The Employee Retention Credit

Background

The ERC was initially enacted in March 2020 as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act to provide eligible employers with a refundable tax credit against applicable employment taxes during qualifying periods between March 13, 2020, and December 31, 2021 (its availability in the fourth quarter of 2021 is limited to “recovery startup” businesses). It has subsequently been amended in three separate pieces of legislation (The Taxpayer Certainty and Disaster Relief Act of 2020, the American Rescue Plan Act of 2021, and the Infrastructure Investment and Jobs Act of 2021). The result is a complex law with shifting eligibility criteria.

Although the ERC eligibility period ended no later than December 31, 2021, amended employment tax returns may generally be filed within three years of the date the initial return was filed. Forms for a calendar year are considered filed on April 15 of the succeeding calendar year if filed before that date. This means that amended returns for calendar year 2020 may generally be filed through April 15, 2024, and for calendar year 2021 filed through April 15, 2025.

Many employers who timely filed their 2020 and 2021 employment tax returns did not claim the ERC on the initial returns. Reasons could include lack of familiarity with the credit, uncertainty about eligibility, and workforce demands during the initial period of the pandemic. Regardless, the IRS has recently seen an influx of amended returns claiming the ERC, with approximately 15% of all claims being filed between mid-June and mid-September 2023.

Some employers have sought advice from attorneys and CPAs when determining their eligibility for the ERC. Others have relied on marketers advertising large refunds, often on contingency, with insufficient attention to the required eligibility determinations. This has led to IRS concerns about potential abuse of the credit, ranging from fraudulently claiming the credit for nonexistent businesses to unsupported or aggressive claims on the part of legitimate businesses.

Recent IRS Initiatives: Processing Moratorium and Withdrawal Options

On September 14, 2023, the IRS announced a moratorium on processing new ERC claims through at least the end of 2023. Claims received prior to the moratorium will continue to be processed, but with stricter compliance reviews and a corresponding extension of the standard processing goal from 90 days to 180 days, and even longer if a claim faces further review or audit. Stated IRS goals include both protecting against fraud and protecting businesses from penalties resulting from bad claims.

On October 19, 2023, the IRS announced the details of a withdrawal process for certain employers that filed an ERC claim but have not yet received a refund to withdraw their submission and thereby avoid future repayment, interest, and penalties. Employers are eligible to use the process if: 1) they claimed the ERC on an adjusted employment return; 2) they filed the adjusted return only to claim the ERC, and made no other adjustments; 3) they want to withdraw the entire amount of their ERC claim; and 4) either the IRS has not paid their claim, or the claim has been paid but they have not cashed or deposited the refund check.

The specifics of the process depend on factors such as whether the employer used a professional payroll company and whether the employer has been notified that it is under audit. Also, employers that are not eligible to use the process may be able to file an amended employment tax return using the existing amendment procedures..

Considerations for Employers

Employers with pending ERC claims must decide whether to proceed or withdraw, and whether they have any legal recourse in the face of extended processing times. Employers who have yet to submit a claim must decide whether to do so in an environment in which the IRS has explicitly warned taxpayers to use extreme caution before applying for the ERC due to aggressive maneuvers by marketers and scammers. With that caveat duly acknowledged, employers should not forego applying without first objectively assessing the merits of their claim.

Although the decisions are procedural, legal and factual considerations will play a significant role for most employers. These include the following:

• Which specific ERC rules am I using to determine eligibility?
• Does the applicable rule vary from quarter to quarter?
• Is there IRS guidance on the application of the rule to facts like mine?
• If not, what legal rationale supports my position?
• What factual support can I provide for my position?

