Employer tax credit crackdown could hit industry — if it passes

A bipartisan bill awaiting action in the Senate after easily passing the House would crack down on a troubled pandemic-era tax credit in a way that may affect financial advisors.

The Tax Relief for American Families and Workers Act proposes to extend $78 billion in tax breaks and credits through expansions of the child tax credit; deductions for business depreciation, interest and research and development costs; and pulling back slightly on a requirement for taxpayers to report more of their incoming third-party payments to the IRS. The legislation seeks to pay for those benefits by ending the employee retention credit permanently and boosting penalties against so-called promoters involved with submitting faulty claims.

As a credit designed to reward employers who kept workers on the payroll at the height of the pandemic, the tax break's cost has ballooned to as much as $550 billion from an initial estimate of a tenth of that expense only four years ago, according to the nonpartisan Tax Foundation. The IRS has rejected tens of thousands of claims, opened hundreds of criminal fraud investigations, imposed a moratorium on payouts and started a voluntary disclosure program inviting business owners who may have filed for the tax credit in error to avoid penalties by paying back 80% of it. The bill would cut off any new claims after Jan. 31.

It could also impose a "heavy burden that's being placed on the advisors" who may have recommended the credit, according to Niles Elber, a member in the Washington, D.C. office of law firm Caplin & Drysdale who represents businesses and other taxpayers before the IRS. The bill may define them as a "promoter" subject to penalties up to the greater of $200,000 or 75% of the income they received from the taxpayer for a faulty claim and a fine of $1,000 for each failure to comply with due diligence requirements, a House summary of the legislation showed.

"It's a significant bump up, and so you're getting a combination of, 'OK, we're not going to be paying any more claims,' and 'We're bumping up these two penalties,'" Elber said in an interview.

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That provision of the bill could raise up to $78.6 billion in revenue through the enforcement crackdown and unsought claims for the credit, according to the Joint Committee on Taxation. Considering how long promoter cases can take and the typical difficulty of clawing back money from bad actors who may have disappeared or spent the money, Elber cast doubt on how much enforcement cases could contribute to a predicted $40 billion in revenue this year and next from a Congressional Budget Office estimate of the bill.

Regardless, the idea has earned praise from policy experts who have long criticized Congress for passing legislation without any actual offsets against the budget impact of their cost. The retention credit "has been plagued with fraud from unscrupulous promoters encouraging businesses to improperly claim the credit," Garrett Watson and Erica York of the Tax Foundation wrote in a blog this month.

"Some critics argue that Congress should not rely on scored revenue from a failed program," Watson and York wrote. "While it would have been better if Congress avoided this mess to begin with, that does not change the fact that greater enforcement will bring in real money today that otherwise would not be collected. If offsets do not count because they should have been enacted earlier, we'd have very few offsets to consider more generally. The fact that policymakers chose on a bipartisan basis an offset that does not contain a budget or timing gimmick is progress. As our deficit situation worsens, we should be encouraging more offsets like this from Congress."

The bill's path forward in an election year remains unclear, even though the legislation got through the House on Jan. 31 with a rare overwhelming bipartisan vote of 357 members approving and only 70 against it. Despite coming from the Republican-controlled House Ways and Means Committee and providing a variety of tax benefits to families and businesses this year and through 2025, influential GOP Senate Finance Committee member Chuck Grassley told reporters that the bill could alter the party's strategy for expiring provisions of the Tax Cuts and Jobs Act and this fall in elections against President Joe Biden and other Democrats.

"Passing a tax bill that makes the president look good — mailing out checks before the election — means he could be re-elected, and then we won't extend the 2017 tax cuts," Grassley said just before the House passed the bill last month, according to NBC News.

That uncertain fate added some new questions to this year's filing season, Kristine Tidgren, the director of the Center for Agricultural Law & Taxation at Iowa State University, wrote in a blog summarizing the bill's provisions.

"It appears that the proposed tax package has widespread support, although no one in Washington appears to be satisfied with all of the provisions," Tidgren said. "It is not certain at this time whether the bill will pass or if it will pass without significant amendment. If the bill does pass, the timeframe for its passage is unclear."  

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IRS officials have instructed taxpayers to file their returns this year without waiting on Congress to act, and business owners and their advisors should try to be patient and likely plan to never receive payment of the employer credit if they haven't already gotten it from the IRS, according to Elber. The fraudster promoters who collected money then vanished from their business owner clients or the government may have ruined a valuable credit for companies that kept people employed when their operations were affected by shutdowns during the pandemic, he said.

"The problem is that there are employers who are legally entitled to payments," Elber said. "They're the ones who are left at this point, at least from an enforcement standpoint, holding the bag, because the service is going to look at each and every one of them, and they're going to do it with an intense lens."