Opting for IRS self-reporting: a smoother path for ill-gotten pandemic funds

The Internal Revenue Service (IRS) offers a "conditional partial amnesty" to ineligible firms who received the popular Employee Retention Tax Credit if and only if they snitch on themselves, as well as others involved in obtaining the funds. Firms must also return 80% of the refunds received.

The IRS informed the public that any employer taxpayer who received the popular pandemic-relief tax credit can return 80% of the money and escape most scrutiny from the agency. And the same fate will result to those taxpayers who have not yet received or cashed the IRS's check if they withdraw their application.

Questions presented: What are the important components of the Employee Retention Tax Credit (ERTC), including eligibility requirements, the time period and amount the credit covers, the reasons the IRS has shut down the credit application process, and how is it now offering a way out for taxpayers who applied for and/or received the credit and refunds, even though they were not eligible?

Summary answers: The ERTC is available to employers who experienced a full or partial suspension of operations either due to a government order, or who experienced a significant decline in gross receipts directly related to the Covid-19 pandemic. The credit is equal to a percentage of qualified wages paid to employees during the eligibility period, with a cap on the amount of wages that can be considered.

However, since the IRS has spotted what it considers to be rampant fraud in taxpayers' applications, it has halted the review of new applications and implemented a couple of processes that may provide a way out for affected taxpayers via either (1) the IRS' Voluntary Disclosure Program, what I refer to as a "conditional partial amnesty program" for those taxpayers who received the refunds, but now realize that their purported eligibility was not kosher and now qualify for the "amnesty" or (2) the IRS's Withdrawal Program, which provides the taxpayer with an opportunity to withdraw their pending application for those taxpayers who applied for the credit, were approved, and either (a) have not as yet received the funds or (b) if they have received the funds have not as yet negotiated the check from the IRS.

Analysis: The Voluntary Disclosure Program and the Withdrawal Program both allow employer taxpayers to avoid penalties and interest related to the ERTC. However, the two programs differ in terms of eligibility and requirements.

The Voluntary Disclosure Program is available to employer taxpayers that have already received a credit or refund of taxes attributable to the ERTC. To be eligible, the taxpayer must not be under criminal investigation, have not been notified of an impending criminal investigation, and have not been subject to an employment tax examination by the IRS. Additionally, the taxpayer must not have received a notice and demand for repayment of the ERTC. To participate in the program, the taxpayer must complete and apply on Form 15434, the Application for Employee Retention Credit Voluntary Disclosure Program. If the application includes tax periods ending in 2020, Form SS-10, Consent to Extend the Time to Assess Employment Taxes must be submitted as well. The application deadline is March 22, 2024. They must also cooperate with the IRS, repay the entire ERC received (minus 20%), and sign a closing agreement. See, https://www.irs.gov/newsroom/irs-new-voluntary-disclosure-program-lets-employers-who-received-questionable-employee-retention-credits-pay-them-back-at-discounted-rate-interested-taxpayers-must-apply-by-march-22.

The Withdrawal Program, on the other hand, is available to taxpayers that have submitted a claim for the ERC but have not yet received it (or who received a check but haven't cashed or deposited it). To withdraw the claim, businesses must follow the instructions provided by the IRS. See, https://www.irs.gov/newsroom/withdraw-an-employee-retention-credit-erc-claim.

Background: As found on the U.S. Department of the Treasury's website located at https://home.treasury.gov/policy-issues/coronavirus/about-the-cares-act, the ERTC was created as part of the Coronavirus Aid, and Economic Security (CARES) Act of 2020, and was designed to incentivize employers to keep employees on the payroll during the COVID-19 pandemic. According to the applicable law found at title 26 U.S.C. § 3134, the ERTC is available to employer taxpayers who meet the stated eligibility requirement, and the credit is equal to 50% of qualified wages paid to employees after March 12, 2020, and before Jan. 1, 2021, up to $10,000 in wages for each employee for all calendar quarters. The credit was extended and expanded by the Consolidated Appropriations Act, 2021. It continued many of the CARES Act programs by adding new phases, new allocations, and new guidance to address issues related to the continuation of the COVID-19 pandemic, and increased the credit rate to 70% of qualified wages and reduced the required decrease in gross receipts from 50% to 20%. So, the maximum amount for each eligible employer is $26,000 for each eligible employee. The CARES Act was passed by Congress on March 25, 2020, and signed into law on March 27, 2020. The Consolidated Appropriations Act (2021) was passed by Congress on Dec. 21, 2020 and signed into law on Dec. 27, 2020.

