Avoid the Employee Retention Credit Refund Trap

The employee retention credit (ERC) provided a powerful tool to help employers keep their employees on payroll during 2020 and 2021, amidst the height of the COVID-19 pandemic. For some, however, the rules were confusing, and many businesses were uncertain whether they qualified. Those who did qualify and failed to claim the credit could file amended returns to reap the benefits. Now, however, the IRS is warning business owners about scams whereby third parties claim that employers are eligible for large employment tax refunds generated by improperly claiming or overstating the ERC. Business owners should proceed with caution and remember that they must either satisfy the gross receipts test or the governmental order test to qualify for the tax credit.

New Third Party Scams

The recent IRS release warns taxpayers who are approached by third parties who claim the business may be entitled to a substantial refund by filing amended payroll tax returns for 2020 and 2021 even if the business owner does not actually qualify for the ERC. According to the IRS, these third parties typically charge a large fee or may require a percentage of the tax refund generated by the amended return.

While it’s possible that some business owners do legitimately qualify for a refund, many do not. Similarly, the business owner must remember that if the business files an amended return, they must also reduce the wage deductions they took on their tax return based on the amount of the ERC that is claimed on the amended return.

The scams take on various forms. In general, the third party offers to prepare an amended return that either improperly determines that the business is eligible for the ERC or overstates the amount of the credit available. Business owners should closely examine the qualification requirements and their individual circumstances before filing an amended return to claim the ERC.

In some cases, third parties are advising that businesses may qualify for the ERC if general supply chain problems impacted the business’ operations. However, in reality, the business owner must be able to demonstrate that a governmental order issued by the U.S. federal government, state or locality impacted its critical suppliers’ operations—orders issued by foreign governments do not qualify.

Some third parties are also advising business owners that they may qualify for the credit under the governmental shutdown test if the orders that require social distancing in the workplace were in effect. However, if the business was able to operate in a way that was comparable to operations before the order, the order would not be sufficient for the business to qualify for ERC relief.

Does the Business Qualify for the ERC?

Initially, the ERC was a refundable tax credit designed to help employers who retained employees during the COVID-19 health crisis. The credit, taken against employment taxes, was originally equal to 50 percent of the first $10,000 of qualified wages paid to the employee between March 12, 2020 and January 1, 2021. These rules essentially limited the credit to $5,000 per employee in 2020. In 2021, the limit on qualified wages per-employee increased from $10,000 per year to $10,000 per quarter. Businesses could either take the credit on an original tax return or file an amended return.

To qualify, the employer had to meet certain criteria to show that the employer had experienced a significant decline in gross receipts or was forced to shut down due to a governmental order. For 2020, employers were generally eligible if gross receipts declined by more than 50 percent when compared to the same calendar quarter in 2019. For 2021, the "decline in gross receipts" threshold decreased from 50 percent to 20 percent, and a new safe harbor rule allowed business owners to use the calendar quarter immediately preceding the quarter in question to determine eligibility. Gross receipts of related companies were also factored into the equation.

Businesses that did not qualify for the ERC under the gross receipts test may have qualified if a governmental order related to COVID-19 forced the business to totally or partially suspend operations.

Taxpayers should also remember that only recovery startup businesses qualified for the ERC in the fourth quarter of 2021.

Conclusion

The IRS reminds taxpayers that they’re always responsible for the information that is reported on their tax return. If a promise of a refund seems too good to be true, it very well may be. To avoid large penalties in the future, taxpayers should consult their tax and business advisors before filing an amended return for 2020 or 2021.

Your questions and comments are always welcome. Please post them at our blog, AdvisorFYI, or call the Panel of Experts.