Employee retention credit updates

Editors: Brian Hagene, CPA, CGMA, and Mark G. Cook, CPA, CGMA

The employee retention credit (ERC) has been on the IRS’s “Dirty Dozen” scam list for the past couple of years. As a result, the IRS now has several programs implemented to help reduce fraudulent refunds. To assist clients in taking advantage of these programs, practitioners need an understanding of claim disallowance appeals and requests for additional information, as well as insight into how the voluntary disclosure program may affect practitioners themselves.

History of IRS actions addressing ERC claims

Before delving into the existing initiatives, it is helpful to review a timeline of the IRS’s ERC-related actions over the last couple of years.

In fall 2022, the IRS warned businesses that the ERC program had become the target of several “promoters.” The following March, the Office of Professional Responsibility (OPR) released a bulletin (OPR Bulletin No. 2023-02) highlighting tax preparers’ responsibility under Circular 230 for due diligence in preparing and filing returns. “If a practitioner cannot reasonably conclude (consistent with the standards discussed in this [bulletin]) that the client was eligible to claim the ERC, then the practitioner should not prepare an original or amended return” (id.). In addition, preparers should notify clients of potential applicable penalties.

On Sept. 14, 2023, the IRS announced a moratorium on issuing ERC-related refunds while it caught up on processing and determined its next steps to reduce fraudulent refunds. In October 2023, the IRS made an ERC claim withdrawal process available for filers who wanted to withdraw illegitimate claims. And in December 2023, the IRS implemented a voluntary disclosure program that allowed qualifying businesses to repay 80% of the credit and be exempt from an audit on the ERC claim. That program ended March 22, 2024. The voluntary disclosure forms required listing the third-party preparers who assisted with the credit and the tactics or reasoning given to the business prior to their initial filing.

A holding pattern of sorts came between December 2023 and August 2024 while the U. S. Senate waited to vote on the Tax Relief for American Families and Workers Act of 2024 (H.R. 7024), which would have retroactively changed the statute of limitation to file a claim to Jan. 31, 2024. This legislation would have also extended the statute of limitation to six years for auditing ERC claims. Ultimately, this legislation failed to pass.

With no congressional action, the IRS responded in August 2024 with several measures. The Service sent out 28,000 dis-allowance letters to businesses and started processing 50,000 refund claims that were filed between Sept. 14, 2023, and Jan. 31, 2024. Additionally, the IRS opened a second voluntary disclosure program on Aug. 15, 2024, that was set to run through Nov. 22, 2024. The credit repayment increased to 85% from 80% in the initial voluntary disclosure program, but substantially everything else remained the same as the first program.

How should I advise clients who received a disallowance letter?

If a client received a disallowance letter and they did not meet any qualifications for the ERC, then the answer is simple: Do nothing. However, there are cases where the IRS issued a disallowance letter and a business does meet the qualifications. In this instance, filing an appeal is warranted.

The appeal process will follow either a small-dollar case (or “small-dollar request,” for amounts of $25,000 or less) or a formal protest for credits larger than $25,000. The IRS Letter 105-C claim disallowance specifies, as seen in a sample letter from TaxAudit.com and listed below, what to supply to the IRS for reviewing a small-dollar case or formal protest. (See also “Understanding Letter 105-C, Disallowance of the Employee Retention Credit.”)

For a small-dollar request appeal, the taxpayer needs to do the following within 30 days of receiving the letter:

1.Prepare a written statement that you want to appeal to the Office of Appeals.

2. List the tax periods or years and disallowed items you disagree with and why you do not agree with each item.

3. Provide your name, address, taxpayer identification number, phone number, and a copy of the disallowance letter.

4. Mail your request to the address at the top of the first page of the letter received.

For a formal protest appeal, the taxpayer needs to do the following:

1. Prepare a written statement that you want to appeal to the Office of Appeals.

2. List the tax periods or years and disallowed items you disagree with and why you do not agree with each item.

3. Provide your name, address, taxpayer identification number, phone number, and a copy of the disallowance letter.

4. Include a detailed statement of facts with names, amounts, locations, etc. to support your reasons for disputing the disallowance.

