Is the ERC an IRS audit waiting to happen?

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August 8, 2022

Photo: designer491/iStock / Getty Images Plus/Getty Images

Photo: designer491/iStock / Getty Images Plus/Getty Images

When enacted in 2020, the federal Employee Retention Credit (ERC) received little attention. That’s because at the time, if taxpayers received a forgivable Paycheck Protection Program (PPP) loan, they were ineligible for the ERC. In 2021, however, that requirement was lifted — and the ERC became extremely popular.

As happens with many gold rushes and tax credits that are enacted to promote taxpayer financial assistance or a public policy that has benefits to society — such as research credits — there often is a proliferation of instant experts who open shops to profit from helping clients “get theirs.” Unfortunately, many of them have little, if any, expertise offering questionable advice in exchange for large fees.

Be especially wary of “experts” who overstate their credentials and/or their ability to provide advice regarding the ERC. Some claim to have received special training from the IRS; they have not. Others claim to have special knowledge regarding the law for one reason or another; they do not, as detailed information about the ERC is available to anyone with an internet connection.

Pest control was designated an essential service by the government during the pandemic and, although there are some exceptions, most pest management professionals (PMPs) experienced revenue growth during the measurement period. In other words, most PMPs don’t qualify for the ERC. If you think you may be an exception, check with your certified public accountant (CPA) or tax attorney.

REQUIREMENTS IN REVIEW

In general, there are two eligibility tests for the 2020 ERC and for the first three calendar quarters of 2021. They are:

  1. The gross receipts test. Taxpayers need to show a decline in gross receipts of more than 50 percent in any calendar quarter in 2020, or more than 20 percent in any of the first three calendar quarters in 2021.
  2. The suspension of operations test. This is the test that is used when a taxpayer does not meet the gross receipts test. It generally requires the taxpayer to establish the following:
    • The taxpayer suffered a full or partial suspension of business operations due to a governmental order that limited commerce, travel, or group meetings because of COVID-19.
    • The taxpayer’s employees were not able to work comparably through telework.
    • The full or partial suspension of operations had more than a nominal effect on the taxpayer’s business operations.

If there is a full or partial suspension of business operations, the taxpayer generally can include in the ERC calculation those wages and health plan expenses paid during the period of the suspension.

TAXABLE ERC CREDITS

One of the biggest, yet least-mentioned aspects of this program is that the ERC credits are taxable; the wages used to calculate the credit is not deductible for income tax purposes. In this case, not only do payroll tax returns need to be amended to receive the credit, but income tax returns also need to be amended to add back the wages taken as a deduction. In many cases, this causes an immediate tax liability.

While I fully support any and all tax deductions for our clients, the credentialled accounting and legal communities expect there to be a rash of audits of ERCs in the future. And while many of the tax credit advisors who have set up shop will provide indemnification for their fees, there will be repayment of tax and penalties, and interest due should an audit result in a disallowance.

If you go forward in taking the ERC, understand your risk.

About the Author

Dan Gordon owns PCO Bookkeepers, an accounting and consulting firm that caters to pest management professionals throughout the United States. He can be reached at dan@pcobookkeepers.com.

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