Common Mistakes Made By ERC Service Providers
Choosing a compliance-focused and experienced Employee Retention Credit (ERC) service provider is of paramount importance in your efforts to compliantly and effectively benefit your business. In this article, we cover some of the most common mistakes made by ERC preparers, simplified definitions of technical ERC terms, and what makes the difference between a quality ERC firm and one that takes the easy way out.
These are 5 of the most common ERC mistakes we see:
Getting the Aggregation Rules Wrong
Aggregation is the process of combining entities that are related to each other for one or more reasons related to ownership, management, or operational services between the entities. A controlled group is a group of entities that are aggregated with each other pursuant to the aggregation rules.
In all aspects of claiming the ERC, entities are required to aggregate themselves per the aggregation rules outlined by the IRS and by statutory and administrative law. ERC claimants are subject to aggregation under sections 52(a), 52(b), and 414(m) of the tax code. Sections 52(a) and 52(b) cover aggregation based on shared/overlapping ownership, and Section 414(m) covers aggregation based on affiliated service group rules.
Common mistakes made when analyzing an entity for aggregation requirements include mistakenly aggregating entities that are not in the same controlled group, or failing to properly aggregate the members of a controlled group. Either of these mistakes could result in an improper claim or lead a taxpayer to believe it is ineligible to claim the ERC when it is in fact eligible.
Aggregating entities that should not be aggregated can cause an employer to be erroneously deemed too large to be an eligible employer for most purposes, resulting in a missed opportunity to receive the ERC. Failing to aggregate entities that should in fact be aggregated can cause a large employer to believe that it is below the applicable “large employer” threshold(s), resulting in a non-compliant ERC claim.
Additionally, erroneous aggregation will cause unaggregated entities to be lumped together for ERC eligibility assessment purposes, often causing eligible entities to be deemed ineligible or ineligible entities to be deemed eligible. Similarly, failing to properly aggregate a controlled group will result in mistakenly assessing eligibility for aggregated entities on an individual basis, which will also often result in eligible entities being deemed ineligible or ineligible entities being deemed eligible. Taxpayers and ERC preparers that fail to properly account for aggregation rules run the dual risk of leaving money on the table and filing non-compliant ERC claims.
What can be done
When dealing with multiple related entities, it is critical to appropriately determine aggregation and controlled groups under the ERC rules. To avoid the potential complications that come with over- or under-claiming the ERC based on misapplication of the aggregation guidelines, a knowledgeable and compliance-focused team of ERC professionals can help ensure your claim meets all the requirements of the aggregation rules. Taking the care and necessary steps to avoid aggregation mistakes will not only help you maximize your business’s lawful credit, but it can also help you avoid potential adverse outcomes like an IRS clawback, interest, and/or penalties.
Misinterpreting the FPSO Test
Full or Partial Suspension of Operations (FPSO) is one of the two primary ways of qualifying for the ERC. It consists of a full or partial suspension of an employer’s operations due to mandatory government orders applicable to its operations, provided the suspension had more than a nominal effect on the employer’s operations. Per the IRS’s safe harbor rule, a partial suspension of operations is considered to have more than a nominal effect if it causes the suspension of at least 10% of an employer’s operations as measured by employee hours or gross receipts. Significant Decline in Gross Receipts (SDGR) is the other primary ERC qualification test, which compares a business’s gross receipts in a 2020 or 2021 calendar quarter to its gross receipts in the corresponding quarter of 2019.
While the black-and-white SDGR test is relatively simple to apply, many ERC service providers misinterpret or misapply the more subjective FPSO test when determining ERC eligibility.
A full suspension of operations is pretty straightforward. This would be when a business experienced a government-mandated full closure of operations. However, a partial suspension of operations is more ambiguous. The term “more than a nominal effect” can be difficult to define or determine, even with the assistance of the above-noted 10% safe harbor rule. Accordingly, it is often challenging to gauge the merit of an ERC claim that is based on this relatively subjective test.
Taking advantage of the ambiguity surrounding partial suspensions of operations, some less-than-scrupulous ERC service providers will take aggressive positions, unsupported by either the law or common sense, and gladly prepare weak claims on behalf of their clients. Moreover, even where a qualifying suspension exists, these firms will often go overboard and claim the ERC for wages paid on dates when no orders applied or there was no more than nominal effect. These claims run an especially high risk of being subject to IRS clawback, interest and/or penalties upon examination.
Conversely, some ERC preparers will take overly conservative approaches to partial suspensions, such as only assisting employers who experienced a full suspension of operations (or experienced the suspension of their main business segment). These providers, too, fail to properly apply the rules on behalf of their clients. Some businesses that are actually eligible based on a qualifying partial suspension of operations may be told by their CPA or tax preparer that they do not qualify for the ERC, based on an unnecessarily narrow understanding of the more than nominal effect requirement.
What can be done
Of course, the appropriate balance between these two extremes lies in actually understanding the rules, examining the effects of government orders on the business’s operations, and using qualified professionals to assist with FPSO determinations.
In contrast to an ERC firm that will consider your business eligible or ineligible without much thought or scrutiny, a qualified ERC preparer will undertake extensive research and analysis of the impact that COVID-19 government mandates had on your business operations. This process requires an understanding of the specific requirements imposed upon your business, the business operations you perform, and an accurate depiction of the individual effects suffered by your business due to COVID-19 government orders. Few firms have the expertise and willingness to put in the hours of work necessary to effectively gauge whether a qualifying partial suspension applied to your business – but it’s well worth identifying and engaging a firm that does.
Reliance On Non-Qualifying Effects
OSHA – Occupational Safety and Health Administration is a federal agency, part of the Department of Labor, that sets the standards for creating safe and healthy work environments at the federal level. CDC – Centers for Disease Control is the national public health agency of the United States, part of the Department of Health and Human Services. The Supply Chain Argument attempts to make the case for FPSO eligibility based solely on supply chain issues suffered by the taxpayer.
