Tax News

Employee Retention Credit - Did you truly qualify?

Did you really qualify for the credit or were you convinced you qualified from a 3rd party company?

The Employee Retention Credit (ERC) is a hot topic. Even though it only existed for parts of 2020 and 2021, the opportunity to amend the Forms 941 to claim this credit is still here.

There are specific rules that have to be met in order to qualify for this credit. The basic rules for ERC can be found in IRS Notices 2021-20, 2021-23, 2021-49, and 2021-63. IRS did a pretty good job of explaining the rules in a Question-and-Answer format when it wrote these Notices.

There are many companies promoting the ERC and sending out telephone calls, emails, text messages, etc. Some of these companies are basically stating that EVERY BUSINESS is entitled to this credit. These companies often focus on a “shutdown” provision that, basically, stating “the inability to get one or more supply is sufficient to qualifying a business for the ERC.” This interpretation is NOT the way the law is written.

On July 21, 2023, IRS released a Chief Counsel Memorandum which discusses the inability to get supplies and whether this qualifies the business for the ERC. Below are the scenarios (as written by IRS) mentioned in the CCM.

SCENARIO 1: Employer A was not subject to any governmental orders limiting commerce, travel, or group meetings due to COVID-19 at any time. However, during 2020 and 2021, Employer A experienced several delays in receiving critical goods from Supplier 1. At all times during 2020 and 2021, Employer A continued to operate because Employer A had a surplus of the critical goods normally provided by Supplier 1. Employer A assumed that Supplier 1’s delay in delivering critical goods was caused by COVID-19. Employer A inquired and Supplier 1 vaguely confirmed that the delay was due to COVID-19. Supplier 1 did not provide a governmental order from an appropriate governmental authority and Employer A was unable to locate one.

CONCLUSION SCENARIO 1 – Employer A does not meet the definition of eligible employer provided under section III.D., Q/A-12 of Notice 2021-20 because Employer A cannot demonstrate that a governmental order applicable to Supplier 1 fully or partially suspended Supplier 1’s trade or business operations. Even if Employer A received or could locate the governmental orders applicable to Supplier 1, Employer A did not have to cease operations because Employer A had a reserve of critical goods allowing Employer A to continue operations; thus, Employer A did not experience a full or partial suspension of operations due to an inability to obtain Supplier 1’s critical goods. The relevant inquiry is whether Employer A’s trade or business operations could continue; since Employer A was able to continue its own business operations despite the supply chain disruption, it was not subject to a full or partial suspension of operations.

SCENARIO 2: Employer B was not subject to any governmental orders limiting commerce, travel, or group meetings due to COVID-19 at any time. However, certain critical goods from Supplier 2 were stuck at port in State X. Employer B assumed the bottleneck at the port was a result of COVID-19. Employer B could not identify any specific governmental order applicable to Supplier 2 or any specific governmental order that caused the bottleneck at the port. Some news sources stated that COVID-19 was the reason for the bottleneck, while others cited reasons such as increases in consumer spending and aging infrastructure. In addition, Supplier 2 mentioned to Employer B that other critical goods that were not stuck at port would be delayed due to a truck driver shortage. Employer B saw some discussion on social media that the truck driver shortage was because drivers were out sick due to COVID-19.

CONCLUSION SCENARIO 2: Employer B does not meet the definition of an eligible employer under section III.D., Q/A-12 of Notice 2021-20 because Employer B cannot demonstrate that a governmental order applicable to Supplier 2 fully or partially suspended Supplier 2’s trade or business operations. In addition, while COVID-19 may have been a contributing factor to the bottleneck at the port or the truck driver shortage, Employer B could not substantiate that any specific governmental order caused a bottleneck at the port. Even if Employer B could identify governmental orders applicable to the bottleneck, Employer B must substantiate that the bottleneck and thus the suspension of Supplier 2 was due to the orders.

SCENARIO 3: Employer C and Supplier 3 are located in a jurisdiction that issued governmental orders suspending both of their business operations for the duration of April 2020. Employer C and Supplier 3’s jurisdiction lifted all orders related to COVID in May 2020. For the remainder of 2020 and 2021, Employer C experienced a delay in receiving critical goods from Supplier 3. Supplier 3 does not provide a reason for the delay, but Employer C assumes the delay is due to the governmental order in place in April 2020.

