. Not only don’t they quality, explained Pantaleo, but there’s no point pushing that weak argument.
Cautionary tales
Not long ago, a CPA called me about an engineering firm client that believed it was entitled to $4.5 million worth of ERC credits over six quarters even though it suffered no significant revenue drop during the pandemic and was deemed an essential business. So, it was not under any government restrictions. The client was a very sophisticated taxpayer and not pleased when I expressed my opinion that it wouldn’t qualify. They said they would just take the $4.5 million and put it in the bank and let it sit there for three years. I understand $4.5 million worth of free money is very tempting, but remember, there are strings attached.
Wittich said he works with a salon that hired one of those “weird ERC credit companies” to help them qualify for ERC. On the surface, the salon easily qualified since it had significant capacity restrictions for a long period of time and was located in a very blue state. However, the credit company’s study came up with only $100,000 in credits. “That seemed low to me based on how many employees and locations they had,” recalled Wittich. “So, we ended up filing for them and they received about $1 million. I was baffled by how the credit company could miss so many obvious things.”
On the other extreme, Wittich related a situation in which a restaurant in a blue state endured clear restrictions for about 14 months. “Obviously, they qualified and one of these credit companies swoops [in], applies a bogus OSHA argument to the whole six quarters, based on a weak OSHA argument which they didn’t even need. They legitimately qualified. When we reviewed their final report — if you want to call it that — there was no mention of a restaurant or brewery. It was just a copy/paste of three pages of OSHA stuff, with no reference to the local orders.”
Wittich said it’s a double-edged sword: On one hand, the pop-ups are claiming too little “because they have no idea how to even figure out ERC.” Or they try to claim way too much, “based on a bogus argument they’re applying to every business that walks through their door with zero risk audit protection.”
Read the fine print
If you have clients working with pop-up shops, it’s very important to read the fine print. “One of our manufacturing clients — deemed essential —- had taken a credit with one of the pop-up ERC shops, but they wanted our firm to take a second look just to make sure they qualified,” related Pantaleo. “They stayed open throughout the pandemic and didn’t have a drop in revenue. Obviously, they didn’t qualify for a single quarter.” But the contract they signed with the credit company obligated them to have the refund check sent to the credit company first, which should have been a red flag. “Now they’re trying to figure out how to un-file for the credit before it gets processed. And it’s a pretty big number: About $1.1 million in credits claimed with no qualification whatsoever,” cautioned Pantaleo.
Reporting headaches
Chodan said incorrect filings done by unqualified preparers, such as upstart credit companies, can make things “very ugly” from a financial reporting perspective. “Financial statement auditors are reviewing ERC claims to understand whether the position would be sustained on IRS audit,” added Chodan. “Ineligible claims must be recorded as liabilities and material noncompliance must be disclosed. These impacts will linger on financial statements for years to come over the audit statute period.”
Chodan said he recently had a prospective client that claimed millions of dollars over both years 2020-2021 despite not being eligible. “They will have a big issue with their audited financial statements due to recording this liability and disclosing the noncompliance,” he added.
Both the IRS and AICPA have been calling for a crackdown on bogus ERC claims. As the old saying goes, if it sounds too good to be true, it probably is. “I still get calls from clients who were up and running throughout the pandemic but still think they can get $26,000 per employee because the radio ad said so,” said Chodan.
Wittich concurred: “I just came back from a tax conference and the IRS made it very clear they’re coming after fraudulent claims hard. In audits, they’ll be asking taxpayers how they found out about the ERC and who did their calculations. You can’t always know who did the work just by looking at the 941-X since ERC shops often won’t sign the form. If they’re not willing to sign your 941-X, why would you hire them to do your study? If your provider can’t provide a specific executive order number or state order number, that’s a red flag too, and you need to disengage.”
The pandemic was tough on all of us. If your client’s business was deemed nonessential and was significantly impacted by mandatory shutdowns or other pandemic-related factors, then it’s worth looking into the ERC. Just know that the rules are complex and enforcement over fraudulent claims is getting tougher.
Co-Founder And Partner, Tri-Merit Specialty Tax Professionals
