House lawmakers are scrutinizing the employee retention tax credit during the pandemic

IRS Commissioner Daniel Werfel testifies before a Senate Finance Committee hearing on February 15, 2023.

Kevin Lamarck | Reuters

Scrutiny of the pandemic-era tax credit intensified this week as lawmakers, the IRS and tax experts sought solutions to a wave of small businesses mistakenly claiming the tax break.

The Employee Retention Credit, or ERC, was enacted in 2020 to support small businesses affected by shutdowns during the Covid-19 pandemic and is worth thousands of dollars per employee. Eligible businesses still have time to turn over income and apply for credit, which has led to a cottage industry of firms known as “ERC mills” that push credit to businesses that may or may not qualify.

“This is a huge opportunity and a much-needed lifeline for small businesses, but it’s riddled with fraud,” Roger Harris, president of accounting and tax firm Padgett Advisors, said at a House Ways and Means Committee hearing Thursday.

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“When that much money is distributed through the tax system, bad actors emerge, and they emerge in large numbers,” he said.

As of July 26, the IRS said it had about 506,000 unprocessed Form 941-X amended payroll tax returns.

Because the IRS works with a backlog of unprocessed adjusted returns, it’s unclear how many small businesses may be incorrectly claiming the credit. But according to Harris, a future audit “could destroy them.”

The IRS has received more than 2.5 million ERC claims since the program’s inception, but processing has been slow due to the “complexity of adjusted returns,” according to the agency.

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“The joy of getting the money can very quickly be replaced by the scary reality that because you didn’t qualify, you could now be fired for the amount of money you owe the federal government,” Harris said.

According to Pat Cleary, president and CEO of the National Association of Professional Employer Organizations, who testified before the House, the true ERC claim backlog may be significantly higher due to professional employer organizations or PEOs that provide payroll benefits and other HR services. hearing This is because a single PEO claim can represent many small businesses.

IRS says legitimate ERC claims are declining

The IRS has issued several warnings about “ERC schemes” and added the issue to the “Dirty Dozen” list of tax scams for 2023. This week, the agency said it was “increasing inspections and criminal investigations” in the area. .

IRS Commissioner Danny Werfel said this week at the IRS National Tax Forum in Atlanta, “We believe the percentage of legitimate claims is going down the further we get away from the pandemic.” “Instead, we continue to see more and more dubious claims come in, following a deceptive marketing onslaught by promoters who entice businesses to apply.”

The further we get from the pandemic, we believe that the percentage of legitimate claims coming in will decrease.

Danny Werfel

Commissioner of the IRS

Small businesses currently have until April 15, 2024 to adjust returns for 2020 and April 15, 2025 to adjust returns for 2021. “It raises concerns going forward,” and the agency is considering an earlier expiration date, Werfel said.

Tax professionals need a “real-world solution.”

In the meantime, questions remain for tax professionals with questions about ERC claims from small businesses.

“As practitioners, we need guidance,” Larry Gray, a certified public accountant and partner at AGC CPA, said in written testimony for the House hearing. “We need guidance to be able to clearly show our customers why they are or are not a good fit.”

ITM professionals help companies amend their payroll tax returns, he said, but don’t amend their income tax returns to reflect the change, which drives clients back to him.

In addition, “claiming a loan and preparing a tax return are probably not done by the same people,” because many tax professionals don’t handle payroll tax returns, Gray said.

Harris stressed the need for a “real-world solution” for small businesses that make false credit claims because “there is no way in the world to audit our way out of this problem.”

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