Employee Retention Credits – Issue Spotting

Updated March 14, 2022

Many businesses will benefit from the Employee Retention Tax Credit (ERTC), most will not. Tax Guard does not prepare returns or directly file for ERTCs. However, we wanted to share some of our clients’ experiences. We’ve received several calls from lenders asking if we could help them fund ERTCs. Essentially, they wanted to know if there was any way to help them protect their collateral – the refund itself. Unfortunately, the answer is no. There are a few major issues with the ERTC.

Lenders’ Concerns

  • No assignment. The IRS will NOT assign the ERTC refund to a lender (or any refund, for that matter). There is no method for doing so. The IRS will issue the refund check directly to the taxpayer.
  • Cannot confirm the credit. The IRS does not require the taxpayer to include supporting documentation for the credit when filing the return. Since the fourth quarter 2021, our monitoring uncovered several erroneous credits issued for a substantial sum of money. Many businesses submitting requests for the credits either (1) do not meet the qualifications and/or (2) calculated the credits incorrectly.
  • Cannot confirm timing. The IRS indicated in late October 2021 that it had a backlog of 2.7 million 941-X returns that require processing. Much of the backlog includes amended returns to take advantage of the ERTCs. In a recent example, an amended return submitted in June 2021 was processed on February 20, 2022 (eight months later). It’s likely that amended returns filed during the fourth quarter 2021 will take substantially longer to process. Additionally, until the IRS issues the credit/refund, the ERTC transaction does not show up on an IRS transcript. It’s quite possible for the business to receive the refund check and cash it before noticing the transaction code on an IRS transcript.

Background

The CARES Act created the ERTC in March 2020. Later, three additional bills modified the ERTC, including the Consolidated Appropriations Act (December 2020), American Rescue Plan Act (March 2021), and Infrastructure Investment and Jobs Act (November 15, 2021). Qualifying businesses can claim these credits on wages and health insurance benefits paid to employees. Properly calculated credits reduce payroll taxes. And, depending on the amount, credits can generate cash refunds as well because the credit is “refundable”. As such, it is an extremely valuable tool for some businesses. Every business should consult its CPA or tax professional to determine whether it qualifies for the generous benefits. 

Unfortunately, we’ve seen a number of ERTCs through our monitoring service that don’t pass the sniff test. We’ve also seen an explosion in the number of companies offering to prepare tax credits in the past few months. The current situation is a bit like the wild west. Businesses are shooting first by filing for credits without considering the rules, which are confusing and cumbersome. The sheriff, the IRS, will ultimately get around to cleaning up the mess, but it will take a few years. Our advice is simple. businesses should ask their CPA or tax professional about the ERTC, make sure they qualify, and not be tempted to overstate the amount of the credit. 

Step 1: Eligibility

The ERTC is available for both for-profit and non-profit employers, but not all businesses are eligible. Businesses must qualify for the credit. There are two tests for eligibility: (1) a partial or total government-ordered shutdown or (2) an applicable decline in gross receipts.

Shutdown. The credit for a partial or total government shutdown not apply to the entire quarter. It only applies to the portion of the quarter business subject to the suspension.  

Decline in Gross Receipts. The decline in gross receipts test depends on which quarters a business claims a credit.  

  • For the second, third, and fourth quarters of 2020, gross receipts must be at least 50% less than the same quarter in 2019.  
  • For the first, second, and third quarters of 2021, gross receipts must be at least 20% less than the same quarter in 2019.  
  • Businesses also have the option of determining eligibility based on gross receipts in the immediately preceding calendar quarter (compared with the corresponding quarter in 2019). 

Step 2: Amount of the Credit

Assuming a business qualifies for the ERTC, the next step is to calculate the credit. The amount of the credit also depends on the quarter in which the business claims the credit.  

