Employee Retention Credit
The Employee Retention Credit (ERC) is a refundable tax credit against certain employment taxes that was intended to help businesses and non-governmental tax-exempt organizations cover the cost of keeping workers employed during the pandemic. The ERC was originally created under Section 2301 of Coronavirus Aid, Relief, and Economic Security Act (the CARES Act), and extended and expanded under Section 3134 of the American Rescue Plan Act of 2021 (the ARPA). The amount of the ERC is based on the percentage of the “qualified wages” (including allocable qualified health plan expenses) an eligible employer pays to employees.
Eligibility - For calendar year 2020, employers were generally eligible to claim the ERC if they operated a trade or business during the calendar year and experienced either: (i) a full or partial suspension of the operation of their trade or business during any calendar quarter on account of a governmental order limiting commerce, travel or group meetings due to COVID-19; or (ii) a significant decline in gross receipts by more than fifty (50%) percent when compared to the same quarter in 2019 (beginning with the calendar quarter starting January 1, 2020).
For calendar year 2021, employers were generally eligible to claim the ERC if they operated a trade or business during 2021 and experienced either: (i) a full or partial suspension of the operation of their trade or business during a calendar quarter on account of a governmental order limiting commerce, travel or group meetings due to COVID-19; or (ii) a decline in gross receipts in the 1st, 2nd or 3rd calendar quarter in 2021 where the gross receipts of that calendar quarter are less than 80% of the gross receipts in the same calendar quarter in 2019 (i.e., a 20% or more decrease).
ERC Claims – To the extent an employer did not claim the ERC on its original quarterly Form 941, the employer could retroactively claim the ERC by filing an amended Form 941-X payroll tax return. The deadline for filing ERC claims expired on April 15, 2024 for claims related to 2020 and on April 15, 2025 for claims related to 2021. As of this past April, over 597,000 ERC claims remained unprocessed, including approximately 11,000 unresolved cases submitted through the Taxpayer Advocate Service.
Subject to certain limited exceptions, the general three (3) year statute of limitations under Code § 6501 expired on April 15, 2024 for all calendar quarters of 2020, and on April 15, 2025 for the 1st and 2nd calendar quarters of 2021 (assuming no fraud or misrepresentations, in which case there is no statute of limitations).[1] The statute of limitations for the 3rd quarter of 2021 expires on April 15, 2027 (i.e., five (5) years from April 15, 2022 – assuming no fraud or misrepresentation).[2]
Additionally, pursuant to Code § 7405(b) and § 6532, the IRS has two (2) years to pursue civil litigation to recover an erroneous refund. This two (2) year period runs from the date of the refund and is extended to five (5) years if the refund was induced by fraud or misrepresentation of a material fact.
Denial of Refunds Filed After January 31, 2024 – As currently drafted, the proposed tax legislation provides that ERC claims filed after January 31, 2024 shall be disallowed regardless of whether such claims were timely and validly filed under existing law. In light of the fact that the earliest date the statute of limitations expired for filing ERC claims was April 15, 2024, this change has the potential to retroactively deny bona fide claims filed by businesses and tax-exempt organizations related to both calendar year 2020 and 2021.
Extension of Statute of Limitations - The proposed tax legislation also contains provisions that extend the statute of limitations on assessments relating to the ERC to six (6) years for all applicable calendar quarters. As currently proposed, the six (6) year period runs from the later of (i) the date the original return was filed, (ii) the date the return is treated as filed under Code § 6501(b), (iii) or the date on which the claim for credit or refund for the ERC was made. While some employers claimed the ERC on their original quarterly Form 941, a substantial number of employers claimed the ERC by subsequently filing an amended Form 941-X for the applicable calendar quarter(s) in which they qualified. Accordingly, this provision has the potential to substantially extend the statute of limitations for the majority of employers who claimed the ERC.
The IRS has issued numerous statements and warnings regarding potential fraud and abuse related to the ERC. In particular, the IRS has justifiably expressed concern about aggressive marketing tactics employed by third-party ERC promoters who purportedly encouraged businesses to apply for the ERC even when the facts or law did not support qualification. In fact, the IRS previously placed a moratorium on processing ERC claims to free-up resources to ferret-out fraudulent ERC claims. The moratorium, however, also had the undesirable effect of significantly delaying the processing of refunds to employers who submitted bona fide ERC claims.
The retroactive nature of these changes has the potential to deny bona fide claims timely made in good faith by employers based on existing law and applicable IRS guidance. In addition, while the IRS has previously asked Congress for an extension of the statute of limitations due to the overwhelming number of ERC claims submitted (many of which are still awaiting processing), the retroactive extension of the statute of limitations will undoubtably create substantial uncertainty for employers who claimed the ERC. For example, in the merger and acquisition context, buyers and sellers commonly negotiated indemnity provisions and escrow arrangements tied to ERC claims made by the seller. In situations where these terms are tied to the running of existing statute of limitations, the buyer’s rights to indemnification could potentially be extended for a substantial period of time. Additionally, buyers will need to continue to consider the risks associated with potential ERC assessments against a seller in connection with any pending or contemplated transaction.
Due to substantial push-back from employers and the potential for substantial legal challenges to the retroactive nature of the proposed ERC changes, the House is currently in the process of proposing amendments to the OBBB that would eliminate all of the ERC provisions contained in the OBBB. Additionally, as the Senate considers the proposed tax legislation, it is crucial for employers, businesses, investors, and stakeholders to stay informed and engaged. Buchanan’s attorneys and government relations professionals will continue to monitor and provide additional analysis, as well as personalized guidance on navigating the complexities of the proposed tax provisions. In addition, our government relations team can help your business have a seat at the table with complex policy advocacy, supporting key relationship-building, and strategic planning that supports your short and long-term business goals.
[1] An employment tax return filed by April 15th of the following calendar year for any calendar quarter ending within the preceding calendar year is considered filed as of April 15th, regardless of the quarter to which the return relates. See, Code §6501(b)(2).
[2] Under ARPA, the statute of limitations for assessment of any amount attributable to ERC claims was extended from three (3) years to five (5) years for the 3rd and 4th calendar quarters of 2021.
Author:
John E. McGrady, III, Shareholder
Email: john.mcgrady@bipc.com