The IRS, in its role as primary administrator/implementer of the Acts, subsequently issued guidance clarifying that an employer taxpayer may be considered to have a full or partial suspension of operations due to a governmental order if the taxpayer's suppliers are unable to make deliveries of critical goods or materials due to a governmental order.

On Sept. 14, 2023, the IRS stopped processing new ERTC claims due to concerns about fraudulent claims. See, https://www.irs.gov/newsroom/to-protect-taxpayers-from-scams-irs-orders-immediate-stop-to-new-employee-retention-credit-processing-amid-surge-of-questionable-claims-concerns-from-tax-pros. And on Dec. 6, 2023, the IRS announced that it had rejected 20,000 claims and initiated hundreds of investigations into potentially fraudulent claims. See, https://www.irs.gov/newsroom/irs-expands-work-on-aggressive-employee-retention-credit-claims-20000-disallowance-letters-being-mailed-more-action-and-voluntary-disclosure-program-coming.

As a result of the divergence between the IRS' role in safeguarding business savings tax credit funds and the business taxpayer's need to access them, there is a lot of federal money riding on what counts as a precipitating government order. As such, the IRS and tax firms are preparing for legal fights about that crucial definition of one of the eligibility requirements: the definition of a government order that can be used by a business to gain access to the funds.

According to a Memorandum from the Office of Chief Counsel of the IRS, Number AM 2023-007, dated Nov. 3, 2023, [see, https://www.irs.gov/pub/lanoa/am-2023-007.pdf ] some employers and tax advisers say that a taxpayer can rely on Occupational Safety and Health Administration (OSHA) guidelines encouraging ventilation, physical distancing, and other measures. The IRS says no!

The IRS' argument is the latest sign of the tax agency's tough line in audits of the ERTC because, thus far, the credits have cost the Treasury at least $230 billion, roughly triple earlier estimates [see, https://www.cato.org/blog/employee-retention-credit-shows-folly-tax-code-subsidies] after a cottage industry of firms popped up to help employers claim it, sometimes illegitimately so. The IRS says fraud and ineligible claims are rampant, and it is now giving its auditors a road map for denying refunds and setting up potential prosecutions of the taxpayers and those that advised them.

In sum, it is the IRS' position that an employer cannot simply reference pre-existing OSHA standards to claim entitlement to the credit due to a full or partial suspension of operations. As such, the IRS has stopped processing new ERTC claims. The IRS is concerned about fraudulent claims, specifically where the taxpayer-credit applicant used United States Occupational Safety and Health Administration guidelines. Guidelines which encouraged employers to implement ventilation, physical distancing, and other prophylactic measures designed to inhibit the spread of Covid-19 as a proxy for the required government shut down order. This occurred in the City and County of San Francisco, which issued its initial Order, entitled the Local Emergency Declaration of the Health Officer, C19-01, on March 6, 2020. For the complete list of the scores of Orders and Directives issued by San Francisco's chief health officer related to Covid-19, including the Termination of Declaration of Local Health Emergency Regarding Covid-19, the City has placed them in an Archive, located at https://sfbos.org/health-orders-and-directives

So if a taxpayer filed the required tax documents indicating that its business met the eligibility requirements, obtained a tax refund and now the taxpayer has concerns that it may not have actually met those requirements, the taxpayer should (1) check with a trusted tax professional to make sure it obtained the tax refund on the up and up, and (2) if not, or where the taxpayer has any doubt, and the taxpayer meets the eligibility requirements for the Voluntary Disclosure Program, (3) the taxpayer should consider taking the IRS up on this "conditional partial amnesty program" and voluntarily return 80% of the tax refund received. Where the taxpayer either has an application pending or has received the ERTC refund check but has not as yet cashed it, the taxpayer should consider withdrawing the application via the Withdrawal Program. Taking either of the routes, under the appropriate facts and circumstances, may allow the taxpayer to otherwise escape most agency scrutiny. Otherwise, the affected taxpayer may find that the taxing authority will commence an audit with the goal of holding the taxpayer liable for the full amount received, along with penalties and interest, and any and all other applicable sanctions under law, including possible criminal prosecution.