In the wake of the recent increase in the popularity of the Employee Retention Credit (ERC), many business owners have begun their search for a credible ERC advisor while a multitude of opportunistic “ERC mills” flood the market to offer their services. Our company recently published an informative article addressing what an ERC mill is and how to spot one. However, ERC mills are not the only ERC advisors offering services that they may be ill-equipped to provide. For example, we have seen boutique CPA firms, large accounting firms, and law firms provide ERC advice that either (i) causes their client to believe that they are ineligible for the ERC based on a misinterpretation or lack of knowledge of the law, or (ii) causes their client to believe that they are eligible for a credit that far exceeds the ERC that such client is entitled to under the law. Both mistakes can result in a costly, time-consuming headache for an employer seeking assistance with the ERC.
When discussing the ERC with potential clients, we are often asked “what is the worst outcome, other than IRS-imposed interest and penalties, that can result from engaging the wrong ERC advisor?” This article will discuss some of the pitfalls and risks business owners face when they retain an inexperienced ERC advisor to determine their “eligible employer” status and to calculate “qualified wages” under the ERC legislation.
1. Getting the FTE Count Wrong. Many retail and hospitality business owners (very often restaurants) tell us that their accountant advised that they were too large to take the ERC because they had more than 100 employees (i.e., the 2020 small employer full-time employee (FTE) threshold) or more than 500 employees (i.e., the expanded 2021 small employer FTE threshold). However, when we dig into the client’s FTE reporting documentation, we discover that the same client had far less FTEs (i.e., employees that worked at least 130 hours per month) than their accountant suggested based on an inaccurate FTE count that either (i) counted all W-2 employees as FTEs, or (ii) counted full-time employee equivalents as FTEs. Therefore, in some cases, instead of being eligible for zero dollars (as advised by their accountant), a client with 1,000 W-2 employees, but only 400 FTEs, may be eligible for a seven-figure ERC for the 2021 eligibility period. We have corrected this mistake countless times and have explained to our clients that the FTE count was miscalculated, and they almost completely missed out on a substantial credit.
2. Misapplication of the Aggregation Rules or Related Parties Rule. Entities must be aggregated for ERC analysis purposes for the following reasons: (i) five or fewer individuals own 80% or more of multiple employers (i.e., a “brother-sister controlled group”); (ii) an employer owns greater than 50% of another employer (i.e., a “parent-subsidiary controlled group”); (iii) two or more professional service organizations are deemed to be an “affiliated service group”; or (iv) a “management organization” receives greater than 50% of its revenues from a “managed employer” (or related group of “managed entities”).
Our experience is that the vast majority of ERC advisors do not understand how to properly apply the aggregation rules, which may result in one of the following three unfortunate outcomes: (i) an ERC advisor improperly concludes that the employer is part of an aggregated group that is too large to take the credit (which can result in completely missing out on a potentially substantial credit); (ii) an ERC advisor fails to realize that the employer is part of an aggregated group that is too large to take the ERC and they file for an ERC for which they are objectively ineligible; or (iii) an ERC advisor fails to take advantage of the fact that when a given entity is aggregated with other entities, it may turn on eligibility for such other entities that may not have qualified on a stand-alone basis (as ERC eligibility tests are applied on an aggregated basis). If such aggregated group is too large to take the credit, and the IRS discovers the misapplication of the aggregation rules, the employer will have to forfeit their entire credit (perhaps with interest and penalties).
Business owners are prohibited from filing for the ERC on wages paid to relatives of a majority equity owner of a business (e.g., parents, siblings, spouses, aunts, uncles, nieces, nephews, etc.). Unfortunately, we have discovered that many ERC advisors neglect to ask their clients if any employees are related to a majority owner, and, therefore, fail to remove any related party wages from the ERC calculation. The IRS’ request for documentation regarding the ERC (the precursor to an ERC audit) asks whether any employees are related to a majority owner; therefore, related party wages are “low-hanging fruit” for the IRS to claw back if your ERC advisor misapplied, or failed to apply, the related party rules.
3. Misunderstanding the Partial Suspension Test. The partial suspension test is often misunderstood and misapplied. Some ERC advisors (think traditional CPA firms) take an overly conservative reading of the Partial Suspension Test and conclude that a business is only eligible during times in which it was completely shut down by governmental order (i.e., a Full Suspension) or an overall revenue decline was present. Contrary to this overly conservative reading, the rules call for a Full or Partial Suspension of Operations and IRS Notice 2021-20 gives extensive examples of companies that are eligible for the ERC during periods in which they continued to operate, provided (i) more than a nominal portion[1] of such business operations were subject to modifications due to a COVID governmental order, and (ii) such modifications had more than a nominal effect[2] on such more than a nominal portion of such business operations.
