The Employee Retention Credit: A Modern-Day Scarlet Letter?

Authors: Matt Kelley, Esq. and Tim Parrish, Esq.

We also fought to include provisions to shore up the financial health of small business and other struggling employers. We were adamant about the inclusion of the employee retention credit because we know that the American economy will bounce back from this, and employers who take action to keep their employees on the payroll should be rewarded.?

Rep. Richard Neal (D-MA) discussing the CARES Act on the House floor – March 27, 2020?

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The Employee Retention Credit (“ERC”) was passed in March 2020 in the wake of the COVID-19 pandemic and government orders restricting business operations across the country. Initially intended to provide fast and direct financial support to employers, it was lauded and celebrated as an important stimulus measure.? Since then, the ERC has gone from hero to zero in the eyes of the IRS – and small businesses are paying the price.??

Relentless and questionable advertising by non-tax professionals has damaged the ERC’s reputation, and the IRS was right to institute enhanced reviews to combat potentially fraudulent claims when the volume of claims increased after the pandemic.? However, the IRS’s shift from openly supporting and encouraging employer participation to unilaterally shutting down the ERC seems diametrically opposed to congressional intent.? Businesses that kept their employees on payroll and engaged tax professionals to evaluate and confirm eligibility should be rewarded with refunds – not with lengthy delays, an information vacuum, and accusations of fraud.?

The ERC, like other tax laws, is not perfect.? But the vilification of the ERC and its participants seems unjustified based on the facts we know.? In Nathaniel Hawthorne’s The Scarlet Letter, it becomes clear by the end of the novel that Hester’s treatment is unwarranted.? In the ERC story, Hester is represented by thousands of employers with legitimate ERC claims who have been treated as suspect simply for claiming the ERC. Since instituting the moratorium, IRS officials have singularly blamed fraud and bad actors for the growing cost of the ERC program.? However, that reasoning conveniently disregards other contributing factors such as the complexity of the underlying statute, confusion about eligibility following retroactive legislative changes, and complicated and iterative IRS guidance.? Further, when the ERC was extended into 2021 and the maximum benefit per employee was increased from $5,000 to $33,000 (a 560% increase), the official cost estimate was too low – the Joint Committee on Taxation and the Congressional Budget Office only estimated an additional budgetary impact of 56% ($55B to $86B)!? The unrealistically low budget estimate compared to the amount of ERC refunds paid out to date by the IRS has certainly contributed to the impression that bad actors are to blame.? What do you think - should the ERC have to endure the proverbial scarlet letter??

As questions continue to mount around the ERC, it’s important to set the record straight. Over the next few weeks, we will publish a series of articles that will address:?

• The impact of misleading ERC marketing and best practices for evaluating the validity of your claim;??
• Technical aspects of the ERC, including important income tax considerations;?
• How to prepare for an IRS audit and trends in ERC audit activity to date;?
• A solution for protecting taxpayer funds and businesses with legitimate ERC claims; and?
• The hidden costs of IRS processing delays.?

As of today, the IRS has not announced an ERC Moratorium end date and hundreds of thousands of businesses are waiting to understand when or if they will receive their refund and still others are unsure if they can file an ERC claim.? Throughout the series, we will reference important pieces of legislation and events that have transpired over the last four years. As painful as it may be to revisit a timeline of the COVID-19 pandemic, it is critical that we review the evolution of the ERC program starting from the very beginning if we are to understand how we ended up where we are today. The below timeline will come in handy as we unpack the ERC in this series.?

ERC – A Brief History?

March 27, 2020: Congress approved the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”).? Section 2301 of the CARES Act provides the statutory law for the ERC.? The original provisions of the ERC can be summarized as follows:?

• Eligible employers were allowed to claim a refundable payroll tax credit for wages paid beginning March 13, 2020 through December 31, 2020;?
• Eligible employers were those that met either of two tests: 1) a significant decline in gross receipts OR 2) operations were fully or partially suspended due to COVID-19 governmental orders;?
• The maximum benefit was $5,000 per employee (50% of up to $10,000 in qualified wages);?
• Employers that received forgiveness for a Paycheck Protection Program (“PPP”) loan were ineligible for the ERC;?
• The ERC was most beneficial to small employers (those with 100 or fewer full-time employees on average in 2019).? Large employers could still qualify but had to demonstrate that they paid wages to employees “not providing services” due to the suspension of operations or significant decline in gross receipts.? Small employers, on the other hand, could claim the credit on all wages paid to employees during the period the employer was eligible - even if employees continued working - up to the maximum amount and excluding wages taken into account for certain other credits.?

April 29, 2020: the IRS provided an initial set of non-binding Frequently Asked Questions (“FAQs”).? The FAQs specifically state that taxpayers cannot rely on them as legal authority.? Legislators immediately reacted to specific FAQs which the IRS then updated to conform to the legislation.?

December 21, 2020: Congress extended and expanded the ERC under the Consolidated Appropriations Act of 2020 (“The Relief Act”).? The Relief Act contained several important provisions:?

• Extended the ERC through June 30, 2021;?
• Increased the maximum benefit for employers eligible in 2021 to $7,000 per employee per quarter (70% of $10,000 in qualified wages).? For employers eligible in 2020 and the first two quarters of 2021, the maximum benefit was now $19,000 – a 280% increase from the original maximum;?
• The small employer threshold for the 2021 ERC was increased from 100 or fewer full-time employees to 500 or fewer full-time employees;?
• The PPP exclusion rule was retroactively repealed, allowing employers that received a forgiven PPP loan to claim the credit (excluding any wages paid for with forgiven PPP proceeds);?