IRS guidance may provide some assistance with these questions. In addition to a series of FAQs on its website (http://tinyurl.com/3729nr5x), the IRS has issued three notices addressing various aspects of the ERC such as the definition of qualified wages, what constitutes a full or partial suspension of operations, and the interaction of the ERC with the Paycheck Protection Program (IRS Notices 2021-20, 2021-23, and 2021-49). The IRS has also issued Revenue Procedure 2021-33 providing a safe harbor for certain exclusions from gross receipts for purposes of determining ERC eligibility; a Generic Legal Advice Memorandum (GLAM) addressing full or partial suspension of operations in the context of a supply chain disruption (http://tinyurl.com/3u58u2pk); and a GLAM that clarifies the status of Occupational Safety and Health Administration (OSHA) communications as government orders for purposes of the ERC (http://tinyurl.com/3ae34vn8).

IRS guidance, however, can prove insufficient given the interplay of the complexity of the ERC and the diversity of employer fact patterns. Statutory requirements such as employer aggregation receive only cursory attention in the guidance, leaving unanswered many questions essential to eligibility determination. Furthermore, although the IRS will generally be bound by its guidance and taxpayers may generally rely on it, it may be possible to prevail with a position regarding ERC eligibility that is not supported or addressed in the guidance. (See Revenue Ruling 87-138, 90-9;. FAQs and GLAMs may not be used or cited as precedent.) For these reasons, accounting and legal advice can assist employers in deciding how to proceed with their ERC claims in the wake of the processing moratorium and the new withdrawal options.

Recent Developments

Two additional developments have taken place since this article was initially written in November 2023:

• On December 1, 2023, a southern California medical corporation whose amended returns claiming the ERC were denied by the IRS in late October filed a complaint in federal district court in California requesting that the court enjoin the IRS from enforcing IRS Notice 2021-20, which was the primary basis on which the IRS denied the corporation’s ERC claim. The legal argument set forth in the complaint is that the IRS legislated improperly through guidance documents in violation of the notice-and-comment process required under the Administrative Procedure Act.The complaint represents only the first stage of the legal process it initiates. Although its ultimate resolution has yet to be determined, it is notable in at least two respects. First, the IRS’s disallowance of the claim does not assert any negligence or willfulness on the part of the corporation, nor is there any indication of reliance on a third-party ERC service provider. Rather, the complaint results from a denial of a claim that appears to fall outside the IRS’s publicized focus on abusive positions and practitioners.

  Second, as the request to enjoin the IRS implies, the complaint does not seek a refund on behalf of the corporation. Instead, by challenging the legal validity and force of Notice 2021-20 itself, the complaint has the potential to invalidate IRS ERC enforcement on the basis of that guidance for all affected taxpayers. Therefore, the IRS is likely to respond vigorously, and the progress and outcome of the complaint should be closely watched by all stakeholders.

• On December 6, 2023, the IRS announced that it is sending an initial round of more than 20,000 letters notifying taxpayers of disallowed ERC claims. The stated focus of these disallowance letters is employers that did not exist or did not have paid employees during the period of eligibility. Although not explicitly stated in the IRS announcement, it is likely that these letters result from computer matching of ERC claims against data points already in IRS systems, such as Form W-3, prior Form 941, and other corporate filings. Other letters are planned in addition to these disallowance letters.The letters will be issued using Letter 105C, “Claim Disallowed.” Taxpayers who receive a disallowance letter can respond with documentation supporting their eligibility or claim amount; they also have the right to request administrative appeals and file suit in federal court. They can be represented by attorneys, CPAs, or other persons authorized to practice before the IRS. Therefore, taxpayers who receive a disallowance letter that they believe to have been issued in error may benefit from professional advice in assessing both the substantive merits of their claim and their procedural options.

Ronald G. Cluett, JD, is of counsel, the Caplin & Drysdale law firm, employee benefits/exempt organizations, Washington, D.C., and New York, N.Y.

Christopher S. Rizek, JD, is a member of the Caplin & Drysdale law firm, tax disputes/tax litigation.

Richard W. Skillman, JD, is a member of the Caplin & Drysdale law firm, business, investment & transactional tax/employee benefits/international tax (http://www.capdale.com).

Adapted with permission of the New York Law Journal, copyright 2023 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited; contact 877.257.3382 or reprints@alm.com.