The Internal Revenue Service (IRS) continues to intensify its efforts to address employee retention credit (ERC) fraud, enlisting its Criminal Investigation division to identify fraudulent claims and the firms that promote them.
Speaking at the IRS Nationwide Tax Forum in Atlanta on July 26, 2023, IRS Commissioner Daniel Werfel said “the amount of misleading marketing around this credit is staggering, and it is creating an array of problems for tax professionals and the IRS while adding risk for businesses improperly claiming the credit. A terrible scenario is unfolding that hurts everyone involved — except the promoters.” The Commissioner has also lobbied Congress to assist in the fraud prevention efforts by early sunsetting the ERC.
In a separate development, the IRS recently issued an updated list of frequently asked questions (FAQs) to help combat ERC eligibility misinformation, and a generic legal advice memorandum (GLAM) that confirms the “suspended supplier exception” that allows employers affected by supply chain disruptions resulting from COVID-19-related government orders to be eligible for the ERC is a “narrow, limited exception”. The GLAM applies the law and guidance under IRS Notice 2021-20 to five separate examples to illustrate the limited applicability of the suspended supplier exception.
Key takeaways
Compliance audits of ERC claims continue to be a focus for the IRS. However, as indicated by the Commissioner, investigations that could result in potentially both civil penalties and criminal charges have intensified.
The IRS has identified several “warning signs of aggressive ERC marketing” that taxpayers should walk away from. If you have worked with a promoter employing any such tactics to claim the ERC, we strongly encourage you to consult with your tax advisor and legal counsel immediately to assess your risk exposure and possible remedies.
On July 27, 2023, the House Ways and Means Oversight Committee held a hearing to address concerns with fraud in the ERC and the IRS’ backlog of unprocessed claims. The IRS’ efforts to address the former have resulted in 122 criminal investigations of claims totaling over $1.2 billion as of this spring.
The FAQs and GLAM confirm several positions Baker Tilly has taken with respect to eligibility under the suspension test, including but not limited to:
Recommendations, bulletins and statements encouraging, but not mandating, employers to take certain actions are not government orders that give rise to eligibility under the suspension test
An employer that can continue its operations despite its supplier’s suspension is not eligible under the suspension test
Bottlenecks or delays at shipping ports must be identifiably the direct result of a domestic government order, and in turn, the suspension of the supplier must be the result of the order, to give rise to eligibility
Incurring a higher cost for critical goods does not result in a full or partial suspension
While neither the FAQs nor the GLAM can be used or cited as precedent, they indicate how the IRS will consider the applicability of the suspension test upon audit.
Fraud and criminal investigations
While the IRS has been warning taxpayers against the dangers of pursuing aggressive ERC claims for some time now (see our previous tax alert), as evidenced by the Commissioner’s focus on the issue at the IRS Nationwide Tax Forum, the IRS issuing the GLAM and updated FAQs, and the Ways and Means subcommittee meeting, it’s clear that combating erroneous and fraudulent claims is a critical government objective. Commissioner Werfel noted, “The further we get from the pandemic, we believe the percentage of legitimate claims coming in is declining. Instead, we continue to see more and more questionable claims coming in following the onslaught of misleading marketing from promoters pushing businesses to apply. To address this, the IRS continues to intensify our compliance work in this area.” On a July 25, 2023 webinar hosted by the IRS, Carolyn Schenck, IRS national fraud counsel, offered it may include “the ability to assess the erroneous refund as an underpayment of the employment tax as well as imposing penalties, including the fraud penalty on the underpayment.”
Warning against the dangers of working with ERC mills remains a primary focus, and the newly issued IRS FAQs offer assistance to taxpayers by highlighting signs of aggressive ERC marketing, including, but not limited to:
Unsolicited calls or advertisements mentioning an "easy application process," or offering a short eligibility checklist
Statements that the promoter or company can determine ERC eligibility within minutes
Large upfront fees to claim the credit
Fees based on a percentage of the refund amount of Employee Retention Credit claimed. This is a similar warning sign for average taxpayers, who should always avoid a tax preparer basing their fee on the size of the refund.
