A pandemic-era tax break that remains rife with abuse — the ERC

It began as a way to help business owners and workers by providing a tax credit for employers that continued to pay employees at the height of the COVID-19 pandemic. But the employee retention credit (ERC) became so rife with abuse that the IRS cannot keep up with the legitimate filings.

The Service has published at least six warnings about ERC abuse since October 2022, including making it No. 1 on its annual "Dirty Dozen" list of the 12 top tax scams earlier this year. It added a seventh release last week with another warning about "a barrage of aggressive broadcast advertising, direct mail solicitations, and online promises" from ERC promoters.

These promoters "present wildly misleading claims about this credit," IRS Commissioner Danny Werfel said in the latest IRS release. "They can pocket handsome fees while leaving those claiming the credit at risk of having the claims denied or facing scenarios where they need to repay the credit."

As of March 3, 866,326 employers had filed ERC claims totaling over $152.6 billion, the IRS said. Employers who filed for multiple credits are counted once toward the total, the Service said. Although the tax credit — which began March 13, 2020 — ended at the end of 2021, the IRS still faces a backlog of amended returns.

The IRS is stepping up its audit and criminal investigation work involving claims for the ERC, including businesses and promoters of fraudulent claims, the Service said. While it is a legitimate tax credit, the bad actors make it hard for IRS staff to process those claims in a timely way, Werfel said.

According to the IRS, as of April 30, IRS Criminal Investigation (IRS-CI) had initiated 122 investigations involving over $1.2 billion of potentially fraudulent ERCs in tax years 2020, 2021, and 2022. Eleven of the 122 investigations have resulted in federal charges. Of those 11 cases, six have resulted in convictions and three have resulted in sentencings. The average sentence is 22 months.

Lenford Smith, CPA, owner of CPA SMITH LLC, and tax attorney Lauren-Nikai Harry, who has a law practice and works as a consultant with Smith's firm in Upper Marlboro, Md., have firsthand experience with the backlog of payments for ERC claims.

Of the approximately 20 CPA SMITH LLC clients who were qualified for the ERC, only a few made claims and none has received their payment, Harry said. Some of that problem lies with the ERC form itself, said Harry, managing attorney of LH Law Firm LLC.

"I can see where certain people who may not know how to read or interpret the way that the IRS communicated the requirements would make errors," she said. "The process wasn't as coherent, as easy as maybe it should be, especially for small businesses and independent business owners to do on their own."

CPA SMITH LLC did not advertise the ERC outside its own clients, reaching out to about 200 or 250 of those, Harry said. After Smith and Harry reviewed the requirements for filing, about 20% decided to move forward. Some of those dropped out along the way, she said.

"One of the reasons why these [ERC] mills are finding it so enticing is because of the nebulousness of the entire situation," Smith said. "They can interpret for you, hoping, potentially, in my opinion, to get that credit by way of a check, get their part of it, disappear, and then maybe you the employer are subjected to an audit later on and they've disappeared. They've closed shop and disappeared, and you're left unsupported."

When properly claimed, the ERC is a refundable tax credit intended for businesses that continued paying employees while shut down due to the COVID-19 pandemic or that had a significant decline in gross receipts during the eligibility periods. The credit is not available to individuals. It was established by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136.

One of the best ways for a business to protect itself from an IRS audit for potential ERC abuse is to work with a tax professional rather than a promoter, the IRS said.

"The IRS urges people not to rely on the advice of those soliciting these credits," the release said. "Promoters who are marketing this ultimately have a vested interest in making money; in many cases, they are not looking out for the best interests of those applying."

AICPA advocacy

In October, the IRS provided a new way for CPAs and others to make anonymous reports about the third-party vendors that promote improper ERC claims, a move that the AICPA endorsed.

The AICPA had expressed its concerns about "the unscrupulous business practices of ERC mills" for over a year, Barry Melancon, CPA, CGMA, the CEO of AICPA & CIMA, together as the Association of International Certified Professional Accountants, said at the time.

"This credit has been hugely beneficial to countless businesses that struggled to navigate the challenges brought on by the pandemic, and CPAs have often advised clients and business owners against taking the improper recommendations of these third-party vendors," Melancon said. "We are pleased that employers and others now have a mechanism to anonymously report bad actors and help to protect the public against them."

Form 3949-A, Information Referral, previously was used to report fraud anonymously and now allows CPAs, firms, and individuals to do the same with questionable ERC mills.

Source: www.journalofaccountancy.com