As if being ill-prepared to assess and establish an FPSO claim wasn’t risky enough, some firms will blanket-claim the ERC for essentially any business based on weak positions like OSHA or CDC guidance, or by making a Supply Chain Argument.
The CDC/OSHA argument rests on general guidance issued by these 2 federal agencies recommending various measures to mitigate the spread of COVID-19. Some ERC preparers encourage their clients to rely on CDC or OSHA guidance as government orders for purposes of FPSO qualification.
Reliance on federal OSHA or CDC guidance is tenuous at best. If federal OSHA guidance alone were enough to substantiate a claim for the ERC, then all employers in the U.S. could potentially qualify – which was not likely Congress’s intent in creating the ERC program, and is certainly not in compliance with applicable IRS guidance. A more reasoned perspective on OSHA, CDC, and other generally-applicable federal guidance is that if a state or local order required businesses to comply with aspects or all of such guidance, then those guidelines are incorporated into qualifying orders for ERC purposes. Otherwise, they should not be considered toward eligibility.
When it comes to the Supply Chain Argument, some ERC firms will apply general supply chain issues (which, as with the OSHA argument, nearly all employers dealt with in some capacity). Sometimes they will even consider supply chain issues caused by foreign COVID-related orders, which do not meet the requirements for qualification. While supply chain disruptions can qualify where they are attributable to qualifying government orders, the Supply Chain Argument (as defined above) appears to be based on a misreading of the IRS’s published guidance on the ERC program.
Using an ERC service provider who relies on shaky arguments like federal CDC/OSHA guidance or the Supply Chain Argument will likely result in a shoddy and weakly-supported ERC claim, even if the claimant actually qualifies to claim the ERC.
What can be done
Instead of using an ERC service provider who relies on weak positions and takes the easy way out, focus on establishing the best claim possible with due diligence and a compliance-focused approach. This approach will give your business the best chance of claiming the ERC safely and appropriately. The Supply Chain Argument can be effective when used correctly and in compliance with Q&A 12 of IRS Notice 2021-20, which requires the facts and circumstances of the supply chain issue to substantiate a full or partial suspension of operations. The simple truth is this – not every business suffered more than a nominal effect due to COVID-19 government orders, and you want a firm that will tell you the truth and put together the best possible case for eligibility if you indeed have a valid claim.
Misapplying the PPP/ERC Interplay Rules
“Anti-double-dipping” is a common term used for rules that aim to avoid an entity receiving duplicative government benefits. ERC-eligible wages are subject to anti-double-dipping rules as they apply to forgiven Paycheck Protection Program (PPP) loans. PPP loans are government-funded loans made to businesses during the COVID-19 pandemic to fund (among other things) wages paid to workers. Forgiven PPP Loans are PPP loans whose repayment has been forgiven in whole or in part.
Generally speaking, a business’s ERC claim may not overlap with wages funded by Forgiven PPP Loans (or the forgiven portions thereof). Applying the anti-double-dipping rules to an ERC claim in the most favorable manner for the claimant can be quite tedious. Inexperienced ERC preparers might take a more simplified approach by failing (or refusing) to examine your PPP-covered period for ERC-eligible wages, or by designating the first wages paid within a PPP-covered period as non-ERC-eligible until such bucket of wages reaches the amount that the employer reported to its PPP lender as the amount used to pay employees. Neither approach will maximize the ERC amount your business is eligible for.
What can be done
The more difficult approach, and often the better approach for the client, is to analyze wages at the individual employee level to compliantly maximize the wages allocated towards the ERC refund. Engaging an ERC service provider that is able and willing to thoroughly analyze your payroll records on an individual employee level will help maximize the benefit you receive from the ERC.
FTE stands for Full-Time Employee. An employee must work at least 130 hours per month to qualify as an FTE. “Full-Time Equivalents” do not count toward the FTE count. A Small Employer with respect to 2020 eligibility is one that had (an average of) up to 100 FTEs in 2019, and with respect to 2021 eligibility is one that averaged up to 500 FTEs in 2019. A Large Employer with respect to 2020 eligibility is one that had more than 100 FTEs in 2019, and with respect to 2021 eligibility is one that had more than 500 FTEs in 2019. A Large Employer is ineligible for the ERC except with respect to wages paid to employees for time the employees spent not providing services.
Too often, FTE counts are miscalculated by firms that erroneously count all W-2 employees without accounting for the number of hours worked by each employee. This frequently results in business-owners being turned away as a large employer who is ineligible to claim the ERC, when in fact they may have had less than 100 or 500 full-time employees as defined by the applicable rules. This mistake particularly plagues businesses in the hospitality industry, as they often have high overall employee counts but with many part-timers, and thus do not necessarily have high FTE counts.
What can be done
Properly counting FTEs can make all the difference when determining whether your business qualifies to claim the ERC with respect to wages paid to employees. For example, a business may employ 250 people, but its average monthly FTE count in 2019 was only 87. This business can qualify as an eligible employer for the ERC for both 2020 and 2021. An inexperienced ERC preparer might take the employee count of 250 at face value and write off 2020 accordingly, leaving funds the business is entitled to unclaimed.
Claiming the ERC can be quite complicated, and it’s not something you or your business wants to get wrong. With nuanced rules to follow, various tests to apply, and thorough analysis needed to make an appropriate and compliant claim, not every ERC firm is equipped to provide the high level of service necessary.
At ERTC Funding, helping you maximize your lawful ERC claim is our mission. Doing so with a compliance-focused, leave-no-stone-unturned approach is what makes the difference between the average ERC services firm and one that cares deeply about doing things the right way in the interest of its clients.