COVID-era tax credit still leading to confusion

My column for September 11, 2023, addressed the employee retention credit (ERC). This is a tax credit for employers affected by COVID-19-era business restrictions. The focus of that column was twofold. First, to defend certified public accountants and other tax return preparers against dubious claims by ERC promoters. Second, to note IRS challenges to the ERC.

The ERC was designed to get cash in the hands of employers to offset wage costs. It should have eased the burden of employers trying to keep their workers employed. The ERC claims were made on payroll tax returns. Many income tax preparers do not do payroll tax returns for all or some of their clients.

That opened the door for “promoters” to contact employers with “information” about the availability of the credit.

Promoters took a percentage of the ERC paid by the government. It was a lucrative business.

Promoters often told employers that the ERC required specialized knowledge that their CPA or other return preparer lacked.

If the employer’s normal tax advisor said the ERC was not available, the promoter told the employer that they, as an expert, knew better.

The ERC has made the IRS’ “Dirty Dozen” — the worst of the worst tax scams — list for 2023 and 2024. Members of tax writing committees from both political parties have alleged fraud.

A Democrat said the program is a “gushing firehose of fraud.” A Republican said, “it’s like almost universal fraud.”

The program has a lot of problems with documented abuses. But gushing firehoses of universal fraud is a bit over the top.

The ERC was introduced in March 2020. It initially applied to the last three quarters of 2020. Phase II extended it to the first two quarters of 2021.

Phase III added the last two quarters of 2021 and added a new type of “recovery start-up business.” Phase IV dropped the fourth quarter of 2021 except for the recovery start-up businesses.

A credit was paid for qualified wages during the applicable period. The percentage of wages that could be offset changed from Phase I to II and beyond.

The business had to be affected by a government-ordered shutdown or experience a significant decline in gross receipts. Recovery start-up businesses had separate rules.

If an ERC was claimed, the employer had to amend income tax filings to remove any tax deduction for wages offset by the credit. No double benefit was allowed.

In September 2023, the IRS announced that it was suspending the processing of new claims (claims could be filed through April 2025).

In October 2023, the IRS announced a voluntary claim withdrawal program that could help avoid penalties.

In December 2023, the IRS announced that employers could voluntarily disclose improperly paid claims before the IRS made such a determination.

The voluntary disclosure allowed the employer to keep 20% of what had been paid. That was intended to offset fees the employer might have paid to a promoter.

The voluntary disclosure also avoided penalties and interest and allowed the employer to keep 100% of their wage deduction.

Also, in December 2023 IRS disallowed 20,000 filed claims because the employer listed did not exist, or the employer had no employees. OK, that was fraud.

In January 2024, the IRS Criminal Investigation Division notified 220 firms that had filed many ERC claims to check to be sure the claims were valid.

This was a “soft” notice to those promoters that IRS was aware of their filings, and it might be a clever idea to clean things up.

There has been a lot of fraud. But not a universal firehose. IRS audits have identified 60 to 70% of the filings as having an unacceptable level of risk.

The audits of existing claims also show 10 to 20% have a low level of risk. IRS will start paying on those claims this summer.

About 10 to 20% of claims are classified as having the highest level of risk. These appear to be the blatant abuse situations justifying the Congressional claims.

There are many lessons here. First, I stand by my earlier column. Promoters claiming expertise your tax advisor lacks should never be trusted.

Second, this was a poorly conceived plan. Congress needs to look in the mirror before it starts accusing people of fraud.

Many business owners have been victims of the ERC program. They trusted the wrong people. But that’s not fraud.