  • For wages paid between March 13, 2020, and December 31, 2020 (the second, third, and fourth quarter 2020 941 returns), the ERTC is 50% of qualified wages paid, up to $10,000 per employee annually. The maximum is $10,000 per employee for the year.  
  • Initially PPP recipients were not eligible for the ERTC. However, credits can now be taken on wages so long as they are not forgiven or expected to be forgiven under PPP. 
  • For wages paid between January 1, and September 30, 2021 (first, second, and third quarter 2021 941 returns), the ERTC is 70% of qualified wages paid, up to $10,000 per employee per quarter. The maximum is $21,000 for the year, which means the 2021 credits are much more robust than the 2020 credits. 
  • Note: the description of the ERTC in this blog post applies to small employers (less than 500 employees). There are different and/or additional rules that apply to large employers, recovery startup businesses, etc. Again, before filing for the credit, the business should check with its CPA or tax professional. 

Nature of the Credit 

Businesses claim the ERTC on the quarterly Form 941 payroll tax returns. There are two parts to the credit – non-refundable and refundable.  

  • First, the non-refundable portion of the credit offsets the Social Security or Medicare portion of the taxes, depending on the quarter in question. The nonrefundable portion of the ERTC reduces either (a) Social Security taxes for the 2020 quarters as well as the first and second quarters of 2021, or (b) Medicare taxes for the third quarter of 2021.  
  • Second, if the credit exceeds the employer’s total liability of the portion of the Social Security taxes (or Medicare taxes for the third quarter 2021), the IRS refunds the excess credit to the employer/business. 

Issue 1: Calculation

Again, the ERTC is potentially an awesome tool, but make sure the business qualifies and the calculations are correct. There are some common issues. 

First, ERTC rules are confusing. Four pieces of legislation created and modified the ERTC. The rules are complex, and as recently as early August the program looked like a failure. However, during the fourth quarter of 2021 we saw a surge in the number of claimed credits. Unfortunately, many of these credits may not be legitimate. The IRS does not require proof of eligibility or the calculations when submitting a claim for an ERTC. As such, it’s easy to play fast and loose with the numbers up front. Note: the IRS will eventually reconcile the credits and ask for the money back with penalties and interest, if applicable. 

For example, we recently came across a $1.5 million ERTC for the second quarter 2021, which raised a few questions. First, the 941 return indicates there are approximately 80 employees. In theory, the maximum credit is $560,000 ($7,000 * 80; note: this crude calculation does not account for the non-refundable Medicare tax offset). Second, there were only approximately 40 employees in the same quarter in 2019. This would seem to indicate the business’s receipts or revenues probably increased in 2021 compared to 2019. One could assume that with double the number of employees, the business likely had more work. More work means more revenue. If so, the business would not qualify for the ERTC (no decline in gross receipts). 

  • Takeaway – businesses should make sure ERTCs are prepared by a reputable and knowledgeable CPA or tax professional. Also, businesses shouldn’t be tempted to overstate the credit because the IRS does not require proof up front. The IRS will reconcile the credits within two or three years. And, at a minimum, the IRS pursue collection of any erroneous credits or refunds. 

Issue 2: Backlog

Second, businesses can retroactively claim the ERTC using amended returns (941-X). So, if they missed claiming the credit the first time around, there is a second bite of the apple available. Many businesses are now filing amended 941 returns. Not surprisingly, the IRS, who has not recovered from its collection moratorium in 2020, is behind in processing the returns. Per the National Taxpayer Advocate (NTA), as of October 30, 2021, the IRS has a backlog of 2.7 million unprocessed amended returns. Although the IRS says its current processing time is 20 weeks, the NTA data indicates the processing time is considerably longer than 20 weeks. Additionally, the NTA indicates it will not provide any assistance relative to the amended returns (instead, businesses and lenders will have to “hurry up and wait”). 

  • Takeaway – if a business filed for an ERTC, especially during the fourth quarter of 2021, it should expect to wait 9 months or more from the date the amended return was filed for the refund check to be mailed to the business. 

Conclusion 

Many businesses will benefit from the ERTC. However, if not calculated properly, the ERTC can create problems for the business (and lenders). Proceed with caution and use a trusted professional. Tax Guard primarily negotiates installment agreements and subordinations of federal tax lien for businesses that owe money to the IRS and also borrow money from banks, asset-based lenders, and other lenders. If a business has an IRS liability and does not qualify for an ERTC, give us a call to discuss options for resolving the liability and preserving your funding relationship.