Recent changes have extended the eligibility of employers to claim the Employee Retention Credit (ERC) for 2021.
With these changes has also come a veritable cottage industry of scammers and irreputable companies claiming that you may qualify for the credit without the necessary analysis and documentation required to substantiate a claim for the ERC.
What is the Employee Retention Credit?
The often-abbreviated ERC is a refundable employment tax credit. The credit was originally enacted to incentivize employers experiencing significant financial hardship and government-mandated closures during the Covid-19 Pandemic to retain their employees. Since its initial enactment in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) in March 2020, the ERC has been amended three times. These amendments have included various changes to who is eligible to claim the credit and the maximum amount that can be claimed.
Do I Qualify?
For an employer to qualify for an ERC they must have experienced either a decline in gross receipts (subject to a gross receipts test established by the IRS) or had a partial suspension of operations during any quarter of 2020 or 2021 due to orders from a governmental authority limiting commerce, travel, or group meetings due to COVID-19. It is important to note that a copy of the orders with the specific dates outlined must be included in your ERC documentation. Other factors which can affect your qualification and credit amount include the number of full-time employees (FTEs), possible aggregation requirements, certain owner wages, and other Covid payments/credits (PPP, FFCRA, etc.).
- Eligible employers for periods in 2020 include any employer operating a trade, business, or a tax-exempt organization excluding governments, their agencies, and instrumentalities
- Eligible employers for periods in 2021 include all those eligible in 2020 in addition to certain governmental employers that are organizations described in section 501(c)(1) and colleges or universities whose principal purpose is to provide medical or hospital care.
Recent amendments to the ERC extended the period for qualified wages paid to include quarter three of 2021 for normally qualifying businesses (based on employer share of Medicare tax rather than social security tax), as well as making the credit available to Recovery Startup Businesses for quarter three and quarter four of 2021. Recovery Startup Businesses are defined by the Internal Revenue Service (IRS) as businesses that:
- Began carrying on any trade or business after February 15th of 2020, that
- Had average annual gross receipts under $1,000,000 for the 3-taxable-year periods ending with the taxable year that precedes the calendar quarter for which the credit is determined
- (2021 quarter three requirement only) and do not meet the other eligibility criteria
Increasing Fraud and IRS Assessment
The maximum credit eligible employers may receive in 2020 is $5,000 total per employee and $7,000 per employee per qualifying quarter for 2021. This massive benefit for employers is also a lure for bad actors and those who wish to exploit the limited IRS guidance on the subject of ERC.
Many companies can be found that offer to calculate ERC for a contingent fee, generally, a large percentage of the credit claimed. Cold calls and emails offering substantial credits to employers despite them not qualifying are increasing and fraud is rampant. It is important to be vigilant in vetting these companies and to ensure that your ERC claim can be substantiated under increasing IRS scrutiny.
With the Inflation Reduction Act’s passage into law by President Biden on August 16th, 2022 comes $80 billion in additional funding to increase enforcement by the IRS. One of the targets of this increased enforcement will be ERC claims. The IRS will soon begin auditing ERC claims and will have three years from the filing date of the relevant Form 941 or 941X tax returns, and five years for claims for quarters three and four of 2021 (§3134(l)). There is a distinct possibility that certain irreputable companies started for the sole purpose of calculating ERC may not be around for the duration of this potential audit period.
While most IRS audits result in civil liability, which can include penalties and interest, the IRS will undoubtedly refer many of these ERC audits to the IRS’ Criminal Investigation Division (“CID”). After consulting with Attorney Daniel Treuden from the Bernhoft Law Firm, S.C., a law firm that is experienced in representing clients in criminal tax cases and investigations, he confirmed that most criminal cases begin as an audit. During an audit, the auditor can make a referral to criminal investigators if they identify what they believe to be indicators of fraud. These indicators are not narrowly defined and include an act done to “make things seem other than what they are.” I.R.M. § 188.8.131.52(2)(a). Ultimately, the IRS CID will be most interested in the intent of the taxpayer. A willful act of deceit is required to prove a tax crime, but unfortunately, when the IRS believes it can make its case, a taxpayer claiming a good faith misunderstanding of the law might need to present that defense to a jury of his peers.
The most likely charges a taxpayer might face if they file a false claim for an ERC credit include (1) tax evasion in Internal Revenue Code (“IRC”) § 7201; (2) False subscription in IRC § 7206. Tax evasion involves some affirmative act designed to evade either the assessment or payment of tax and false subscription involves someone who signs a return under penalty of perjury knowing at least one line on that return is false or fraudulent in a material way. Both crimes have a $100,000 maximum fine, and the criminal penalties are five and three years maximum, respectively. Further, there is a federal criminal statute that bars anyone from aiding and abetting another to commit a criminal act, and if guilty of that statute, the person is guilty as if they committed the act themselves. The IRS will sometimes charge a company principal with aiding and abetting the filing of false corporate tax returns.
Ultimately, the criminal penalties a person might face are driven by the amount of tax the taxpayer received or attempted to receive. Other factors will affect a sentence as well, such as whether this person is a first-time offender. But it does not take a lot before the United States Sentencing Guidelines recommend some jail time. If the Court determines the crime used sophisticated means (and most tax crimes are deemed sophisticated), anything more than $15,000 of tax loss is sufficient for some jail time.
Taxpayers should be absolutely sure that they are entitled to an ERC before taking it because trying to convince a criminal investigator after the fact that the taxpayer had no ill intent is no position anyone wants to be in.
A person would be wise to follow the old adage: If it sounds too good to be true, it probably is.
The ERC is a complex tax credit that requires individual analysis of your company and thorough documentation of your claim to withstand IRS audits. Caution must be exercised when determining if you qualify and when claiming the ERC credit.
- Employee Retention Credit Fraud Alert – Beaird Harris (bh-co.com)
- Will The IRS Deny Your Claim For The Employee Retention Tax Credit? (forbes.com)
- Prepping for the next phase of stimulus fraud probes | CFO Dive
- Watch out for ERC scams | Occams Advisory
- Employee Retention Credit – 2020 vs 2021 Comparison Chart | Internal Revenue Service (irs.gov)
- 3134. Employee Retention Credit For Employers Subject To Closure Due To Covid-19 (bloombergtax.com)
- Internal Revenue Manual, § 184.108.40.206
- Tax Crimes Handbook, Office of Chief Counsel, Criminal Tax Division (2009)
- 18 U.S.C. § 2
- 26 U.S.C. § 7201
- 26 U.S.C. § 7206
- United States Sentencing Guidelines, § 2T4.1 and Ch. 5, Part A, Sentencing Table
- The Bernhoft Law Firm, S.C.