Government

The Employee Retention Credit Is A Lesson On How NOT To Implement A Stimulus Plan

The ERC was written with good intentions at the time of the COVID-19 pandemic. But as a practical matter, the jury is still out.

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Government Financial Crisis Bailout Check Economy Coronavirus StimulusThe Employee Retention Credit (ERC) was implemented in 2020 and 2021 in response to the COVID-19 pandemic as part of the CARES Act. It was meant to help struggling businesses pay for employees who are not eligible for the Paycheck Protection Program (PPP) forgivable loans.

But as time passed, the ERC got a bad rap from the IRS. Many eligible businesses did not claim the credit at the outset and waited until the very end to claim it and get a refund. As a result, the IRS received a large number of credit requests and issued a temporary moratorium on processing ERC claims. Why did this happen? And what is the IRS and the rest of the government doing about it?

The ERC in general allows businesses to claim a refundable tax credit for qualifying wages paid to an employee during 2020 and 2021.

For 2020, an employer will get a tax credit of one half of an employee’s qualifying wages up to $10,000. This leads to a maximum tax credit of $5,000 per employee.

For 2021, employers get a tax credit equal to 70% of wages paid (up to $10,000) per quarter for three quarters. This means a credit up to $7,000 per employee for three calendar quarters can be claimed for a total of $21,000 for 2021.

So for most businesses operating in 2020 and 2021, they can get up to $26,000 per employee. They can use the ERC to lower their employment tax bill or get a refund of taxes paid. If businesses have not claimed the credit for multiple quarters and have a substantial number of even modestly paid employees, the tax refund can be very large.

To be eligible to claim the ERC, a business must meet one of two tests. The first test requires that a business suffer a “significant decline in gross receipts.” For 2020, this means that a calendar quarter must have less than 50% of gross receipts compared to the same quarter in 2019. For 2021, the business must have less than 80% of gross receipts in a calendar quarter compared to the same quarter in 2019.

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The other way to qualify is if the business suffers a full or partial suspension due to a COVID-19 related government shutdown order.

Many businesses did not claim the ERC initially for several reasons. First, fewer businesses knew about it because more attention was given to the PPP. Also, businesses were more interested in the PPP because it allowed owners to get stimulus money while the ERC was only available for employees. Also, there was initial confusion as to whether employers can use PPP money for ERC purposes. Lastly, it took some time before professionals understood how to calculate qualifying wages for ERC purposes.

Another reason why the ERC was not initially claimed was because the rules were complex. While calculating a significant decline in gross receipts was mostly straightforward, determining whether a business suffered a suspension due to a government order was not as clear.

The IRS issued Notice 2021-20 which answered many frequently asked questions about qualifying governmental orders and what constitutes a suspension of a business for ERC purposes. But  it also made some questionable decisions.

For example, the IRS does not believe a business suffered a full or partial suspension if it was due to a reduction of customer demand because of a government stay-at-home order. In this case, a business will not qualify for the ERC even though a government order indirectly impacted its operations.

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It seems to have put the burden on ERC claimants to keep records of governmental shutdown orders. It seems more efficient for the IRS to issue a notice identifying shutdown and reopening dates in key cities and states.

The IRS further stated that employers who received forgivable loans through PPP cannot count those funds as wages for the purposes of claiming the ERC.

Lastly, there is the recent proliferation of ERC mills. They send mailers to businesses and would even call them on a daily basis claiming large, too-good-to-be-true refunds. These mills are known to charge high fees and take very aggressive, if not fraudulent, positions on ERC claims.

As a result of these questionable claims submitted by these mills, the IRS issued a moratorium on new ERC claims on September 14, 2023. In addition, the IRS listed too-good-to-be-true ERC claims in its annual Dirty Dozen tax scams. The IRS has stated on multiple occasions that it will aggressively audit ERC claims.

Due to the unexpected cost of the ERC, Congress is contemplating ending the program altogether. Congress is considering H.R. 7024 which would set a deadline for ERC claims to January 31, 2024.

The ERC was written with good intentions at the time of the COVID-19 pandemic. But as a practical matter, the jury is still out. The ERC could have been applied differently to make it easier for taxpayers to claim it on time. For example, it would have been easier to implement a 100% credit for $5,000 of qualified wages in 2020 (or 100% of $7,000 of qualified wages in 2021) which would have achieved the same result with less complicated calculations.

Also, there should be stronger verification procedures before issuing large refunds, similar to how the IRS processes Earned Income Credit claims. Some will argue that that this will hurt the underground economy of those who are generally the most needy.

While the IRS is trying to combat fraud, its strong language and threats of severe penalties may have scared businesses with legitimate ERC claims. Their only fault is not claiming it timely because at the time, the rules were unclear and they (along with their advisors) were more focused on easier stimulus applications such as the PPP.

In a few years, if the stars in the sky align a certain way, another pandemic panic could happen, and the government will issue stay-at-home orders and stimulus packages. It would serve policymakers well to learn from the ERC so they can prepare to craft a stimulus plan that businesses and individuals can claim as soon as it is released while minimizing the chances of fraud.

Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at [email protected]. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.

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