It seems one cannot get through a day without hearing or seeing an ad for the tax credits that you may be eligible for. I’ve received two voicemails and four emails regarding our firm’s eligibility just within the last week. This is of course promoting the Employee Retention Credit. Unfortunately, we have seen and heard too many stories of business owners getting bad advice that could have drastic effects down the road.
The ERC started in its original form under the CARES Act in deep in the throes of the COVID pandemics shock effects on businesses. It has since been modified and extended multiple times. Just like the PPP, this was a well-intended program that unfortunately has in many cases been abused and misunderstood. The goal was to keep employees on payroll and provide an incentive to do so. While there is always grey area, guidance for eligibility is fairly clear, and companies every day are signing up and receiving credits that they are not eligible for. Unless you believe the IRS will just look the other way, there are some key aspects to understand.
- The credit amount was increased from an original 50% to 70% of eligible employee wages per eligible quarter (capped at $7,000). The goal here is not to get into all the specifics, but at a high level, eligibility for the credit is based on one of two factors:
- Your business had to partially or fully suspend operations due to some form of government order during the pandemic or
- Your business suffered a significant quarterly revenue decrease compared to the prior year. The exact calculations vary by the time period the decrease applies to.
- What has unfortunately occurred is that opportunistic businesses have popped up offering to help businesses obtain these credits, and we have seen contingency fees of 20 to 25% being charged to do so. Firms have popped up all over the place, and millions of marketing dollars are being spent to get the attention of the business owner in applying for the credit. Worse still, these firms are obtaining credits countless instances where companies are not eligible. Of course this means no upfront out of pocket by your business, but you could have significantly more risk than you realize.
- Let’s talk about a quick real-world example. A successful technology company had to shift to a remote workforce during the pandemic due to stay at home orders. It was approached by one of these firms and shown how they could obtain $600,000 in ERC credits. The firm would charge 20%, so the business would end up with $480,000 net – sounds great right? The issue is in what the IRS calls comparable operations. The business did not suffer any significant revenue declines during the pandemic, and it was able to operate its business with only minor disruptions. Per the IRS guidelines, this business had comparable operations and would not be eligible. Yet, they received the credit, and the processing firm got its $120,000.
- Unlike the PPP, which was a loan that then had a forgiveness process, the ERC is a tax credit, meaning once the credit is applied for, businesses can get a check in the mail or offset other tax liability with what they think are no strings attached.
- What could well happen is in the event of an IRS audit, non-eligibility will be confirmed, and the IRS will find the full $600,000 to be the responsibility of the taxpayer, and worst still, possibly even with penalties tacked on to it.
So, what does a business owner do?
- First and foremost, this is one of those essential areas where a business owner must be in regular dialogue and get support from a good tax CPA. Get educated on how this impacts your business. Many CPA firms are processing these for clients for minimal fees and ensuring they are done correctly. Make sure you clearly understand what makes your business eligible. If you have used an outside firm and are not concerned, talk to your CPA as they can review the credit and determine future steps needed. Whatever you do, keep them in the loop.
- Do you need the money? If not and you are playing in the great area, it is likely not worth the risk. If you recently received the credit and are now worried about eligibility, don’t spend the cash, work with your tax CPA and develop a plan specific to your situation.
Nothing is free in business. You didn’t build your company based on easy handouts. You survived the pandemic. There is no reason to have to keep looking over your shoulder. And don’t get sold by a company charging huge contingency fees, especially when they can’t in a detailed manner show you exactly why you are eligible.