Although the employee retention credit (ERC) is currently being abused by many tax promoters, legitimate employers should take advantage of the ERC. The ERC is available to help employers (including nonprofits) who paid wages during the 2020 and 2021 Covid crisis. Each employee may be eligible for a tax credit up to $26k resulting in a $26k refund!
Due to the high level of fraudulent ERC claims, the IRS is scrutinizing payroll returns claiming the ERC and auditing ERC refunds issued. Here are some tips:
WHAT IS THE DEADLINE TO FILE FOR THE ERC?
Taxpayers generally have 3 years to amend a tax return.
For payroll returns, there is a special rule on the 3 year statute of limitations. All quarterly Forms 941 (payroll return) filed for a calendar year are considered filed on April 15th of the following year if they are actually filed before that date.
For example, if you filed the first three quarterly returns in 2020 and you filed the fourth quarter Form 941 on January 31, 2021, the IRS treats all quarterly payroll tax returns as though they were filed on April 15, 2021. The deadline to file corrections for all four 2020 quarterly Forms 941 would be April 15, 2021.
Therefore, the final deadlines to claim the ERC are:
2020 ERC: April 15, 2024
2021 ERC: April 15, 2025
IS THE ERC AVAILABLE FOR 2021 Q4?
A law to allow the ERC for 2021 Q4 was passed and then repealed for most taxpayers.
A special exception applies to recovery startup businesses for 2021 Q4. A recovery startup business is an organization that began after February 15, 2020, and had average annual gross receipts of $1 million or less. A recovery startup business may claim a maximum credit of $50,000.
HOW LONG DOES THE IRS HAVE TO AUDIT YOUR ERC CLAIM?
It depends. 3 years. 5 years. Forever.
Normally
The IRS generally has 3 years to audit a tax return. Amending a tax return does not extend the 3 year statute of limitations.
For payroll returns, there is a special rule on the 3 year statute of limitations. All quarterly Forms 941 filed for a calendar year are considered filed on April 15th of the following year if they are actually filed before that date.
2021 Q3 and Q4
Legislation was passed to extend the statute of limitations to 5 years for auditing ERC claims related to 2021 Q3 and Q4. This special 5 year statute only applies to the IRS auditing your ERC claim. Taxpayers are still limited to 3 years to amend their payroll return to claim the ERC for 2021 Q3 or Q4.
Therefore, the final deadlines for the IRS to audit your ERC claims are:
2020 ERC: April 15, 2024
2021 Q1 and Q2 ERC: April 15, 2025
2021 Q3 and Q4 ERC: April 15, 2027
Fraud
If the IRS suspects fraud, the statute of limitations is unlimited. That means you can be audited forever. The IRS knows many taxpayers have filed fraudulent claims due to unscrupulous ERC refund mills preparing fraudulent ERC claims. Taxpayers who hired an ERC consultant (particularly one who advertised on TV, radio or internet and charges a fee based on your credit) may have committed fraud if the ERC consultant said they were eligible but didn’t actually qualify.
Possible Law Change
Biden’s tax proposals issued in the March 2023 ‘Greenbook” included a proposal to extend the statute of limitations for audit to 5 years for all ERC claims. The ERC credit was listed as the number one item on the 2023 IRS Dirty Dozen list of tax scams. It is highly likely that Congress will pass a law to extend the ERC audit statute to 5 years.
HOW LONG DOES THE IRS HAVE TO AUDIT YOUR INCOME TAX RETURN FOR THE ERC CLAIM?
A huge problem for ERC claims is that the ERC impacts your income tax returns. Many ERC consultants don’t tell their customers that claiming the ERC credit reduces the allowed tax deduction on their income tax return.
Some ERC consultants have mistakenly told clients that the ERC credit becomes income in the year when it is received.
The IRS in Notice 2021-49 clarified that a reduction in the amount of the income tax deduction allowed for qualified wages, including qualified health plan expenses, caused by receipt of the Employee Retention Credit occurs for the tax year in which the qualified wages were paid or incurred. Therefore, you would amend the income tax return related to the year the ERC relates to.
Many taxpayers have not amended their income tax returns.
Normally
The IRS generally has 3 years to audit a tax return but the deadline depends on the type of business (sole proprietorship, corporation, S-corporation, partnership) as original due dates and extended due dates differ depending on the type of business.
Fraud
If the IRS suspects fraud, the statute of limitations is unlimited. That means you can be audited forever.
If the IRS asserts your ERC claim is fraudulent and you don’t amend your income tax return, it’s possible the income tax return may be considered fraudulent as well.
WATCH OUT FOR IRS CIVIL LAWSUITS
Even if it too late for the IRS to audit your ERC claim, they may sue for a refund of ERC claims that were incorrectly issued.
The government under IRC Sec 7405(b) may sue you to return your ERC. The IRS has 2 years from the date the refund was issued to file a civil lawsuit. This deadline is extended to 5 years in cases of fraud.
WHAT WILL THE IRS LOOK FOR IN AN ERC AUDIT?
The IRS has provided 56 hours of training and a 72 page training manual to about 300 employees investigating ERC claims.
Here is what I think they will look for:
Does the Employer Qualify?
· Were your 2020 gross receipts for Q2, Q3, or Q4 less than 50% compared to the same quarter in 2019? Which quarters?
· Were your 2021 Q1, Q2, or Q3 gross receipts 20% less when compared to the same quarter in 2019? Which quarters?
· Did you have any forced government shutdowns in 2020 or 2021 that reduced capacity or the ability to work?
· Did you work remotely? Working remotely generally does not qualify you for the credit.
Did the Employer Receive Other Pandemic Relief?
The IRS will look for double dipping (i.e. claiming multiple benefits on the same wages).
Originally, employers receiving PPP funds were not eligible for the ERC. This law was repealed but many people do not realize you can not use wages paid from PPP funds for ERC qualified wages.
Similarly, the IRS will look to see if you received the Shuttered Venue Operators Grant or Restaurant Revitalization Grant. However, there is incorrect information on these grants on the IRS website that says these wages cannot be used for the ERC. According to IRS Notice 2021-49, an employer cannot claim the employee retention credit on amounts taken into account as payroll costs paid in the third and fourth quarters of 2021 in connection with the shuttered venue operators grant or restaurant revitalization grant programs.
Did the Employer Include Related Parties In Qualified Wages?
Generally, wages paid to family members of the owners are not qualified ERC wages.
Sometimes, wages paid to owners are eligible but generally wages paid to owners are not qualified ERC wages. The IRS will ask if the owner has living relatives (even if not employed by the business). Due to constructive ownership rules, if the owner has living relatives, the owner’s wages would not be qualified wages. (This also comes from IRS Notice 2021-49)
For a consultation on the ERC tax credit, contact me today.