5 ERC Mistakes Employers Can’t Afford to Make
Many myths and mistakes have hampered Employee Retention Credit calculations. Here are five errors businesses can’t afford to make.
Digital Exclusive – 2023
Rewind! About two years ago, I wrote the popular Insight article, “The 10 Biggest Myths of the Employee Retention Credit.” I mentioned then that many of us CPAs were either missing this credit, not properly educating our clients about it, or simply doing the calculations wrong.
Where are we now? There’s good news, bad news, and five common errors that so many of us CPAs and employers alike are still making today when it comes to the Employee Retention Credit (ERC).
The good news: More CPAs and their clients are aware of the value of the ERC today than ever before.
The bad news: The amount of misinformation surrounding the ERC has also reached seemingly record levels, with many businesses being told that basically everyone can claim the credit for the maximum amount!
Many employers are being led to believe that they’re eligible for the full $26,000 credit, per employee, by any number of “here today, gone tomorrow” third-party providers looking to make a quick buck off their questionable ad campaigns (you’ve almost certainly heard the radio ads or seen the spammy emails). As a result, the IRS recently issued IR-2022-183. The notice warns of third parties who are often improperly computing the credit; advising businesses to claim the credit when they may not or do not qualify; not gathering, applying, and documenting the facts correctly; and not providing employers the full story about the ERC.
The misinformation is so severe that the IRS has gone so far as to issue a 72-page training guideline on the credit and is requiring its auditors to complete a 56-hour training course.
Now, you may be saying to yourself that CPAs can’t be held responsible if their clients engage with a third party. Wrong! Remember that the AICPA Code of Professional Conduct requires a CPA to do due diligence to determine whether the third party has the appropriate expertise in the area relied upon by the CPA. Meaning, if you’re signing the tax return, you better do your due diligence!
So, what are the top five ERC errors you should be watching for?
Error #1: Being affected by COVID-19 qualifies you for the ERC
Unfortunately, this is an overgeneralization. There are two COVID-19-related consequences that could lead toward ERC eligibility: revenue decline and “more than nominal” impacts on the business. The main issue is that it’s widely believed that any COVID-19-related complications qualify a business for the ERC.
For instance, merely adjusting one’s operations in response to COVID-19 isn’t enough to qualify for the ERC. There are two things employers must demonstrate to be eligible under the business impact test:
- You must show that a specific COVID-19-related government order or mandate (federal, state, or local) caused the impact to your business.
- You must show the extent and duration of that impact.
In short, you need to clearly illustrate that the order had a more than nominal impact on your business. Current best practice is that you need to document the specific government order and detail and document the impact on your business for the relevant time period.
Error #2: Any government guideline qualifies you for the ERC
Again, this is an overgeneralization. There are varying levels of government orders and guidelines pertaining to COVID-19—not all of them qualify a business for the ERC. For instance, I’ve heard some folks telling businesses that CDC and OSHA guidelines will qualify an employer for the ERC, but this isn’t always true.
First, an order must actually be “an order.” There’s a big difference between government orders that say a business must or shall do something versus a guideline that simply recommends or advises a business should take some form of action. The latter doesn’t qualify a business for the ERC.
As noted in IRS Notice 2021-20, a mayor giving a speech encouraging residents to practice social distancing isn’t an order. Further, as the IRS guidance makes clear, a qualifying order must limit commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to COVID-19. Finally, the order must come from a government that has jurisdiction over the employer’s operations, and the order must also have a more than nominal impact on the business’ operations. So, it’s imperative to be mindful of what orders you think may qualify you for the ERC.
Error #3: A qualifying COVID-19 mandate that impacted your business qualifies you for the ERC
Not so fast! Even if a qualifying government order affected your business, you still may not qualify for the ERC. IRS Notice 2021-20 requires that there be a “more than nominal” impact on the business to be eligible. Unfortunately, the “more than nominal” test often goes unmentioned and/or overlooked despite it being a critical part of the ERC calculation analysis.
A suspension of a more than nominal portion of a business’ operations is a very technical calculation based on IRS Notice 2021-20 and it needs to be well documented.
Error #4: You get $26,000 for every employee
Oh, really? Calculating the eligible ERC amount is quite complicated and employers and their CPAs should exercise extreme caution. It’s simply wrong to assume that you can multiply how many employees you or a client has times $26,000 and claim that total on Form 941-X.
There are three major factors that impact the potential ERC amount: wages paid, duration of impact, and other incentives already claimed.
The ERC is calculated as 70% of qualified wages paid to an employee in a given quarter, up to $10,000. Let’s say an employer paid an employee $7.25 per hour for working 60 eight-hour days in a quarter. That means the wages paid would be $3,480. Multiplying that by 70% gives a maximum credit of $2,436.
However, this assumes the qualifying government mandate lasted for the whole quarter. Not only do wages paid matter, but also the length of time the mandate was in place. For instance, let’s say that same employee qualified due to a social distancing order that was only in effect for half of the quarter. In this case, only half of the maximum credit would be available.
Error #5: If you received PPP loans, you can still qualify for the full ERC amount
Do your homework! Interplay with other COVID-19 relief programs is where most employers and CPAs get led astray when it comes to the ERC. While you can claim PPP forgiveness and the ERC together, they’ll have interplay between themselves and any other incentives taken, such as a restaurant revitalization grant. IRS Notice 2021-20 notes that the law now allows employers who received PPP loans to claim the ERC for qualified wages that weren’t treated as payroll costs in obtaining PPP loan forgiveness. In short, there’s no double-dipping allowed.
These are the five most common ERC errors I’ve been seeing, but there are certainly others to avoid. While the ERC is a fantastic tax incentive and cash infusion for qualifying businesses that suffered economically from the effects of COVID-19, it’s not the easiest credit to navigate. As businesses’ most trusted and strategic advisors, let’s make sure all us CPAs are doing our part to spread awareness of the proper ways to qualify for and claim the credit.
Rick Meyer, CPA, MBA, MST, a director at alliantgroup, is a longtime member of the Illinois CPA Society and has served on various tax committees over the past 40 years. He can be contacted at [email protected].