Key observations and the IRS Voluntary Disclosure Program to return incorrect payments

By Pete Kennedy, CPA, Director

Background

The Employee Retention Credit (ERC) – sometimes called the Employee Retention Tax Credit or ERTC – was a refundable tax credit for certain eligible businesses and tax-exempt organizations who continued paying employees while shut down due to the COVID-19 pandemic. Eligible organizations could claim the ERC on an original or amended employment tax return for a period within the eligible timeframe, which was March 13, 2020 through December 31, 2021. In October 2022 the IRS issued its first warning to employers to be wary of third parties who were advising them to claim the ERC when they may not qualify. Please click here to read our post “ERC – Too Good to be True?”

What follows is an update related to our first-hand experience with the IRS audit program to identify ineligible claims.

What we learned from two client audits

There have been a number of developments with the Employee Retention Credit (ERC) that we think might be of interest.  The IRS has begun an audit program that is probably as aggressive as they are able to manage.  We had two clients selected for audit.  In both cases the period selected was Q3 of 2021, and in both cases the credit for that quarter had not yet been paid although other quarters were.  We were told by one of the agents that as a policy, the IRS will reopen earlier quarters if they find issues with the quarter they are auditing.  Both audits were successfully concluded – the credit for one client has been paid and the other should be on the way.

Our experiences with the audits were interesting.  In both cases, the auditors – one from a Pennsylvania office and one from a Massachusetts office – were new to the ERC and had been pulled from other Government duties. One was reassigned within the IRS while the other was from a different branch of the Federal Government altogether.  One audit was done in person and the other was done through correspondence. Both Agents were completely professional throughout – we were able to walk them through the calculations and methodology for both the period of qualification and the actual credit calculations, PPP exclusion etc.  For both credits, the qualification was achieved through a calculation of reduction in gross receipts rather than a curtailment via COVID-related government order.  I think that made everyone’s life a lot easier since there was no real judgment involved – the numbers are the numbers.

As I said to each auditor – and they probably don’t hear this very often – we are pulling for them to go after and nail the fraudsters who made an absolute mockery of this credit.  Go get ‘em!

IRS attempts to recoup incorrect payments 

Recognizing the enormity of the task before them, the IRS has begun a special program to attempt to recoup a portion of the ERC Funds paid to entities who did not qualify for them.  Here’s how the Voluntary Disclosure Program works – if an organization was paid for ERC on a quarter where they do not now believe they were qualified, and they have not been notified they are under audit, they may return 80% of the funds and have the rest forgiven.  They will also not need to pay interest or penalties on the funds nor will they need to file revised tax returns for the applicable year (for profit organizations are required to file amended income tax returns for 2020 and 2021, removing the deduction for the amount of the pay they have been refunded – only applies to NPOs if they deducted the payroll against UBI).  Finally, they will need to supply information on any advisors who got them into this mess.

Presumably, allowing organizations to keep the 20% is in recognition that many of these organizations trusted a 3rd party ERC mill to perform the calculations for a hefty contingent fee of up to 25%.  Anyway, if you know of anyone who has discovered they were paid ERC funds they did not qualify for, this is almost certainly the best deal they are going to get.  The alternative is to play the “audit lottery” and as I said earlier, the IRS is going after this credit with all the vigor they can muster.  This program ends at midnight on March 22nd.

The IRS announced another hack for withdrawing applications that have not been paid and are not under audit – Print “WITHDRAWN” in the margin of a copy of the 941X, sign and date in the other margin and fax in.

You can’t make this stuff up

Lastly, as most of you know, the IRS ceased processing new ERC claims back in September.  Nearly simultaneously, one of the largest ERC service providers announced it was axing nearly half of their staff.  Here is the article where the former employees are suing for wrongful termination, but wear a raincoat as you read it to keep off the dripping irony.  https://iowacapitaldispatch.com/2024/01/04/billion-dollar-iowa-business-tied-to-pandemic-relief-is-accused-of-wage-violations/

A firm that made fortunes for its owners by charging an outrageous 25% contingent fee on claims for a credit designed to keep people employed summarily fires almost half its staff.  You can’t make this stuff up…

Other information

This IRS article appeared in the IRS newsroom on February 13, 2024: IRS shares 7 warning signs Employee Retention Credit claims may be incorrect; urges businesses to revisit eligibility, resolve issues now before March 22 | Internal Revenue Service