CONCLUSION SCENARIO 3: Employer C is an eligible employer in the second calendar quarter of 2020 because its business operations were fully or partially suspended due to a governmental order. However, only wages paid with respect to the period during which Employer C is fully or partially suspended due to a governmental order may be considered qualified wages. See section III.D., Q/A-22 of Notice 2021-20. Employer C does not meet the definition of an eligible employer under section III.D., Q/A-12 of Notice 2021-20 for any subsequent calendar quarter in 2020 or 2021 because Employer C cannot demonstrate that a governmental order applicable to Supplier 3 fully or partially suspended Supplier 3’s trade or business operations. The residual delays caused by a governmental order in place during a prior calendar quarter will not constitute a governmental order in subsequent calendar quarters once the order has been lifted.

SCENARIO 4: Employer D was not subject to any governmental orders limiting commerce, travel, or group meetings due to COVID-19 at any time. During 2020 and 2021, Employer D could not obtain critical goods from Supplier 4. However, Employer D was able to obtain the goods from an alternate supplier. The critical goods from the alternate supplier cost 35% more than those from Supplier 4. Employer D could continue to operate its trade or business even though it was not as profitable as in 2019.

CONCLUSION SCENARIO 4: Employer D does not meet the definition of an eligible employer under section III.D., Q/A-12 of Notice 2021-20 because Employer D could continue to operate its trade or business. Employer D was not prevented from operating its trade or business at any point during 2020 or 2021. Incurring a higher cost for critical goods does not result in a full or partial suspension of operations.

SCENARIO 5: Employer E operates a large retail business selling a wide variety of products. Employer E was not subject to any governmental orders limiting commerce, travel, or group meetings due to COVID-19 in 2021. Due to various supply chain disruptions, Employer E was not able to stock a limited number of products and was forced to raise prices on other products that were in limited supply. However, at no time did the product shortage prevent Employer E from continuing to fully operate as a retail business during 2021.

CONCLUSION SCENARIO 5: Employer E does not meet the definition of an eligible employer under section III.D., Q/A-12 of Notice 2021-20 during calendar year 2021 because Employer E cannot demonstrate that a governmental order applicable to a supplier of critical goods or materials caused the supplier to suspend operations and that Employer E was unable to obtain critical goods and materials causing a full or partial suspension of Employer E’s business operations. At all points during 2021, Employer E was able to operate its retail business. While a limited number of products were not available, Employer E was still able to offer a wide variety of products to its customers and Employer E was not forced to partially suspend operations.

Comments – Don’t forget that the wages/health insurance expenses must be reduced on the income tax return by the credit amount FOR THE YEAR these expenses were incurred. AND don’t forget IRS has previously stated a tax professional can rely on another preparer’s work, but not blindly. In other words, the tax professional must reasonably know the tax rules and feel comfortable that the other preparer properly followed them. Therefore, it is not acceptable to amend the income tax return unless the tax profession feels comfortable that the business was properly eligible for the ERC and that the ERC was properly calculated.

Chief Counsel Memorandum AM-2023-005.

Upcoming ERC Audits - IRS Compliance

IRS Compliance – Upcoming ERC Audits

In connection with its recent warning, the IRS is preparing for a major compliance enforcement effort of ERC refund claims. Recently, the IRS Small Business/Self-Employed Division has begun training 300 examiners to examine ERC refund claims.

Last month, the Commissioner of this IRS Division, told tax practitioners that the IRS is encouraging taxpayers to take advantage of the credit, but that the IRS is “monitoring the situation very closely.” She said the warning signs of these schemes include large upfront fees, advertised solicitations and suggestions that businesses have nothing to lose by submitting these claims. As of February 14, 2023, the IRS Criminal Investigation division has initiated 44 investigations into ERC fraud that include aggressive ERC promoters and enablers. Eleven individuals have been charged to date.

