Tom Cullinan's article "Multiple ERC Clocks are Ticking – What To Do Before Time Runs Out," in Forbes
On January 16, House Ways and Means Committee Chair Jason Smith, R-Mo. and Senate Finance Committee Chair Ron Wyden, D-Ore, released the Tax Relief for American Families and Workers Act of 2024 framework. If enacted, the proposed legislation would terminate the Employee Retention Credit (“ERC”) effective January 31, 2024. At the same time, the IRS has created a Voluntary Disclosure Program that gives taxpayers who already received ERC refunds until March 22, 2024, to apply for a program that would give some audit certainty in exchange for returning a chunk of the refund. Additionally, an ongoing IRS withdrawal program (that could end at any time) allows taxpayers to withdraw ERC claims that the IRS has not yet paid. With multiple clocks ticking, taxpayers need to make some quick decisions.
The ERC was one of several programs that Congress enacted during the darkest days of COVID-19 to keep the American economy out of the ditch. The uptake was slow at first. In fact, Congress expanded the program in late 2020 and early 2021 to make more employers eligible and increase the possible credit. As currently enacted, it allows eligible employers to claim refundable credits of up to $26,000 per employee. The ERC was terminated for most employers as of September 30, 2021, but the law currently allows employers until April 15, 2024 to file refund claims for 2020 credits and until April 15, 2025 to file refund claims for 2021 credits. As noted above, however, legislation is in the works to change those dates to January 31, 2024.
The most important thing for taxpayers to understand in deciding whether to file refund claims, withdraw pending refund claims, or participate in the ERC Voluntary Disclosure Program is that their eligibility for the ERC has not changed since the relevant periods in 2020 or 2021. Although current IRS messaging about “fraud” is certainly disconcerting, whether an employer qualifies depends on nothing more than the application of ERC law (which has not changed since 2021) to the employer’s facts.
So, who qualifies? Employers can be eligible in one of three ways: as a “recovery startup business,” under the “gross receipts” test, or under “the full or partial suspension test.” The latter two are more common, so I’ll spell those out.
The IRS explains that the “gross receipts” test “is met by comparing the gross receipts of the calendar quarter in which ERC is considered to the gross receipts of the same calendar quarter in 2019. For 2020, you begin qualifying in the quarter when your gross receipts are less than 50% of the gross receipts for the same quarter in 2019. You no longer qualify in the quarter after the quarter in which your gross receipts are more than 80% of the same quarter in 2019. For 2021, the gross receipts for the quarter must be less than 80% of the gross receipts for the same quarter in 2019. For calendar quarters in 2021, you can also use the alternative quarter election rule, which gives employers the ability to look at the prior calendar quarter and compare to the same calendar quarter in 2019 to determine whether there was a decline in gross receipts.”
The “full or partial suspension test” is met if the “operation of the trade or business… is fully or partially suspended during the calendar quarter due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to the coronavirus disease 2019 (COVID–19).” See 26 U.S.C. section 3134(c)(2)(A)(ii).
In some cases, a taxpayer’s eligibility under these tests is an easy call. But many cases leave at least some uncertainty, requiring taxpayers to decide whether their fact pattern is strong enough to justify filing a refund claim. The IRS has issued a lot of guidance about the ERC that can help taxpayers make informed decisions.
Unfortunately, there is an issue with some of the guidance that makes things more complicated. Some of the guidance adds restrictions to the ERC that may not stand up in court (the IRS, as an administrative agency, does not have the authority to unilaterally restrict a statute). This puts taxpayers in a tough spot. Obviously, nobody wants to pick a fight with the IRS, but a lot of taxpayers who do not qualify under the IRS guidance may be entitled to the ERC.
For example, one way an employer can be eligible for the ERC is if (in addition to satisfying other requirements) the operation of the employer's trade or business was "fully or partially suspended during the calendar quarter due to orders from an appropriate governmental authority… due to the coronavirus disease 2019 (COVID-19)." “Partially" is ordinarily defined as "to some extent" or "to some degree." Thus, the statute makes any employer whose operations were suspended "to some extent" eligible, assuming it meets the other requirements.
The IRS, on the other hand, says in its FAQs that it “will consider you to be partially suspended if more than a nominal part of your business was suspended by a governmental order. The IRS considers ‘more than nominal’ to be at least 10% of your business based on either the gross receipts from that part of the business or the total hours your employees spent working in that part of the business. If all parts of your business could operate but you had to modify how it operated, then we will consider you to be partially suspended if you can show that the order had more than a nominal effect on your business. We consider ‘more than a nominal effect’ to be at least a 10% reduction in your ability to provide goods or services in the normal course of your business.”
The problem is that the statute does not say anything about “more than nominal” or a “10% reduction.” That is the IRS’ interpretation of “partially”, but that interpretation is open to question and is not entitled to any significant deference. I’d be hard-pressed to tell an employer whose ability to provide goods or services declined by 9% that it does not qualify, whereas the employer whose business declined by 10% gets the lifeline. That seems rather arbitrary.
As another example, consider the business that got crushed because, although it was technically allowed to remain open, government orders required its customers to stay home. One could reasonably argue that such a business was “partially suspended… due to orders from an appropriate governmental authority… due to the coronavirus disease 2019 (COVID-19)." Yet, the IRS says that an “employer that suspends some or all of its operations because its customers are subject to a government order requiring them to stay at home or otherwise causing a reduction in demand for its products or services is not considered to have a full or partial suspension of its operations due to a governmental order.” Will a court agree with the IRS? Maybe, maybe not.
On the other hand, there has been a lot of news recently–mostly in the form of IRS press releases–about fraudulent ERC claims. Just last week, the IRS used the word “fraud” seven times in a single ERC press release. Unfortunately, recent IRS press releases seem to present ERC claims as binary–either valid under IRS guidance or fraudulent. To the extent that the IRS finds fraudulent claims, it should deny them and it is to be commended for doing that work. Yet, there will be a lot of legitimate disputes about ERC eligibility rules that are not at all fraudulent, and the IRS could do better to make that clear going forward. Taxpayers with real eligibility issues should do their best to tune out all the noise about fraud and consider their eligibility based on the facts and law.
When considering whether to file or withdraw a refund claim, or participate in the Voluntary Disclosure Program, the safest path (and the least likely to lead to an IRS audit) is to consider whether you qualify for the ERC as interpreted by the IRS. If you do, you should ignore the messaging about “fraud” and file for your refund, or keep it if you already have it. Yes, you may get audited, but if you are certain that you pass the IRS’ eligibility criteria, that headache will typically be worth it.
The harder questions are what to do if it is unclear whether you qualify under the IRS’ restrictive tests or if you have an argument that you qualify under the statute but do not qualify under the IRS’ more stringent eligibility tests. Readers in these groups should have heart-to-heart discussions with their tax advisors. If you are being told you do not qualify, you might want to ask whether that is because the IRS–as opposed to Congress–said so, so that you can make an informed decision. One thing is certain: if you do not file a refund claim by the deadline, you will be out of luck, even if courts reject some of the IRS guidance. The filing deadlines are real.
Although I used to be part of IRS leadership, I now represent taxpayers in IRS matters, including ERC eligibility and audit issues, and I hope that you find the information in this article helpful. Please note, however, that the article is informational only. It does not create an attorney-client relationship, and you should not rely on it for legal advice.