The IRS is eliminating small business tax breaks that could lead to an audit

A cottage industry of specialist firms has sprung up to help employers claim the Employee Retention Credit (ERC), a government tax incentive for companies hit by the pandemic. But businesses should be careful not to cheat.

There are strict eligibility requirements for ERC—one way it can be claimed is wages paid during pandemic periods when gross receipts are down—and many owners don’t really understand the criteria. This means they could inadvertently miss out on an opportunity and lose up to $26,000 in credit per employee. Or, they can easily be cheated by providers who tend to seek money unfairly – with a high fee, of course – and possibly consequences down the road.

Donald N. Hoffman, a partner at Eisner Advisory Group, says the problem is particularly widespread given how easy it is to apply for a loan and defraud small businesses in the process. “Every business owner gets dozens of emails and mail and is bombarded with TV ads,” he said.

To be sure, the IRS last October urged business owners to look for third parties promoting improper ERC claims. It updated that warning in a release this March, saying it “continues to be aggressively misleading people and businesses into thinking they can claim these loans.”

The IRS has gone so far as to add fraudulent ERC claims to its annual “Dirty Dozen” list of tax scams.

“The aggressive marketing of these loans is deeply troubling and of great concern,” said IRS Commissioner Danny Werfel. “There are very specific guidelines around these pandemic-era loans; they’re not just available to everyone.”

The IRS said these promotions may be based on inaccurate information about eligibility or how the credit is calculated. What’s more, some of these ads are designed to collect sensitive taxpayer information, which is then used for identity theft purposes, the IRS said.

Here are the important things owners should know about ERCs to avoid problems in the worst-case scenario, including an audit.

Start by understanding the basic ERC claim requirements

To figure out if your business is eligible for a loan, start by knowing the basics.

Eligible taxpayers may apply to the ERC for an original or amended employment tax return for qualified wages paid between March 13, 2020 and December 31, 2021, according to the IRS. Businesses may be eligible if they have sustained a full or partial suspension of operations due to a pandemic-related government-ordered shutdown for a relevant period of time. A business may qualify if it experiences a decrease in gross receipts in the first three quarters of 2021 or a significant decrease in gross receipts in 2020. Another way to qualify is for the company to qualify as a “recovery start-up business” — a business started during the pandemic — for the third or fourth quarter of 2021.

Gina Perrone, senior tax manager at accounting, tax and advisory firm Sax LLP, said businesses may still be eligible for the loan if the PPP loan is forgiven, which some owners may not realize. This was not allowed when the ERC was first established, but was later revised. However, there are limitations to double dipping that a tax professional can help prevent from occurring.

Before signing a contract with an ERC specialist, consult with a CPA

It’s very confusing for small businesses because of the various requirements, so it’s a good idea to consult with a CPA firm familiar with the ERC rules—even if a third party offers automatic business compliance. There are many definitions and details that need to be sorted out to ensure that a job is actually suitable.

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

Of course, don’t sign an agreement with a third party before consulting with a trusted and reputable financial professional.

Learn how to spot ERC red flags to avoid an audit

Jenn McCabe, a partner at accounting and consulting firm Armanino, said that while a provider may make it seem “very simple,” there are many complex factors that go into determining eligibility. Be wary of any firm that uses pressure tactics to encourage businesses to act quickly, he said. These firms sometimes charge heavy upfront fees or a fee that depends on the amount returned.

Another red flag, Perrone said, is when a third-party business owner doesn’t ask for documentation to ensure compliance. Businesses do not have to submit these documents to the IRS, but they should ensure they qualify for the credit to avoid costly headaches later. Perrone would owe the money back with penalties and interest if the business didn’t actually qualify, but received the loan and was later audited. That could happen in a few years, and in the meantime, the business has already paid the third party and is unlikely to get those funds back, Perrone said.

To help avoid an audit, “make sure you can justify your claim and your compliance requirements,” Perrone said.

Next steps with your tax return if your business qualifies

After the business determines that it qualifies, the next step is to file Form 941-X, which is an adjusted quarterly payroll tax return for each quarter in which the business is seeking the credit. For 2020, businesses must file by April 15, 2024; For 2021, they have until April 15, 2025, Perrone said.

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

Also, be aware that professional standards prohibit CPAs from charging retainer fees for preparing original or amended statements—a necessary step in obtaining a loan.

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