Is the Employee Retention Credit (ERC) too Good to be True?

Have you heard about the employee retention credit (ERC)? Of course you have, who hasn’t? Third party providers have been aggressively promoting ERC schemes on the radio, online and even on television. Many of these promoters promise massive refunds with little to no analysis into your business. These promoters charge large upfront fees or even contingent fees upwards of 25% of your refund.

As someone who’s helped clients file for millions of dollars in ERC claims I can tell you first hand that this credit is real. This is a legitimate tax credit that has provided a financial lifeline to millions of businesses including restaurants and other business shut down by COVID restrictions.

However, with most legitimate claims already filed, promoters are now pushing ineligible people to file for the credit. Promoters purport that you’re eligible even if your business never closed and your gross receipts increased. The IRS originally warned about this scheme in October 2022 and recently issued new warnings in March 2023. The IRS is actively auditing these claims and have opened criminal investigations related to these false claims.

I’ve personally handled several ERC audits and let me tell you… they are not pretty. Although the promoter guaranteed your eligibility, their arguments often get picked apart by the IRS agents.

In this article I will break down all of these purported claims and explain why the ERC may be too good to be true.

Employee Retention Credit Eligibility

You may be wondering who is eligible for the ERC. An employer is eligible for the Employee Retention Credit if it:

• Sustained a full or partial suspension of operations due to a governmental order,
• Experienced a significant decline in gross receipts (greater than 50% reduction in any quarter in 2020 compared to the same quarter in 2019 or a greater than 20% reduction in any quarter in 2021 compared to the same quarter in 2019), or
• Qualified in the third or fourth quarters of 2021 as a recovery startup business (started operations after February 15, 2020).

For the purpose of this article we will focus in on the full or partial suspension of operations.

Full or Partial Suspension of Operations

The IRS has made it clear in Notice 2021-20 that in order for a business to qualify under a full or partial suspension of operations it must show that it:

1. Was directly impacted by a governmental order due to COVID-19,
2. The impact was more than nominal, and
3. The employer could not have operated comparably via telework.

We’ll break down these qualifiers one by one.

Direct Impact

The IRS is persistent that to qualify under a full or partial suspension of operations the business must show a direct impact due to a governmental order. Indirect impacts that reduce demand or otherwise alter customer behavior will not qualify as a full or partial suspension of operations. This is important to understand when determining to file for the employee retention credit.

The IRS gives us an example in Notice 2020-20 FAQ #13.

“Employer B, an automobile repair service business, is an essential business and is not required to close its locations or suspend its operations. Due to a governmental order that limits travel and requires members of the community to stay at home except for certain essential travel, such as going to the grocery store, Employer B’s business has declined significantly. Employer B suspends its operations due to the lack of demand. Employer B is not considered to have a full or partial suspension of operations due to a governmental order.“

More than Nominal Impact

Not only must the impact be direct it must also be a more than nominal impact. For example, requirements to wear mask, sanitize or require customers to social distance generally don’t qualify.

So, when determining employee retention credit eligibility, how does the IRS define more than nominal? In Notice 2021-20 the IRS assigns a 10% threshold to the term ‘nominal’ (see FAQ #11). You need to show that more than 10% of your business closed due to a governmental order. You will measure this in terms of gross receipts or employee hours. For example, a governmental order closed your indoor dining which accounts for more than 10% of your gross receipts and or employee hours.

Inability to Telework

If you were able to transition your business to telework then you most likely don’t qualify for the credit. Unless your business can’t function without in person contact you will not qualify for the credit. Just because your offices closed does not mean you automatically qualify for the credit.

The IRS gives us an example in Notice 2021-20 FAQ #15:

“Employer C, a software development company, maintains an office in a city where the mayor has ordered that only essential businesses may operate. Employer C’s business is not essential under the mayor’s order, and therefore Employer C is required to close its office. Prior to the governmental order, all employees at the company teleworked once or twice per week, and business meetings were held at various locations. Following the governmental order, the company ordered mandatory telework for all employees and limited client meetings to telephone or video conferences. Employer C’s business operations are not considered to be fully or partially suspended due to the governmental order because the employer is able to continue its business operations in a comparable manner.”

Shutting Down Promoter Claims on ERC

Promoters are making several claims that are either wrong or misleading. Several of these claims are addressed in the IRS guidance and have been shut down in IRS audits. I will go through some of the tops claims and show you why they are wrong.

Employee Retention Credit Supply Chain Issues

The most common claim promoters will push is that general supply chain issues will qualify a business for the employee retention credit. This claim is misleading.

The IRS addresses supply chain issues in Notice 2021-20 FAQ #12:

“An employer may be considered to have a full or partial suspension of operations due to a governmental order if, under the facts and circumstances, the business’s suppliers are unable to make deliveries of critical goods or materials due to a governmental order that causes the supplier to suspend its operations.”

Furthermore, the example in the notice specifies that the employer must look for alternative suppliers. Claiming a general supply chain disruption is not enough to claim eligibility. You still need to find the governmental order that directly shut down your supplier which caused you to shut down your business.

CDC/OSHA Requirements

CDC and OSHA guidance may qualify a business under a full or partial suspension of operations but this claim is misleading. The ‘general duty clause’ does not work with IRS agents as they see these requirements as recommendations than orders. Unless a Federal, State or local agency mandates these requirements they will not constitute governmental orders.

Additionally, these orders must have a more than nominal impact on the business. Remember, just because you had wore a mask or had to sanitize a work station doesn’t mean your business qualifies.

It’s a Credit for Retaining Employees

“Every business that retained employees during the pandemic are eligible… I mean it’s in the name of the credit.” Just because you retained your employees does not mean you automatically qualify for the credit. Unless you meet the specific requirements laid out in the IRS notice you will not qualify or win an IRS audit.

Employee Retention Credit Audit Protection

Many of these promoters are offering audit protection to give you some assurance. Some even claim that they have never lost an IRS audit. This claim is extremely misleading.

Only attorneys, certified public accountants (CPAs) and or enrolled agents (EAs) may represent a client before the IRS. Most, if not all, of these promoters are tax credit shops and not CPA firms. They even go as far as disclosing that they are not offering tax services because… they are not attorneys, CPAs or EAs. Unless they outsource the audits to a law firm there is no way they can represent you in the case of an IRS audit.

Don’t Go it Alone

Get a second opinion if a promoter approaches you regarding the employee retention credit. If your tax advisor doesn’t know about the ERC then reach out to me. Whatever you do, don’t assume they know what they are talking about. If it’s too good to be true it probably is too good to be true.

If the IRS is auditing your ERC claim you don’t want to go it alone. These audits can be complex and you want to make sure to get it right the first time. There are no second chances when it comes to an IRS audit.