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The IRS warns employers to beware of third parties promoting improper Employee Retention Credit (ERC) claims. With the filing season underway, the IRS is providing guidance to ensure tax professionals are meeting their Circular 230 professional responsibilities and the standards required to prepare and sign original tax returns, amended returns or claims for refund relating to the credits. The IRS urges filers to carefully review the ERC guidelines before trying to claim the credit as promoters continue pushing ineligible people to file.

Since the Fall of 2022, the IRS has issued several warnings to employers to beware of third parties promoting improper Employee Retention Credit (ERC) claims. With tax filing season in full swing, tax professionals are requesting guidance to ensure they are meeting their Circular 230 professional responsibilities and the standards required to prepare and sign original tax returns, amended returns, or claims for refund relating to these credits.

I. Purpose and Operation of the ERC

The ERC is a refundable tax credit that Congress enacted in 2020 as part of the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act). The ERC was enacted for businesses (employers) who continued paying employees during a shutdown due to the COVID-19 pandemic or who experienced significant declines in gross receipts, from March 13, 2020, to December 31, 2021. Eligible employers may claim the ERC on an original or amended employment tax return for a period within those dates.

To be eligible for the ERC, employers must have:

  • Sustained a full or partial suspension of their business operations in compliance with orders from an appropriate governmental authority limiting commerce, travel, or group meetings due to COVID-19 during 2020 or the first three quarters of 2021,
  • Experienced a significant decline in gross receipts during 2020 or a decline in gross receipts during the first three quarters of 2021 because of COVID-19, or
  • Qualified as a recovery startup business for the third or fourth quarters of 2021. (Only recovery startup businesses are eligible for the ERC in the fourth quarter of 2021.)

The amount of an employer’s eligible ERC depends on several factors, including the number of employees, the amount of the employer’s payroll and gross receipts, and whether the employer paid any sick or family leave wages. Significantly, the amount of the ERC reduces the employer’s allowable wage deduction on its income tax return. In addition, eligible employers cannot claim the ERC for any quarter for which wages were reported as payroll costs in obtaining Payroll Protection Plan (PPP) loan forgiveness or were used to claim certain other tax credits.

In its news releases, the IRS warned employers that some third-party advisers were urging employers to claim the ERC without appropriately informing them of limitations on eligibility and the correct computation of the credit. Often this advice—for which these third-party advisers usually charge hefty upfront fees or a fee contingent on the amount of the refund—has led some employers to claim excessive ERCs based on improper positions. The IRS has urged affected employers to file amended returns to correct the excessive ERC claims and minimize interest charges and possible penalties.

In a related development, the IRS Criminal Investigation Division and the US Department of Justice have initiated criminal investigations and in some cases indictments against promoters (and other enablers) of excessive ERC claims.

II. Tax Professionals’ Role in ERC Compliance

The IRS’s outreach efforts to employers about possible excessive ERC claims have prompted requests from tax practitioners for the IRS—and, in particular, the Office of Professional Responsibility (OPR)—to provide guidance on their professional responsibility obligations in connection with clients’ ERC claims, including prior federal tax returns claiming the ERC that the practitioners did not themselves prepare.

To fulfill their professional obligations to clients and to tax administration, practitioners—attorneys, certified public accountants, and enrolled agents—must meet the applicable provisions in Circular 230, Regulations Governing Practice before the Internal Revenue Service (31 CFR Subtitle A, Part 10). Circular 230, which the OPR administers and enforces, has several provisions that are implicated when dealing with a client who has claimed or is seeking to claim an ERC.

When a practitioner enters into an engagement with a client who has claimed the ERC, wants to claim it, or asks about the possibility, the practitioner needs to have or gain an in-depth knowledge of the credit, especially its eligibility criteria. The practitioner must also follow Circular 230’s requirements of: (1) due diligence in the practitioner’s advice and in preparing and filing returns (including the specific standards in section 10.34); (2) full disclosure to a client of their tax situation; and (3) reasonable reliance on client-provided information and on any advice provided by another tax professional.

If a practitioner has reason to believe that a client’s excessive ERC claim is owing to the client’s reliance on erroneous or improper advice from another practitioner, tax return preparer, or other third party, the practitioner should, consistent with Circular 230 and the guidance above, advise the client of the overstated claim and any additional tax and penalties that could apply and, if requested, competently assist the client in correcting or mitigating the problem. The practitioner should also consider informing the client of the opportunity to file a complaint about the other adviser using Form 14242, Report Suspected Abusive Tax Promotions or Preparers.

Note from the Editor: This has been an issue with many tax professionals, regarding their liability if preparing an amended return for the ERTC, and they are aware the credit was issued in error. During the NSTP Ethics seminars we will discuss this issue and your potential exposure.