Risks associated with the ERC

By now virtually everyone has heard about the Employee Retention Tax Credit. Throughout the day I see advertisements on TV, hear them on the radio, receive emails and text messages. We are probably all tired of hearing them by now. Many of these ads use the strategy of exigency to create action: "Time is running out!", "Claim your COVID credit now!", "It's not too late but hurry before benefits expire!" These are just a few of the claims made by companies that have essentially sprung up overnight.

Make no mistake, the benefits are real for those businesses that actually qualify. The problem is that many of these companies that are promoting benefits may be taking positions that are frivolous. Currently there are no requirements for a business preparing Employee Retention Credits to maintain any kind of credentials or to certify their results. This lack of oversight makes the landscape ripe for fraud.

We have seen many questionable claims by ERC mills, one for example saying, "All businesses impacted by supply chain disruption are eligible for the employee retention credit." While there are legitimate examples of businesses qualifying for the ERC due to a supplier being subject to a COVID-related government shutdown, many of the supply chain disruptions in 2020 and 2021 were not related to domestic government shutdowns and therefore would not likely qualify under this circumstance. 

The IRS has issued multiple warnings to taxpayers and preparers. In November the agency issued COVID Tax Tip 2022-170, "Employers: Beware of third parties promoting improper employee retention credit claim." On March 7, the IRS issued IR 2023-40, a renewed warning urging people to carefully review the ERC guidelines before trying to claim the credit as promoters continue pushing ineligible businesses to file.

The Office of Professional Responsibility has now weighed in providing a bulletin, Issue Number 2023-02, to further address tax preparers responsibilities under Circular 230. The bulletin provides this guidance: "Section 10.22(a) of Circular 230 requires a practitioner to exercise due diligence in preparing and filing tax returns or other documents on a client's behalf with the IRS and in ensuring the correctness of the practitioner's written or oral representations to clients and the IRS."

Taxpayers and their CPAs need to be vigilant when considering who to use to help identify and calculate Employee Retention Tax Credit Claims. Under the AICPA Code of Conduct, Section 1.300.040, "Use of a Third-Party Service Provider," is relevant in this case:

.01. A member who uses a third-party service provider to assist the member in providing professional services such as bookkeeping, tax preparation, or consulting or attest services, including related clerical or data entry functions, is required to comply with the "General Standards Rule" [1.300.001] and the "Compliance With Standards Rule [1.310.001].

To accomplish this,

a. Before using a third-party service provider, the member should ensure that the third-party service provider has the required professional qualifications, technical skills, and other resources. ...

b. The member must adequately plan and supervise the third-party service provider's professional services so that the member ensures that the services are performed with competence and due professional care. The member must also obtain sufficient relevant data to support the work product and comply with all technical standards applicable to the professional services.

What are some of the considerations when evaluating a third party? How long has the third party been in business? What are the qualifications of the principals? Are they making claims that sound too good to be true? Additional considerations include: What protections does my client have if audited? Will the company still be in business if there is a need to submit a claim for refund of the fees? 

Likewise, CPAs should be very concerned about putting their signature on a tax return where adjustments have been reflected as a result of the Employee Retention Credit. What risk do you have if the third party has taken a position that is frivolous? Multiple IRS publications have essentially put the signers of tax returns on notice that they should be performing their due diligence to ensure that erroneous returns are not being signed.

In the bulletin issued by the Office of Professional Responsibility on March 7, it declared the following: "When a practitioner assists or advises a client in reporting income or other items on a tax return, in filing amended returns or claims for refund, or with positions taken on a return or claim for refund, the standards in Section 10.34 apply to the practitioner's activities. For example, Section 10.34(b) prohibits advising a client to take a position that lacks a reasonable basis or is an unreasonable position under Section 6694(a)(2) of the Internal Revenue Code. Additionally, Section 10.34(c) requires a practitioner to advise a client of any potential penalties likely to apply to a position taken on a tax return the practitioner prepares for the client or when the practitioner has advised the client about the position taken. Under Section 10.34(c), a practitioner must also inform the client of any opportunity to avoid penalties through adequate disclosure by, for example, filing Form 8275, "Disclosure Statement"

What about the CPA or tax preparer who inadvertently recommended a firm that is taking overly aggressive positions? If a CPA has recommended a firm to conduct an ERC study and the CPA later obtains information that the firm they recommended to the client is under criminal investigation, I would argue that the CPA — because of their fiduciary duty — is obligated to tell the client of the investigation. The IRS always has the benefit of hindsight. 

Consider the following example: A taxpayer uses a third-party credit company that takes a frivolous position relative to the ERC. The CPA reports the addback of wages in the year of the credit, 2021. The IRS subsequently audits the payroll tax return, which has a longer statute of limitations than the income tax return, and then disallows the credit. The taxpayer may have a circumstance where the statute of limitations on the original reported deduction of wages is closed, but the retention credit claim is required to be paid back to the government. When the IRS evaluates whether the CPA complied with Circular 230, it could look very bad for the tax preparer if an indictment has subsequently been issued for the third party used to prepare the ERC study. The IRS has been paying very close attention to these parties taking overly aggressive or frivolous positions relative to the ERC and will be pursuing them.

Lastly, the OPR bulletin concludes: "The practitioner needs to have or gain an in-depth knowledge of the credit, especially its eligibility criteria. The practitioner must also follow Circular 230's requirements of: due diligence in the practitioner's advice and in preparing and filing returns (including the specific standards in Section 10.34); full disclosure to a client of their tax situation; and reasonable reliance on client-provided information and on any advice provided by another tax professional."

My recommendation is if you are involved in any way with a client that has received the Employee Retention Credit, you have a responsibility to follow professional standards as well as Circular 230. If you are not completely aware and comfortable with the positions taken relative to the credit, you really should consider whether you can sign your name to the tax returns.

Finally, if you have been involved with a taxpayer that used a questionable position, there are remedies to help you and your client get compliant and avoid a criminal investigation by the IRS. For example, if a CPA cannot get comfortable with the position a client is taking, they can have a trusted third-party provider conduct an ERC study to determine if there are any legitimate credit claims. Previously claimed credits can be adjusted or paid back via Form 941-X in the same way they were originally claimed. 

Ultimately, in these cases, we recommend seeking the guidance of an attorney who is familiar with IRS practices and criminal investigation matters.