ERC Claims Review Remains in Limbo While Scammers Lurk

The IRS has released yet another warning regarding the employee retention credit. The news release addressed “aggressive ERC marketing” and promoters of employee retention credit mills. These mills are partially responsible for the significant backlog the IRS is facing, but the IRS’s guidance (or lack thereof) is also part of the problem.

As the news release states, “There are very specific eligibility requirements for claiming the ERC. These are technical areas that require review.” And the IRS is certainly taking its time to review these claims—so much so that it has caught the attention of US senators.

A Senator’s Call for Action

Just a few weeks ago, Sen. Kirsten Gillibrand (D-N.Y.) demanded that the IRS address its backlog and issue overdue ERC refunds “to small businesses and nonprofits that have filed for them.” Many businesses are struggling to survive and relying on these payroll tax refunds to continue their operations.

As Gillibrand said, “They were promised reimbursement, but years after the fact, they still haven’t received it. I am calling on the IRS to speed up its processing to fix this problem as soon as possible and get our hard-working small business owners the refunds they deserve.”

The issue is that small businesses and nonprofits aren’t the only types of businesses eligible for the credit. One of those specific eligibility requirements involves determining whether the business is a large eligible employer or small eligible employer. In terms of the 2021 ERC, a business that had 500 or fewer average full-time employees in 2019 (and met the additional requirements set forth in IRS guidance) may be entitled to the maximum credit of $21,000 per employee for the first three quarters.

Because companies with hundreds of employees may be considered small eligible employers, mom-and-pop stores that are expecting a refund may have to wait in line behind substantially larger businesses.

Business Eligibility

Generally, there are three categories for eligibility (as outlined in the news release).

An employer that “sustained a full or partial suspension of operations due to orders from an appropriate governmental authority limiting commerce, travel or group meetings because of Covid-19 during 2020 or the first three quarters of 2021.”
An employer that “experienced a significant decline in gross receipts during 2020 or a decline in gross receipts during the first three quarters of 2021.”
An employer that “qualified as a recovery startup business for the third or fourth quarters of 2021.”

Each of those tests comes with technical areas that require review, so the backlog isn’t only caused by ERC mills. Inspecting each return will take some time, especially when taxpayers aren’t required to include substantiation as part of filing the refund claim. In particular, the first test (the partial suspension test) is nuanced.

Suspension of Operations

The partial suspension test involves an extremely fact-intensive analysis of the impact that “orders from an appropriate governmental authority” had on a business’s operations. Mayoral orders shutting down nonessential businesses, a state order to shelter in place, or a local health department’s mandate to disinfect certain areas of the workplace are just a few examples of appropriate orders.

While ERC scammers may want businesses to believe that just about any change is sufficient to qualify for the credit, that’s not the case. To be eligible, a business must have had “more than a nominal effect on the business operations under the facts and circumstances” suspended by a governmental order under the facts and circumstances.

What is considered more than nominal? I defer to the classic lawyer response: It depends. While the IRS has provided some guidance, there are still some lingering issues about what that phrase means exactly. For example, Question 16 of Notice 2021-20 asks, “What factors should be considered in determining if an employer is able to continue operations comparable to its operations prior to closure such that the employer’s operations are not considered to have been fully or partially suspended due to a governmental order?”

The notice discusses the employer’s telework capabilities, the portability of employees’ work, the need to be present in a physical work space, and a transition to telework operations. The notice confirms that businesses that easily transitioned to a remote environment during the pandemic didn’t experience a partial suspension of operations and therefore wouldn’t be eligible for the credit under this test.

However, what if a portion of the business operated remotely while another portion was deemed essential? The IRS offers some guidance on that as well, but many questions remain unanswered.

Question 16 states that “additional factors may be considered as well if relevant” but does not offer any guidance on these additional factors and the weight they should be afforded. The pandemic altered the way nearly every industry operates, and the IRS cannot address every possibility, but to what extent must a business have to modify its operations due to governmental orders to qualify? The IRS’s position on this isn’t clear.

Conclusion

Unfortunately, all businesses may have to wait longer for the IRS to process these returns. What was intended to be financial relief to businesses that suffered during the pandemic has now developed into a trillion-dollar industry for third-party scammers. As advised by the IRS, businesses should work with a trusted tax professional to review eligibility for the ERC before filing.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Joshua S. Hamlet is an associate in Akerman’s tax practice. He focuses on a broad range of state and local, international, and federal taxation matters including tax planning, controversy, and compliance issues primarily related to tax-exempt organizations and cannabis businesses.