Suggestions for how taxpayers can protect themselves include working with a trusted tax professional, requesting a detailed worksheet explaining ERC eligibility and not accepting a generic document regarding government orders. If you have worked with a promoter employing any such tactics to claim the ERC, we strongly encourage you to consult with your tax advisor and legal counsel immediately to assess your risk exposure and possible remedies.
Highlights of the subcommittee meeting included Congresswoman Beth Van Duyne (R-TX) sharing a voicemail she received from an alleged ERC mill regarding the eligibility of a marketing firm she left over 10 years ago, and Oversight Subcommittee Chair David Schweikert (R-AZ) noting he was open to considering Commissioner Werfel’s request for an early ERC sunset.
Suspended supplier exception
Background
IRS Notice 2021-20 Answer 12 provides a “suspended supplier exception” which allows an employer which is not directly subject to a COVID-19-related government ordered shutdown or modification to potentially be eligible for the ERC if their supplier of critical goods or materials is subject to such an order. Answer 12 is a mere seven sentences long and includes an illustrative example in which an auto parts manufacturing business’ supplier of raw materials is required to “fully suspend” its operations pursuant to a government order. The manufacturer is unable to obtain these materials from an alternate supplier, and as a result, “is not able to perform its operations for a period of time.” (Emphasis added) Under these facts and circumstances, the manufacturer is considered eligible for the ERC under the suspension test.
Given the guidance providing for the exception is extremely limited and the example it includes illustrates a worst-case scenario, Baker Tilly has taken the position that an employer’s and their supplier’s facts and circumstances must fit within the construct of Answer 12 for an eligibility position to have substantial authority. However, among the many aggressive positions espoused by ERC mills are very liberal interpretations of the suspended supplier exception, to include eligibility arising from generic supply chain issues that are not concretely, or in some cases, even remotely linked to any COVID-19-related government order.
GLAM
The GLAM provides five scenarios in which employers deal with varying forms of supply chain issues. Only one of the five scenarios results in employer eligibility for the ERC, and it should be noted that the employer was also directly subject to a government order. A summary is as follows:
1. Employer is ineligible because they cannot demonstrate that the many delays they experienced in receiving critical supplies were due to their supplier being subject to a governmental order. Further, despite the delays, the employer could continue operating on account of supplies they already had on hand. Critically, the GLAM provides that the “relevant inquiry is whether Employer A’s trade or business operations could continue” and therefore, even if they could refer to a governmental order that shut down their supplier, they would not be eligible for the credit.
2. Employer is ineligible because they cannot demonstrate their delivery of critical goods were stuck at a domestic port due to COVID-19-related governmental orders. In addition, the GLAM provides that even if the bottleneck could be attributed to a domestic governmental order, the employer must also be able to demonstrate that their supplier was suspended by a governmental order.
3. Employer is eligible because they were subject to a government order that suspended its business operations. Their supplier was subject to a government order as well, but the GLAM does not appear to give this fact any distinction. However, we believe this is likely an oversight in drafting rather than an indication that the employer themselves must be under a government-ordered closure or modification to qualify under the suspended supplier exception. Scenario 3 also critically points out that the employer’s eligibility ends upon the lifting of the government order, regardless of the significant residual issues the employer experiences.
4. Employer is ineligible because they could obtain critical goods from an alternate supplier and thus continue operations, regardless of the fact they acquired the goods at a significantly higher cost.
5. Employer is ineligible despite various supply chain disruptions, because they could not be attributed to a government order, and further, they could still operate their business despite a limited number of their product offerings being unavailable.
While the GLAM cannot be used or cited as precedent by taxpayers or the IRS, it does however indicate how the IRS will consider the applicability of the suspended supplier exception upon audit. The language of IRS Notice 2021-20 Answer 12, which is primary authority, supports the IRS’ view. Taxpayers who have relied, or considered relying on the suspended supplier exception should strongly consider this important development.
Erroneous ERCs treated as underpayments of payroll taxes
The IRS and the U.S. Treasury Department have also issued final regulations stating erroneous ERCs (and other pandemic relief credits, such as those available under the Families First Coronavirus Response Act) will be treated as underpayments of the employer’s share of payroll taxes. The regulations finalize temporary regulations with little change, which authorize the IRS to assess tax liabilities on the erroneous credits, including interest, additional amounts, additions to the tax, and assessable penalties.
For more information on this topic, or to learn how a Baker Tilly specialist can help, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.
