Concerned About ERC Scams? Get a Second Opinion
CPAs have a professional responsibility to ensure their clients’ ERC providers are performing their due diligence—and that might mean getting a second opinion.
Digital Exclusive – 2023
Earlier this year, I reported on the IRS’ various warnings related to the employee retention credit (ERC). First, they issued IR-2022-183, warning against third parties improperly computing the ERC. Then, they issued a renewed warning (IR-2023-40) about promoters who aggressively mislead people and businesses into thinking they can claim the ERC. Now, the IRS is taking an even bigger step.
On Sept. 14, 2023, the IRS issued an immediate moratorium on processing new ERC claims through at least the end of the year (IR-2023-169). The caveat is that ERC qualifications haven’t changed, and you can still proactively file a claim. In fact, the IRS is still encouraging businesses to file legitimate claims. However, they’re asking businesses to review their claims with a trusted tax professional who actually understands the complex ERC rules, not a promoter or marketer trying to make a quick buck.
In addition to combating fly-by-night providers, this change will allow the IRS to:
- Add more safeguards to prevent future abuse.
- Protect businesses from predatory tactics.
- Allow time for the IRS to work with the United States Department of Justice to combat aggressive marketing and incorrect ERC claims.
If you hadn’t heeded these warnings before, take the IRS’ latest step as a sign—it’s time to be serious about the ERC. After all, CPAs have a professional responsibility when they sign a tax return to ensure that any third parties who are providing credit numbers are performing due diligence—and that might mean getting a second opinion.
Let’s look at a few actual case studies from wary CPAs, asking for guidance before they signed their name on an amended return reflecting a large refund.
ERC Horror Stories
Notably, many promoters who sprung up during the pandemic are completing an ERC evaluation in minutes and claiming credits without substantiation. These two examples below are no exception.
Commercial Retailer in Alabama
The retailer entered into an agreement with an ERC provider. After responding to a brief questionnaire followed by a short phone call with the ERC provider, the retailer was told it qualified for all quarters in 2021 and that the ERC would be over $1 million!
The CPA and business owner were skeptical about how little time and effort it took to make this determination. So, they came to my firm for a second opinion. We found these red flags:
- There was no significant decline in gross receipts.
- The retailer was located in Alabama and Florida, two states where government orders didn’t extend into the third quarter of 2021; yet, the ERC provider claimed the third quarter in their calculation. Furthermore, the client stated that restrictions for them ended in May 2021.
- There was no reference to the location of the retailer’s suppliers to substantiate any supply chain disruption, but the ERC provider claimed it under the partial suspension test.
- There was no identification of any specific government order applicable to the retailer.
- The retailer estimated the impact in delayed work was 10%, but there was no substantiation.
- None of the information in the questionnaire completed by the retailer was substantiated by the ERC provider.
As you can see, there was no chance of a $1 million credit here. Thankfully, an outside law firm was able to break the contract with this ERC provider and save the retailer from being on the hook for more than $250,000 in fees.
Tool and Equipment Manufacturer in Montana
The manufacturer signed an agreement with an ERC provider. After a few phone calls with the ERC provider, the manufacturer was informed it qualified for an ERC claim totaling more than $750,000 based on canceled trade shows. The manufacturer contacted their CPA about the windfall. Rightfully so, the CPA expressed skepticism and contacted my firm for our thoughts. Like the other example above, we found some red flags:
- Gross receipts? There was no significant decline in gross receipts.
- Qualifying business disruption? There was no evidence showing the trade shows were canceled due to government orders (or any other reason).
- More than nominal impact? The analysis didn’t show a nexus between the closure of trade shows, nor the manufacturer’s supply chain issues and the manufacturer’s more than nominal impact.
- Qualifying mandates? The governmental order referenced was simply the emergency declaration, not a specific governmental order applicable to the manufacturer’s suppliers.
- Substantiation and documentation? The analysis stated that the manufacturer had to wait longer for materials but made no mention as to how long or how much longer they had to wait in comparison to 2019.
As a result, we advised the manufacturer not to file the ERC claim. They were able to disengage the ERC provider and a law firm was able to get the manufacturer’s down payment refunded.
Moral of the Story
When it comes to the ERC, it’s like the Wild West out there. The smell of gold (fast, easy fees) has lured pop-up ERC providers to promise the world without doing the necessary, exact, and meticulous research and documentation to properly qualify and quantify a company for an ERC.
As CPAs, we may find ourselves stuck in the middle between a drooling client hungry for a cash refund and our due diligence responsibility before preparing and signing a tax return promising a huge refund. Like it or not, the facts are the facts. Sometimes we have good news and sometimes we have bad. Either way, we must continue to exercise our great CPA personality trait, using professional skepticism and due diligence to do what’s right for our clients. Unless you have absolute comfort with your client’s ERC provider, it would be wise to get a legal second opinion.
Rick Meyer, CPA, MBA, MST, is a director for alliantgroup, a national firm that works with businesses and their CPAs to identify powerful government-sponsored tax credits and incentives. As a long-time Illinois CPA Society member, he’s served on various tax committees over the past 40-plus years. He can be contacted at [email protected].