July 7, 2023

The Employee Retention Credit

Covid-19, Taxes

Covid-19 Tax Advice from Connie Augustine. The Employee Retention Credit.

First Deadline about to Sunset but Beware the Possibility of an IRS Audit

There is no doubt that you have heard a commercial in the last six months strongly encouraging you to apply for the Employee Retention Tax Credit (ERTC), particularly if you are a small business owner. Email, radio, and social media advertising promise huge windfalls of cash flow if you would just give them a call today! Unfortunately, many third parties offering these services are scam-artists. In fact, the sheer volume of fraud at work has caught the attention of the Internal Revenue Service. As a CPA specializing in taxation, my inbox is filled with notifications every day informing me that the IRS is heavily auditing the refund claims for the Employee Retention Tax Credit.

Take note: The IRS has a full 5 years to audit Employee Retention Tax Credit refund claims.

The statute of limitations for an audit is normally three years, but the IRS specifically extended the statute of limitations for this tax credit because they realized quickly that it would be an easy target for those who like to engage in fraud.

The fact that a taxpayer receives a refund based upon the amended 941 tax form filed is NOT a guarantee or approval of your refund by the IRS.

The receipt of a refund just indicates that the IRS has processed the claim and found no obvious clerical or mathematical errors. The audit notice comes later, and this means that unsuspecting taxpayers may be caught in an unpleasant situation. What is so unpleasant? If the IRS determines that a taxpayer’s refund claim was faulty, they will assess penalties and interest on top of requiring the taxpayer to return the refund.

The Employee Retention Tax Credit is, in fact, worth a substantial amount of money for those who qualify. However, it is extremely important to make sure that you are dealing with knowledgeable and reputable professionals who know the rules, what questions to ask, and what documentation to keep. It is also important to make sure the tax credit calculations are reviewed prior to your refund claim being filed.

How can you know if you qualify? There are some hurdles you need to clear to qualify. These include:

  • A decrease in revenue in 2020 as compared to 2019 of 50% or more,
  • A decrease in revenue in 2021, as compared to 2019 of 20% or more,
  • A shut down due to government order during 2020 or 2021, OR
  • A partial suspension of business operations due to government orders during 2020 or 2021

Revenue decreases are evaluated on a quarter-by-quarter basis, so it is possible that any given taxpayer may qualify for one quarter, but not another. Passing these initial hurdles is harder than it appears on the surface, particularly if a business entity shares common ownership with other business entities. This is because related business entities must consider their combined income in determining whether a decrease in revenue has occurred. Qualifying under partial suspension or complete shutdown rules is also a possibility, but that qualification is more subjective and requires a higher level of documentation (think detailed and compelling evidence that there was a major impact on business operations). For-profit entities must consider not only their regular revenues, but also revenue from any source whatsoever, including investment income or unusual income sources.

Not-for-profit entities must consider gross receipts from all sources as well. This is a change from how most not-for-profit entities determine their income as expenses for fundraising and collection of revenue are not considered for purposes of the tax credit. Gross receipts from sales of assets must also be considered as is investment income, unrelated business income and member dues/assessments. Affiliated organization rules may also affect a nonprofit if ownership and/or common management of organizations exists.

If the first set of hurdles is passed, then the business entity must look at the next set:

  • Employee wages & benefits that qualify for the credit must not have been used to qualify for Paycheck Protection Program (PPP) loan forgiveness. The business may have had a PPP loan, but the same wages cannot qualify for both the PPP loan and the ERTC.
  • Employees who are also family members of a more-than-50% owner of a business entity are considered related parties and their wages do not qualify for the credit.
  • Most business owners who are also employees (think S or C Corporation) are also eliminated from qualifying for the credit unless they have no living family members. (Yes, this is a strange rule.) It does not matter whether the living family members work in the business. If they are alive, they disqualify the business owner’s wages as well as the wages from the owner’s spouse.

The last issue, and one that many do not think about, is the fact that if you file an amended 941 form to claim the ERTC, the business must also file an amended income tax or income reporting return to claim the credit as income in either 2020 or 2021. Depending upon the situation, multiple amended returns could be required since partnership and S corporation returns will require that all K1 recipients also file corrected tax returns. It would follow that the ERTC should generate a refund claim sufficiently high to make the filing of multiple corrected tax returns worth the cost to do so.

If, after reviewing the requirements to qualify for the credit, it is determined that you may qualify, please contact your trusted tax professional right away. The deadline to file an amended 941 form and claim the credit for the 2nd quarter (April, May & June) 2020 is July 31, 2023. The due date for the 3rd quarter 2020 amended 941 forms will be October 31, 2023. As with most things in business, and in life, follow the rules, make sure the cost is worth the benefit and if something sounds too good to be true, it probably is!

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