In its examination of questionable ERC claims, the IRS likely will focus on three areas; eligibility, substantiation of the amount claimed and whether an amended income tax return was filed to correct any overstated wage deduction.

A particular focus of the IRS will be on substantiating qualifications based on a partial suspension of business operations, which requires a taxpayer to demonstrate that a government order interrupted at least a portion of its business operations. Additionally, the order must be more than a recommendation and the shutdown order must have impacted business operations by a more than nominal amount.

2023 Meals are back to 50% deduction

If you’ve splurged on expensive meals for business associates or sprung for high-priced tickets to sporting events or concerts for clients in the past, take heed: the tax deductions aren’t what they used to be.

Prior to the Tax Cuts and Jobs Act (TCJA) of 2018, businesses could deduct up to 50% of entertainment and meal expenses, provided they were associated with conducting or discussing business. The TCJA eliminated the deduction for most forms of entertainment but allowed taxpayers to continue deducting 50% of the cost of business meals.

In 2021, the Consolidated Appropriations Act (CAA) allowed businesses to deduct 100% of certain business meal expenses in 2021 and 2022. But the deduction was temporary, designed to boost the restaurant industry during COVID.

As of 2023, deductions are now back where they were prior to 2021. The majority of business meals are now 50% deductible, and most entertainment expenses are not deductible at all.

What’s Deductible in 2023

Exactly what is deductible, and to what extent, depends on the circumstances. Following are some general guidelines:

100% Deductible

Food for recreational employee events, such as holiday parties, summer picnics, or team-building events
Food provided to the public to promote goodwill (e.g., snacks or coffee for customers)
Food for events in support of a charitable cause
Meals that are an essential part of your business function (for example, if you’re a food critic or food blogger)
Meals provided to the employees for the convenience of the employer (e.g., dinner for employees who work late at the office)
Meals included as taxable compensation to employees or independent contractors
Meals sold to a client or customer

50% Deductible

Business meals
Meals provided in-office for meetings of employees, stockholders, agents, or directors
Employee meals at a company cafeteria if the annual revenue of the facility is equal to or greater than the costs
Food items, such as soda, coffee, or snacks, for employees
Meals while traveling for work
Meals at a conferences

Not Deductible

Entertainment

The Internal Revenue Code defines entertainment as “any activity which is of a type generally considered to constitute entertainment, amusement, or recreation, such as entertaining at night clubs, cocktail lounges, theaters, country clubs, golf, and athletic clubs, sporting events, and on hunting, fishing, vacation, and similar trips….”

Note that you also cannot deduct the costs of renting out an entertainment facility or the cost of membership dues.

Exceptions

Entertainment and meals that are part of your actual business may be deductible. For example, if you own a piano bar, the cost of the piano player would probably be deductible. Similarly, if you are a food blogger or a theater critic, you should be able to deduct the cost of meals or plays that you are actively reviewing.

You may be able to deduct meals at entertainment events if the costs can be separated. For example, while the cost of renting a room at a country club for a business function most likely isn’t deductible, the cost of catering for that function might be.

Criteria for Deductions

To deduct business meals, you must be self-employed or operating a business. As of 2018, employees with W2 jobs do not qualify for business meal deductions.

Business meals can be deducted only when the taxpayer or an employee is present at the meal along with a current or potential client, business contact, or consultant. Meals for guests, such as spouses, are not deductible.

In most cases, meals must be provided by a restaurant or, in the case of larger events, a caterer, to be eligible. Food purchased at a grocery or convenience store is not deductible.

In all cases, the meal must not be “lavish or extravagant” relative to the business context.

Documenting Deductions

You should keep receipts for any business meal over $75, and you should keep a record of all business meals, regardless of cost. Records should include:

The date of the meal
Purpose of the meal as it relates to business
Names, titles, and affiliations of people who attended
Name of the venue
Total amount of the bill, including tax and tip.

ERC tops dirty dozen scams

For the start of the annual Dirty Dozen list of tax scams, the IRS spotlighted Employee Retention Credits following blatant attempts by promoters to con ineligible people to claim the credit. Renewing several earlier alerts, the IRS highlighted schemes from promoters who have been blasting ads on radio and the internet touting refunds involving Employee Retention Credits, also known as ERCs. These promotions can be based on inaccurate information related to eligibility for and computation of the credit.

