Employers can claim the Employee Retention Credit (ERC) against certain payroll taxes on qualified employee wages during the COVID-19 pandemic if eligible. This offered financial relief for many employers, though the IRS noted that many fraudulently claimed the ERC without being legally eligible.
In light of that, the IRS has released guidance on the warning signs they have observed that indicate to them that employers should not have claimed the credit, even if they merely attempted to. For example, eligibility for the ERC hinges on whether or not a business stopped operations or had a decline in gross receipts during the height of the pandemic. This means businesses must fully or partially stop operations because of a COVID-19-related government order. The IRS warns employers who cannot cite a specific government order that would have affected their businesses cannot claim the ERC.
Since the ERC came about, there has been an influx of questionable / patently illegal claims, prompting the IRS to create the ERC Withdrawal Program. This program enables employers who have wrongfully claimed the ERC despite being ineligible to withdraw their claims fully. This can help employers avoid future civil and criminal enforcement issues, as the IRS will not impose financial penalties on or prosecute employers who resolve the matter through the program.
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The IRS’ Five New Signs of Incorrect ERC Claims
The ERC was created to help businesses and some tax-exempt organizations with employees directly affected by the COVID-19 pandemic. Many businesses claimed the ERC without fully understanding their eligibility, leading to rejections from the IRS. With this, the IRS has recently released five new warning signs of incorrect ERC claims that employers can refer to avoid problems down the line.
Businesses Didn’t Stop Operations or Have a Decline in Gross Receipts
To qualify for the ERC, employers must meet certain criteria. They must have experienced a full or partial halt of operations because of an order from a government authority limiting travel or group meetings during the first year or so of the pandemic, experienced a significant decline in gross recipients during that time, or qualified as a startup business during the third or fourth quarters of 2021. Self-employed individuals with employees might qualify for the ERC but cannot use their self-employment wages to calculate the credit.
According to the IRS, a business was not fully or partially suspended if all employees could work remotely from home, customers were affected by a stay-at-home order but a business’s employees were not, or a business voluntarily closed its doors without a government order.
Employers Cannot Cite an Applicable Government Order
When claiming the ERC, employers must point to specific government orders that suspended their operations, fully or partially, during the pandemic. Furthermore, the government order must have affected more than a nominal part of a business, meaning at least 10%.
Employers Report Relatives’ Wages as Qualified Wages
When calculating the ERC, employers may not count wages paid toward relatives, like their spouse, children, siblings, parents, household members, or even extended relatives, like aunts, uncles, cousins, nieces, and nephews. Qualified wages are those subject to Social Security and Medicare taxes and are reportable on Form W-2, meaning the ERC excludes wages paid to independent contractors.
Employers Already Used Wages for Paycheck Protection Program
The U.S. Small Business Administration Paycheck Protection Program (PPP) provided relief for business owners during the pandemic, giving them a loan they could use to keep their workers employed through those uncertain financial times. Employers may not claim the ERC on wages reported as payroll costs to get a PPP loan forgiven.
Large Employers Claim Wages for Employees Who Provided Services
Large employers who averaged more than 100 full-time workers in 2019 and claimed the ERC for 2020 tax periods or averaged more than 500 full-time workers in 2019 and claimed the ERC for 2021 tax periods can only claim wages paid to employees who were not providing services during this time because of a suspension of operations, rather than wages paid to employees who were providing services.
Addressing Incorrect Employer Retention Credit Claims
These are just the most recent warning signs of an incorrect ERC claim from the IRS. Previously, the IRS had explained to employers that if they could not cite a specific government order that would have affected their workforce, they would not be able to claim the ERC. Still, this remains one of the biggest issues with attempts to claim the Employer Retention Credit.
Another enduring issue with claiming the Employer Retention Credit is incorrect calculations, as the guidance for calculating the ERC has changed over time.
The IRS also warns filers of the problems of filing incorrect ERC claims. For example, it could prompt an audit, leading to potential penalties and the IRS looking closely at your business and its finances. Because of the large number of questionable ERC claims in recent years, the IRS started an ERC Withdrawal Program. When employers go through this IRS program, it will be as though they never filed an incorrect ERC claim and will not incur any penalties or interest.
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