The COVID-19 pandemic disrupted business operations like nothing we’ve experienced in the modern era.

As providers of essential services, some companies like septic pumpers remained on the job, but the demand for peripheral services perhaps declined. The business slowdown led to reduced hours, employee layoffs and less revenue. Pandemic relief programs, like the Employee Retention Tax Credit, helped cover some of the losses. This past fall, the ERTC generated renewed attention, and not all of it favorable.

A LITTLE BACKGROUND

The ERTC is a refundable tax credit designed for businesses that suffered losses during the height of the pandemic in 2020 and 2021. This tax-relief program is incredibly complex, but employers who meet the eligibility requirements can recoup thousands of dollars per employee.

“The numbers get pretty big, pretty fast,” says Peter Haukebo, a tax attorney at Frost Law in Maryland. Haukebo has been practicing law for 12 years and currently serves as chair of the Maryland State Bar Association Taxation Section. 

“In a perfect scenario, someone can get up to $26,000 per employee,” Haukebo says.

But the “perfect scenario” is elusive for the average employer because it requires fastidious recordkeeping and a keen understanding of employment tax law. Taking shortcuts can get employers into big trouble, as can filing fraudulent claims.

Aggressive marketing campaigns targeted U.S. businesses in the summer and fall of 2023, using predatory tactics to pressure employers to apply for the ERTC. Inundated with bad claims, the IRS stopped processing ERTC claims in September and didn’t plan to start again until January 2024, at the earliest. During the moratorium, the IRS pursued fraudulent claims and added more safeguards to prevent future abuse. But for employers with legitimate claims, applying for the tax credit is still worth the effort.

“I’ve seen credits of a couple thousand dollars to millions of dollars,” Haukebo says. 

DETERMINING ELIGIBILITY

Eligibility is based on two factors: being an eligible employer and paying qualified wages. 

“You really have to start with, ‘Why am I eligible?’ There are three ways,” Haukebo says.

The first way to qualify is based on a decline in gross receipts in 2020 or the first three quarters of 2021. Specifically, employers are eligible if gross receipts dropped 50% in a pandemic calendar quarter compared with the same calendar quarter in 2019. 

“You remain eligible until gross receipts pop up to 80% of what they were in 2019,” Haukebo says.

The gross receipts comparison is the most straightforward of the three eligibility requirements.

“That’s the most black-and-white eligibility,” Haukebo says. “As long as you’re booking your receipts to the correct calendar quarter according to your method of accounting, there’s not much argument there. The next test is very difficult, and Congress has made this very easy to do incorrectly and very hard to do correctly.”

The second way to qualify for the ERTC is to show that the company experienced a full or partial suspension of business operations due to a governmental order limiting commerce, travel, or group meetings in response to the pandemic. The test is whether the portion of the business that closed was more than nominal. Nominal means 10% or more of total gross receipts or total hours worked came from that shuttered part of the business in 2019. Related to this test is the nominal effect analysis. Employers can qualify for the ERRC if the restrictions had more than a nominal — 10% again — effect on the ability to provide goods and services.

“It’s a 10% test, but now it’s a test of ability, and this is where the stuff goes off the rails,” Haukebo says. “Because how do I test ability? What are the metrics? What are the key performance indicators?”

A professional tax preparer can help employers determine if they’re eligible under this requirement, but it may not be so cut and dried, Haukebo says.

“It may be challenging to go back and find that data and confirm those numbers,” he says.

The third way to qualify for the ERTC is as a recovery startup business that opened after Feb. 15, 2020, and generated less than $1 million in annual gross receipts. 

“Even that has some devil-in-the-details,” Haukebo says. “This is all built on existing tax laws, so that really gets into the qualified wage analysis.” 

MAKING A CLAIM

Employers who meet the eligibility requirements can claim the credit on IRS Tax Form 941X. In the realm of tax forms, the 941X is short — only five pages — without a worksheet showing any computations. Despite this simplicity, Haukebo recommends working with a professional tax preparer to submit an ERTC claim. 

The tax preparer should provide employers with several documents: copies of the governmental orders with language highlighted that relates to the employer’s specific claim; a work paper that lists each employee in each quarter who earned a qualified wage; payroll costs for purposes of Paycheck Protection Program loan forgiveness, if applicable; and a work paper showing how the preparer calculated any permissible health care expenses.

“There’s a ton of work done off of any government form,” Haukebo says.

Once the 941X form is complete, it is mailed to the IRS to be hand-processed. There are no digital interfaces or E-filing systems for the ERTC, and the IRS mails paper checks to employers with successful claims. Because of the manual nature of these claims, errors sometimes occur.

“To give you an example, we had a client who was eligible for $160,000, and whoever keyed this in didn’t put a decimal,” Haukebo says.

Instead of $160,000, the IRS was ready to issue a check for $16 million. Frost Law called the IRS to report the error before the check was cut. 

FILING A BAD CLAIM

IRS slip-ups are one thing, but filing a bad claim is another. A substantial number of recent ERTC claims are, at best, incorrect, and at worst, fraudulent. Some businesses will face penalties and interest payments stemming from bad claims pushed by promoters. In October 2023, the IRS announced an ERTC withdrawal process for employers who have “a come-to-Jesus-moment and say, ‘I actually wasn’t eligible,’” Haukebo says.

The withdrawal process is designed for employers who were misled by ERTC marketers and fell victim to scams. The withdrawn claims will be treated as if they were never filed and will not be subject to penalties or interest. 

However, not every employer gets off the hook so easily. If the IRS processed the claim and an IRS audit reveals the employer was ineligible for the ERTC, the employer must return the tax award and pay any penalties and interest. These costs don’t include fees paid to the aggressive ERTC promoters, some who took a 25% contingency fee.

OTHER TAX CREDITS TO CONSIDER

Haukebo encourages employers to check into other available tax credits as well. For example, employers who install solar panels at their facilities may qualify for solar energy tax credits.

Additionally, the work opportunity tax credit is worth $2,400 to $9,600 per employee. Employers can claim this credit if they hire from certain groups like veterans, the recently incarcerated, and people on public benefits. In addition to the federal tax credits, every state offers various tax credits, also. 

Applying for tax credits like the ERTC can be a complicated process, but the rewards can be great. Tax credits reduce a tax bill dollar-for-dollar, giving employers more money to operate and grow their business. By working with a certified tax preparer, employers can take advantage of beneficial tax-saving opportunities that contribute to the bottom line.