"The aggressive marketing of these credits is deeply troubling and a major concern for the IRS," said IRS Commissioner Danny Werfel. "Businesses need to think twice before filing a claim for these credits. While the credit has provided a financial lifeline to millions of businesses, there are promoters misleading people and businesses into thinking they can claim these credits. There are very specific guidelines around these pandemic-era credits; they are not available to just anyone. People should remember the IRS is actively auditing and conducting criminal investigations related to these false claims. We urge honest taxpayers not to be caught up in these schemes."

The IRS is stepping up enforcement action involving these ERC claims, and people considering filing for these claims – only valid during the pandemic for a limited group of businesses – should be aware they are ultimately responsible for the accuracy of the information on their tax return. The IRS Small Business/Self-Employed division has trained auditors examining these types of claims, and the IRS Criminal Investigation Division is on the lookout for promoters of fraudulent claims for credits.

Abusive ERC promotions highlight day one of the IRS annual Dirty Dozen campaign – a list of 12 scams and schemes that put taxpayers and the tax professional community at risk of losing money, personal information, data and more.

This annual list of schemes and scams is aimed at helping raise awareness to protect honest taxpayers from aggressive promoters and con artists. These schemes put people at financial risk and increase the chances people could become victims of identity theft.

"Businesses should be wary of advertised schemes and direct solicitations promising tax savings that are too good to be true," Werfel said. "They should listen to the advice of their trusted tax professional. Taxpayers should remember that they are always responsible for the information reported on their tax returns. Improperly claiming this credit could result in taxpayers having to repay the credit along with potential penalties and interest."

When properly claimed, the ERC is a refundable tax credit designed 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.

Properly claiming the ERC

Eligible taxpayers can claim the ERC on an original or amended employment tax return for qualified wages paid between March 13, 2020, and Dec. 31, 2021. However, to be eligible, employers must have:

Sustained a full or partial suspension of operations due to orders from an appropriate governmental authority limiting commerce, travel or group meetings because of COVID-19 during 2020 or the first three quarters of 2021,

Experienced a significant decline in gross receipts during 2020 or a decline in gross receipts during the first three quarters of 2021, or

Qualified as a recovery startup business for the third or fourth quarters of 2021.

Source - Notice 2023-49

IRS Warning on ERC Claims

The Internal Revenue Service today issued a renewed warning urging people to carefully review the Employee Retention Credit (ERC) guidelines before trying to claim the credit as promoters continue pushing ineligible people to file.

The IRS and tax professionals continue to see third parties aggressively promoting these ERC schemes on radio and online. These promoters charge large upfront fees or a fee that is contingent on the amount of the refund. And the promoters may not inform taxpayers that wage deductions claimed on the business' federal income tax return must be reduced by the amount of the credit.

"While this is a legitimate credit that has provided a financial lifeline to millions of businesses, there continue to be promoters who aggressively mislead people and businesses into thinking they can claim these credits," said Acting IRS Commissioner Doug O'Donnell. "Anyone who is considering claiming this credit needs to carefully review the guidelines. If the tax professional they're using raises questions about the accuracy of the Employee Retention Credit claim, people should listen to their advice. The IRS is actively auditing and conducting criminal investigations related to these false claims. People need to think twice before claiming this."

The IRS has been warning about this scheme since last fall, but there continue to be attempts to claim the ERC during the 2023 tax filing season. Tax professionals note they continue to be pressured by people wanting to claim credits improperly. The IRS Office of Professional Responsibility is working on additional guidance for the tax professional community that will be available in the near future.

People and businesses can avoid this scheme, and by not filing improper claims in the first place. If the business filed an income tax return deducting qualified wages before it filed an employment tax return claiming the credit, the business should file an amended income tax return to correct any overstated wage deduction.

Businesses should be cautious of advertised schemes and direct solicitations promising tax savings that are too good to be true. Taxpayers are always responsible for the information reported on their tax returns. Improperly claiming the ERC could result in taxpayers being required to repay the credit along with penalties and interest.