ERC is Employee Retention Credit. This refundable payroll tax credit in the CARES Act to keep employees on payrolls during the pandemic became highly complex, so small businesses turned to consultants, some less than scrupulous, to determine eligibility. Subsequently, the IRS is warning employers about third parties — “’bad actors’ – who will ask for a large up-front fee based on the amount of a refund without explaining that wage deductions claimed on the business’ federal income tax return must be reduced by the amount of the credit.”
It’s reflective of turmoil facing the PPP, or Paycheck Protection Program. No longer available, this was a generous lending of funds up to $12 million to businesses based on need during the lockdown and entirely forgivable if the funds were spent according to statute. The process was administered by banking institutions, including FinTech companies using hi-tech technology to make the lending process less onerous for individuals and small businesses. Think of AVANT or Lending Club as examples. Relying on algorithms and access to database information about a borrower, FinTech can process loans without the languid structure traditionally associated with banks or the cross product selling requirements.
Given PPP worked on a first come, first-serve basis, these lenders rose to the occasion to get the money out to those in need, and fast. Underwriting requirements for eligibility were overseen by the Small Business Administration which partially backed the loans and provided the forgiveness money to the lending institution upon a business owner’s demonstration that the funds had been used properly. FinTech made a lot of PPP loans happen while larger banking institutions lagged, struggling to digitize the process according to SBA requirements.
And here you have the makings of a perfect storm. Government monies being handed out, fast. It was a recipe for fraud, and the PPP proved no exception.
Many borrowers simply lied on their applications. Others committed “loan stacking,” borrowing from the PPP monies by submitting more than one application to different lenders, securing more than one PPP handout on the same set of facts and circumstances. Then some legitimate borrowers used the funds for improper or unapproved purposes, and perhaps still getting forgiveness by further falsehoods on how the money was spent. Lovely.
Consequently, the Department of Justice has initiated hundreds of criminal cases against alleged fraudsters, totaling as much as $80 billion—or 10% of the PPP funds. Judging the success of the program may ultimately depend on the DOJ’s ability to convict fraudsters and recover funds.
Now enters the next three letters of the Covid business relief alphabet soup: ERC. It too comes with a lot of misunderstanding, due in part to Congress changing the goal line — three times since the original inception.
For example, the rules differ for years 2020 and 2021. In 2020, a business or tax-exempt organization needed to at least partially shut down due to Covid, with a significant decline in sales—less than 50% of comparable gross receipts compared to 2019.
For 2021 these rules changed. And demonstrating the widespread confusion about the law’s details, a major business magazine, for example, reported: “If you’re trying to qualify for 2021, you must show that you experienced a decline in gross receipts by 80% compared to the same period in 2019. If you weren’t in business in 2019, you can compare your gross receipts to 2020.”
Nicely done, except it’s a misread of the convoluted IRS instructions: “For calendar quarters in 2021, amended decline in gross receipts to be defined as a quarter where gross receipts are less than 80% of the same quarter in 2019”. Unravel that to mean that the decline in gross recipes is 20%, not 80%.
Now the big change for 2021, the maximum credit increased generously — from $5,000 per employee, per year in 2020 to $7,000 per employee, per quarter for 2021. The last eligible quarter ended September 2021, but requests for refunds for either 2020 or 2021 are still statutorily allowed.
Sparing us the math of the credit’s generosity based on those per employee amounts, and depending on the number of employees, the ERC can result in a payroll tax refund to the employer amounting into the millions of dollars.
While FinTech is not involved in this program, the complexities of the refund request process and the details for eligibility and computation of the credit opened the doors for specialists to step in to assist the small business owner. As this developed, the rule of thumb for such consultants quickly became to charge a contingent fee at a rather generous percentage, often as high as one-third of the requested tax refund.
Many of these specialists are scrupulous law firms and accounting firms, but many firms, particularly ones outside of these professions are not. With the myriad of details to the program, the small business owner is at the mercy of the specialist, often signing up for whoever claims they can get the largest refund.
The word on the street is that cold calls and emails from those less than scrupulous outfits, offering substantial credits to employers despite them not really qualifying, are increasing and fraud is rampant. Employers are advised to be vigilant in vetting these companies and to ensure that the ERC claim can be substantiated under increasing IRS scrutiny.
With the Inflation Reduction Act’s inclusion of $80 billion in additional funding to increase IRS enforcement, one of the targets will be ERC claims. The IRS soon will audit such claims – extending three years from the filing date. And it’s possible that certain irreputable companies, started for the sole purpose of calculating the ERC, may not be around for the duration of this potential audit period to help defend their work.
Like the PPP, the jury on the success of the ERC will have to wait for the outcome of those future IRS audits.
Samuel Handwerger, CPA, is a full-time lecturer in the Accounting and Information Assurance Department at the University of Maryland’s Robert H. Smith School of Business.