IRS cracks down on small enterprise tax breaks that might lead to an audit

A cottage industry of specialized firms has sprung up to help entrepreneurs claim the Employee Retention Credit (ERC), a government tax incentive for companies stressed by the pandemic. But companies must be careful not to be fooled.

The ERC has strict eligibility requirements – it can, among other things, be paid for wages during pandemic times when gross receipts have fallen – and many owners may not really understand the criteria. This means they could inadvertently cover up the opportunity and lose up to $26,000 in credit per employee. Or they could easily be tricked by shady vendors into dishonestly seeking money they are not entitled to – with a hefty fee, of course – and likely consequences later.

The problem is especially pervasive given how easy it is to apply for loans and deceive small businesses in the process, said Donald N. Hoffman, a partner at the Eisner Advisory Group. “Every business owner receives dozens of emails and mail and is bombarded with TV ads,” he said.

However, last October the IRS warned business owners to be on the lookout for third parties promoting improper ERC claims. That warning was renewed in March of this year, as a press release said, “Continue to be promoters who aggressively mislead people and businesses into believing they can claim these loans.”

The IRS even went so far as to include fraudulent claims involving the ERC in its annual “Dirty Dozen” list of tax fraud.

“The aggressive marketing of these loans is deeply troubling and a matter of grave concern,” IRS Commissioner Danny Werfel said in a press release. “There are very specific guidelines for these pandemic-era loans; they are not available to everyone.”

These promotions may be based on inaccurate information about eligibility or how credit is calculated, according to the IRS. Additionally, some of these ads aim to collect a taxpayer’s confidential information, which is then used for identity theft purposes, according to the IRS.

Here are important things owners need to know about the ERC to avoid problems, worst case scenario including an exam.

Start by understanding the basic ERC entitlement requirements

Familiarize yourself with the basics first so you understand if your business qualifies for a loan.

According to the IRS, eligible taxpayers can claim the ERC on an original or amended payroll tax return for qualifying wages paid between March 13, 2020 and December 31, 2021. Businesses may be eligible if all or part of their operations have ceased during the applicable periods due to a pandemic-related government-ordered shutdown. A company may also be eligible if it experienced a decrease in gross revenue in the first three quarters of 2021 or a significant decrease in gross revenue in 2020. Another way to be eligible is if the company has qualified as a “recovery startup” — a company formed during the pandemic — in Q3 or Q4 of 2021.

Businesses may still be eligible for the credit if they’ve received forgiveness on a PPP loan, something some owners may not be aware of, said Gina Perrone, senior tax manager at accounting, tax and advisory firm Sax LLP. This was not allowed when the ERC was founded, but was later revised. However, there are limitations to double-dipping that an accountant can help ensure it doesn’t happen.

Consult an accountant before contracting an ERC specialist

Because of the different requirements, it is very confusing for small businesses. As such, it’s wise to approach a CPA firm that is familiar with the ERC rules – even if a third party suggests the firm automatically qualifies. There are many definitions and details that need to be clarified to ensure that a company is actually eligible.

For example, the definition of gross receipts for credit purposes is that used by the Small Business Administration, and it refers to the number reported on your tax return, Hoffman said.

Under no circumstances should you sign a contract with a third party before consulting a trustworthy and reputable financial professional.

Learn how to spot the ERC’s warning signs to avoid an exam

While it sounds “super simple” for a vendor, there are many complicated factors involved in determining eligibility, said Jenn McCabe, a partner at accounting and consulting firm Armanino. Be wary of any company using pressure tactics to get companies to act quickly, she said. These companies sometimes charge high upfront fees or a fee that depends on the refund amount.

Another red flag is when a third party fails to request documentation to ensure a business owner qualifies, Perrone said. Businesses are not required to submit these documents to the IRS, but should still ensure they are eligible for the credit to avoid costly problems later. If the company wasn’t actually eligible but received the loan and was later assessed, it will repay the money plus penalties and interest, Perrone said. This can happen several years later, and in the meantime the company has already paid the third party and is unlikely to recover those funds, Perrone said.

To avoid an exam, “make sure you can support your eligibility and eligibility requirements,” Perrone said.

If your company meets the requirements, the next steps are the tax return

Once the company has determined that it qualifies, the next step is to file Form 941-X, an amended quarterly payroll tax return, for each quarter for which the company is requesting a credit. For 2020, companies have until April 15, 2024 to submit their documents; For 2021, they have until April 15, 2025, Perrone said.

Businesses applying for the credit must also amend their applicable tax returns to account for the additional income based on the year in which they qualified for the credit. “They can’t just report earnings in the year they received the money,” Hoffman said.

Also note that professional standards prohibit accountants from charging contingency fees for preparing original or amended tax returns—a necessary step in obtaining credit.

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