Senators Chuck Grassley (R-IA) and Ron Wyden (D-OR) discussing the Relief Act's ERC changes on the Senate floor:

Mr. GRASSLEY. Mr. President, I ask unanimous consent to engage in a colloquy with my colleague, Finance Committee Ranking Member Wyden, to discuss a tax provision included in the omnibus appropriations bill currently before the Senate. The tax title in this bill contains important clarifications to, and expansions of, the Employee Retention Tax Credit established under section 2301 of the CARES Act. This credit has provided vital payroll support to struggling businesses in Iowa and across the country. The enhancements included in this bill are necessary to help more employers access the credit. Importantly, the bill clarifies that businesses that received Paycheck Protection Program loans, or PPP, are still eligible for the credit based on other wages and benefits paid. Does Member Wyden agree that our intent is to allow struggling small businesses to access the retention credit, even if they have received a PPP loan??

Mr. WYDEN. That is correct. COVID-19 has shuttered small businesses across the Country... Ensuring businesses can access relief from both the Paycheck Protection Program and the Employee Retention Tax Credit is critical. The legislation before us today would allow businesses who took out a PPP loan to access the retention credit... As this change will be retroactive, does the Chairman agree that it is equally as critical that these small businesses are able to quickly and easily claim these past credits they will now be eligible for??

Mr. GRASSLEY. Yes. That is why we are allowing these businesses, both those with forgiven loans and those without, to claim credits for wages paid in previous quarters that this bill makes eligible for the credit on their fourth quarter 2020 payroll tax filings. This will prevent small businesses from having to amend their previously filed payroll tax returns, easing the paperwork burden for both taxpayers and the Internal Revenue Service. I know Ranking Member Wyden will join me in urging the IRS to do all they can to simplify and expedite the process for eligible businesses retroactively claiming the retention credit. The last thing these businesses need right now is additional, complex payroll tax filings.?

January 26, 2021: the IRS publishes the following invitation on its website: “The Internal Revenue Service urges employers to take advantage of the newly-extended employee retention credit, designed to make it easier for businesses, who despite the challenges posed by COVID-19, choose to keep their employees on payroll.”?

March 1, 2021: the IRS provides its first set of formal guidance on the 2020 ERC in Notice 2021-20.? The IRS’s formal guidance generally aligns with its informal FAQs, but there are several substantive modifications.?

March 11, 2021: Congress extends and expands the ERC under the American Rescue Plan Act (“ARPA”).? ARPA contained two key ERC-related provisions:?

• Extended the ERC through December 31, 2021. For employers eligible in 2020 and each quarter in 2021, the maximum benefit was now $33,000 - a 560% increase from the original maximum;?
• Expanded eligibility to include “Recovery Startup Businesses,” businesses that did not meet the existing eligibility requirements but started operations after February 15, 2020 and had less than $1 million in average gross receipts.?

April 2, 2021: the IRS provides formal guidance on the 2021 ERC in Notice 2021-23.?

August 4, 2021: the IRS provides additional formal guidance on the ERC in Notice 2021-49, stating that wages paid to majority business owners are ineligible for the ERC.?

August 10, 2021: the IRS provides additional formal guidance on the gross receipts test in Revenue Procedure 2021-33, stating that certain government grants, including forgiven PPP loans, shuttered venue operator grants, and restaurant revitalization fund grants, do not need to be included in gross receipts for purposes of determining eligibility for the ERC.?

November 15, 2021: Congress retroactively terminates the ERC for the fourth quarter of 2021 under the Infrastructure Investment and Jobs Act reverses.??

February 15, 2022: in a Forbes article, former Senior Tax Attorney for the U.S. Senate Finance Committee Dean Zerbe reported that, “IRS management anticipated that approximately 70-80% of small and medium businesses (as well as tens of thousands of charities) were good candidates for the ERC.”???

August 31, 2022: a report published by the U.S. Treasury Inspector General for Tax Administration (“TIGTA”) titled Delays Continue to Result in Businesses Not Receiving Pandemic Relief Funds, indicated that the IRS did not process any claims for at least the first 12 months of the ERC program.??The report also indicated that, as of March 10, 2022, the IRS’s identify theft fraud filter had identified and prevented $2 trillion in erroneous ERC claims from being paid out.?

October 19, 2022: the IRS issues its first warning about promoters pushing aggressive ERC positions.?

May 20, 2023: in a Wall Street Journal article, the IRS deputy commissioner for services and enforcement Douglas O’Donnell states that most employee-retention credit claims are legitimate.

June 30, 2023: the IRS issues GLAM 2023-005, explaining that eligibility for the ERC does not arise from general supply chain disruptions.

September 14, 2023: the IRS announced a “Moratorium” on processing claims filed on or after this date.? Per a Washington Post article on the same date, the IRS had received 3.6 million ERC claims and paid more than $230B in claims.?

October 18, 2023: the IRS issues GLAM 2023-007 stating that communications from the Occupational Safety and Health Administration (“OSHA”) do not constitute orders from an appropriate governmental authority.

December 6, 2023: the IRS announces it is denying 20,000 ERC claims related to taxpayers that did not exist or did not have employees during the period the ERC was claimed.?

December 23, 2023: the IRS announces a Voluntary Disclosure Program (“VDP”) for employers that believe their ERC claim was incorrect.?

January 17, 2024: the U.S. House of Representatives passes the Tax Relief for American Families and Workers Act of 2024 (“HR 7024”), which would end the ERC prematurely as of January 31, 2024.?

March 22, 2024: an IRS memo announced the agency had found a combined total of $1 billion of fraudulent and erroneous claims in the last 6 months.????

Thanks for reading! Up next: the impact of misleading ERC marketing and best practices for evaluating the validity of your claim. If you have questions about your ERC claim or need a second review reach out to us at [email protected].