When the IRS announced its moratorium on processing new Employee Retention Credit (ERC) claims on September 14, Commissioner Danny Werfel was quoted as saying, “As we move nearly two years beyond the 2021 eligibility date for the program and beyond the end of the pandemic, the reality that we’re seeing and hearing from tax professionals and others is that many of the affected businesses have already come in”; and, “We should see only a trickle of employee retention claims coming in. Instead we are seeing a tsunami.”
These comments echo earlier statements, such as on July 26, 2023: “‘The further we get from the pandemic, we believe the percentage of legitimate claims coming in is declining,’ Werfel told attendees at the IRS Nationwide Tax Forum in Atlanta … ‘This was not how the law was meant to work, and Congress can help with this situation,’ Werfel added. ‘We will work with Treasury to explore legislative solutions we can share with Congress to help address fraud and error, including potentially putting an earlier ending date for businesses to claim the credit and increase IRS oversight of return preparers.’”
Commissioner Werfel seems to suggest that unless ERC claims were made contemporaneously, they are inherently suspect. However, there are legitimate reasons why taxpayers might only now be considering an ERC claim.
Delayed Interest in the ERC
First, at the end of 2020, Congress retroactively changed a fundamental rule of the ERC that had initially prevented most small businesses from eligibility. As explained by the Congressional Research Service, “When the ERTC was enacted in the CARES Act, employers receiving Paycheck Protection Program (PPP) loans could not also claim the ERTC. The COVID-related Tax Relief Act of 2020 provided that employers receiving PPP loans could claim the ERTC with respect to wages not used to support PPP loan forgiveness.” For a variety of practical reasons, most small employers used the PPP program, thus making the use of the ERC impossible. The retroactive reversal of this rule meant that eligible small businesses would have no choice but to amend past returns to participate in the ERC for 2020.
In addition to the confusion caused by numerous legislative changes to the program, the ERC is inherently complex. As Werfel said in the September 14th news release, “Businesses should seek out a trusted tax professional who actually understands the complex ERC rules.” The press release goes on to state, “The ERC is an incredibly complex credit, and there are very specific eligibility requirements for claiming the ERC.” A companion press release, also published on September 14th, the IRS noted, “the Employee Retention Credit is a complex credit that requires careful review before applying.” The eligibility checklist published by the IRS is subtitled, “Help understanding this complex credit.” All that complexity takes time to understand, and small business owners focused on running their own businesses cannot always be expected to have real-time awareness of new provisions to the tax code.
This sentiment was articulated by Ways and Means Chairman Jason Smith in his opening statement for the July 27, 2023, subcommittee hearing on the ERC: “Businesses have found the IRS’ guidance confusing, particularly the rules about whether they are eligible or not. Some have raised concerns about how guidance has been insufficient and changed, forcing small businesses to spend more time with IRS rules that could be spent serving customers.”
The Taxpayer Advocate Service highlighted this complexity and the confusion with IRS guidance in its Objectives Report to Congress Fiscal Year 2021:
“The Employee Retention Credit (ERC) is a complex refundable tax credit that employers can claim. Several of these complexities come from the determination of when a trade or business was fully or partially suspended by government order; an employer’s number of full-time employees; what are qualified wages; if a business’s post-COVID-19 operations are comparable to its pre-COVID-19 operations; and the application of aggregation rules. To address these complexities, the IRS has provided considerable guidance on when and how to claim the ERC; however, several areas demand further clarification. If clarity is not provided, taxpayers will be more likely to make errors when claiming the credit, possibly resulting in an audit.”
The report continues:
“To answer these questions, the IRS has provided nearly 100 FAQs on the ERC. Although these FAQs are helpful to taxpayers and provide answers to many of the simpler questions surrounding the credits, areas of ambiguity remain. For example, the IRS provides that if a business is closed, but the employer is able to continue operations “comparable” to its operations prior to the closure by requiring its employees to telework, there has been no partial suspension…. The question here is what will be considered “comparable?” For example, what if the facts in the FAQ above are largely the same, but only 80 percent of the company’s employees are set up to work from home? Would that still be considered “comparable,” or will the taxpayer then have to analyze what operations are performed by employees who are not set up to work from home?”
The AICPA wrote numerous memos and letters to Treasury asking for clarifications about the complexities of ERC and the IRS guidance.
The lack of tax and legal expertise among small business owners was uniquely compounded by the reality that employers were navigating their businesses through a devastating global pandemic. The very factors the ERC was designed to provide relief for are the same factors that required employers’ focus at the potential expense of awareness of the tax credit. It is not difficult to understand how compliance with evolving government orders affecting business operations and the safety of employees and customers led to some taxpayers’ delay in awareness of or focus on the ERC.
