Although most COVID-19 relief programs have expired, many taxpayers are still sorting through lingering questions about their eligibility for various credits and grants. One such program, the Employee Retention Tax Credit (ERTC), has attracted particular attention in recent months.
The rules governing the ERTC are complex, and some eligible employers might not realize they qualified. Your company certainly should take advantage of tax credits for which it is eligible, and the ERTC was indeed a lifesaver for many businesses.
But some employers have recently encountered specialty tax consultants offering to help them claim surprisingly large retroactive credits—often in the millions of dollars. Approach any such extravagant offers carefully. Filing a questionable or overly aggressive ERTC claim could lead to serious financial and legal jeopardy in coming years.
Be particularly wary of companies that offer to handle your claim in exchange for a percentage of the proceeds. Such contracts often obligate you to pay the consultant’s fee even if you ultimately decide not to file a questionable claim they prepared.
Changing Rules Cause Confusion
The eligibility rules governing the ERTC have undergone several major revisions since it was first introduced in March 2020. The original goal was to encourage employers—especially “small employers” with fewer than 100 employees—to keep paying workers despite government-mandated shutdowns or drastic declines in revenue.
Subsequent congressional actions substantially expanded the program. Eligibility requirements were loosened, making it easier for companies to qualify for the credit due to lost revenue. The definition of “small employer” was expanded to include many more companies, and the maximum size of the credit increased substantially from a maximum of $5,000 per employee during all of 2020 to as much as $7,000 per employee per quarter during the first three quarters of 2021. The combined result of these changes means that, in certain cases, eligible employers could qualify for a total credit of as much as $26,000 per qualified employee.
Employers originally claimed the ERTC on their Form 941 Employer’s Quarterly Federal Tax Return for each quarter in which they qualified, but they can still go back and retroactively claim the credit by filing an amended Form 941-X up to three years after the relevant tax return deadline (April 15, 2024, for 2020 returns and April 15, 2025, for 2021 returns). Before filing a retroactive ERTC claim, however, it is important to take a closer look at the rules.
ERTC and Supply Chain Disruptions
The detailed ERTC eligibility rules include numerous fine points and exclusions, but in general terms there were initially two basic ways a business could qualify for the credit:
- It was either fully or partly shut down due to a government order.
- It suffered a significant decline in quarterly gross receipts compared to the same quarter in 2019 (a 50 percent decline for each qualifying quarter in 2020 and a 20 percent decline per qualifying quarter in 2021).
In March 2021, the IRS published additional guidance that expanded eligibility. IRS Notice 2021-20 (https://www.irs.gov/pub/irs-drop/n-21-20.pdf) said a business could be eligible for the credit if it was either fully or partially shut down due to a supply chain disruption—provided the disruption resulted from a government shutdown order.
Some specialized tax consultants began approaching companies that had supply chain problems, offering to file retroactive ERTC claims on their behalf in exchange for a percentage of the proceeds. For a company with 50 employees, a credit of $26,000 per employee would amount to $1.3 million, so the offer naturally would get management’s attention.
Unfortunately, many such claims could be questionable. IRS Notice 2021-20 states that to qualify under this provision, the employer must identify a specific pandemic-related government order that directly impacted a supplier’s ability to deliver critical goods—general supply chain disruptions caused by employee shortages, increased demand, or other pandemic issues are insufficient. In addition, the claimant must also consider its ability to acquire the needed goods from alternative sources.
Some consultants have reportedly urged businesses to file questionable ERTC claims, arguing that the IRS routinely approves them with minimal scrutiny. But the statute of limitations gives the agency plenty of time to go back and audit any claims that appear dubious. In addition to requiring that taxpayers pay back disallowed credits plus interest and penalties, the IRS could decide to pursue criminal charges if it believes a claim was deliberately fraudulent.
Aggregated entities are treated as a single employer for purposes of the ERTC. This could further complicate determining a company’s eligibility.
A final cautionary note: If you file a legitimate retroactive ERTC claim using an amended Form 941-X, the credit will reduce your company’s tax deduction for qualified wages during that quarter. This means you could face an increased income tax liability even before you receive payment for your ERTC claim.
The IRS recently updated its guidance for handling such situations to avoid inadvertently triggering penalties for underpayment (https://www.irs.gov/newsroom/irs-reminds-employers-of-penalty-relief-related-to-claims-for-the-employee-retention-credit).
Please call Holbrook & Manter with any questions or concerns you may have. We would be happy to assist you.