5. If you know the law or authority that supports your position, identify that law or authority by providing a legal citation.

6. Sign the perjury statement on the letter and include it with your written appeal. If you have an authorized representative prepare the request for an appeal, they must sign the statement.

7. Mail the written formal protest to the address on the first page of the letter.

Note that the 30-day response time frame given on the IRS letter is only an administrative deadline, and the Taxpayer Advocate Service has recommended that the IRS allow additional time to protest.

Whether filing a small-dollar request appeal or a formal protest, a good practice is sending the response via certified mail to the IRS to show proof of mailing and receipt by the Service. It is unknown how long it will take to receive an acknowledgment from the IRS.

It is anticipated that there will be many ERC-claim audits, with thousands already underway (see IRS News Release IR-2024-203). During the audit process, the business will receive an examination letter from the IRS that includes a Form 4564, Information Document Request. The form will specify what documentation the Service requires. Practitioners want to be prepared to guide their clients through the document request and ensure eligible ERC claims. The information request requires submitting the following documentation:

1. Workpapers used to prepare Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund.

2. Documentation that the business is an ERC-eligible organization, whether by a significant decline in gross receipts or a full or partial suspension of operations under a governmental order. This includes records used to determine “more than nominal” effects on a portion of operations or on business operations resulting from a governmental order.

3. Documentation of the average number of full-time employees employed during 2019.

4. Documentation of the ERC calculation, such as records showing qualified wages and qualified health insurance expenses.

5. If the business is a member of an aggregated group, confirmation and explanation of how it determined its membership as well as the aggregation’s effect on determining the credit allocation.

6. Confirmation (if appropriate) of Paycheck Protection Program (PPP) loan receipt and documentation of PPP loan forgiveness that included payroll costs, such as the forgiveness application.

How is the IRS using the voluntary disclosure program information?

On the voluntary disclosure program forms, for both the first and second round, businesses must list the third-party preparers of their ERC claim — it is likely practitioners will have several client businesses that were approached by the same promoters. The IRS has provided a playbook for how it is going to prosecute fraudulent ERC situations. Using the data from the voluntary disclosure programs, the IRS is reviewing commonly listed third-party preparers. It is inquiring with businesses about how they were contacted and encouraged to apply for the ERC. It is suspected that the IRS will prosecute aggressive promoters who charged large contingent fees.

The IRS could certainly review the client lists for promoters and then audit the businesses that used the promoters for their ERC claims. The statute of limitation is important for a potential audit period. The statute of limitation for the third and fourth quarters of 2021 was extended to five years (instead of three) for ERC claims with the passing of the American Rescue Plan Act of 2021, P.L. 117-2, in March 2021. This extension of time may result in the IRS’s auditing more ERC claims from the third and fourth quarters of 2021 (recovery startup businesses only). Keep in mind that if there is a false or fraudulent return filed under Regs. Sec. 6501(c)(1), then that is an exception to the statute of limitation. The IRS may diligently seek to show during the audit process that ERC claim filings were fraudulent, to extend the statute of limitation.

Final thoughts

Regardless of who filed the initial ERC claim, advisers may be asked to assist clients through the appeal and audit processes. It is essential that businesses meet the qualifications set out by the IRS. As an adviser, it is important to perform due diligence with clients’ ERC claims and to inform clients of potential penalties if they do not meet the qualifications.

Editor Notes

Brian Hagene, CPA, CGMA, is partner/owner at Mathieson, Moyski, Austin & Co. LLP in Lisle, Ill., with CPAmerica. Mark G. Cook, CPA, CGMA, MBA, is the lead tax partner with SingerLewak LLP in Irvine, Calif.

For additional information about these items, contact thetaxadviser@aicpa.org.

Contributors are members of or associated with CPAmerica or SingerLewak LLP.