4. Abuse of the OSHA General Duty Clause. On the other end of the spectrum, overly aggressive ERC advisors (think ERC mills) take too liberal a reading of the Partial Suspension guidance and claim that every company in the U.S. is eligible for the ERC. One argument that these ERC mills make is that every company in the U.S. was subject to OSHA’s General Duty Clause for the entirety of the ERC eligibility period (March 13, 2020, through September 30, 2021). The General Duty Clause requires every employer to provide every employee with a place of employment that is free from recognized hazards that are causing, or are likely to cause, death or serious physical harm.
The broad intent of the Partial Suspension legislation was to allow companies to seek ERC eligibility for instances in which executive orders enacted during the pandemic to slow the spread of COVID restricted their business operations (think social distancing orders, increased hygiene orders, and orders prohibiting employees from accessing their workplace within a set number of days after contracting COVID). These Partial Suspensions ceased to exist when the COVID executive order that restricted a business’ operations was lifted. For instance, a Miami-Dade County restaurant that is restricted only by the local Miami-Dade County social distancing order is no longer under a Partial Suspension once that order is lifted, and almost all social distancing orders in the country were lifted by the end of Q2 2021 (i.e., the penultimate ERC eligible quarter under the Partial Suspension test). The intent of the Partial Suspension legislation was not to allow every company across the country to seek ERC eligibility, in reliance on the General Duty Clause, for periods after their local social distancing order was lifted.
5. Abuse of the Supply Chain Argument. Per Question 12 of IRS Notice 2021-20, an employer may be considered partially suspended if the business’ suppliers are unable to make deliveries of critical goods or materials due to a governmental order that causes the supplier to suspend its operations. A reasonable and balanced interpretation of this guidance is that, if: (i) your supplier is U.S.-based; (ii) your supplier is under a Full or Partial Suspension due to a domestic COVID executive order; and (iii) your supplier’s Full or Partial Suspension is causing your business operations to experience a more than nominal effect (i.e., due to a lack of necessary goods or materials), you may also be under an “indirect” Partial Suspension.
Unfortunately, some ERC mills are using this “supply chain hook” to advise their clients that almost all difficulties or delays in obtaining goods or materials through the supply chain can substantiate a Partial Suspension. The most problematic of these arguments is that: (i) a foreign supplier subject to a foreign COVID executive order can cause your business to be Partially Suspended; and (ii) any delay in receipt of foreign goods, perhaps due to delays at the eastern or western seaboard ports, can substantiate a Partial Suspension for your business. A well-crafted Full or Partial Suspension argument requires a strict and mechanical application of the guidance set forth in IRS Notice 2021-20.
6. Misapplication of the PPP/ERC Interplay. An employer may not file for the ERC on the same employee wages reported for PPP loan forgiveness. This is often referred to as the anti-double-dipping rule, as receiving the ERC on a government-provided PPP dollar would doubly benefit the employer. When designating wages as “ERC wages” after an employer has had a PPP loan forgiven, an ERC advisor must take a thoughtful approach to ensure the client is not engaging in “double-dipping,” while concurrently deploying a strategy to maximize the ERC-qualified wages.
More sophisticated ERC advisors preserve the largest permissible pool of ERC wages while “deeming out” ineligible PPP wages by (i) looking inside and outside the PPP covered period to maximize the ERC eligible wages on an individual employee level, and (ii) looking to designate wages of high-earners and wages that exceed the $10,000 per-period ERC cap as PPP wages (as those wages could not be ERC eligible wages). Unfortunately, these more sophisticated techniques are not used by many ERC advisors, particularly traditional accounting and CPA practices. Inexperienced ERC advisors often take a more simplified approach in (i) refusing to look inside your PPP-covered period for ERC-eligible wages, or (ii) 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 amounts used to pay employees. In both approaches, the ERC advisor has not maximized the ERC amount.
Conclusion. The issues detailed above are not an exhaustive list of the matters that can go wrong in engaging an inexperienced or overly aggressive ERC advisor. Of course, while not extensively covered in this article, punitive actions in the form of interest and penalties imposed by the IRS on overclaimed ERC may also result. Falling victim to the pitfalls referenced above may either: (i) cause you to leave ERC dollars on the table (perhaps even your entire ERC claim in some instances), or (ii) cause you to file for ERC amounts to which you are not truly entitled. The pitfalls outlined above are just some of the reasons why you should seek an experienced and credentialed group of both accountants and attorneys to help you navigate the complex and nuanced ERC landscape.
Sagemont Tax is the only ERC advisory firm to have CPAs from the largest accounting firms in the world under the same roof as attorneys from the largest law firms in the world. Sagemont Tax combines decades of first-in-class tax advisory experience, gained at highly reputable firms such as Deloitte, KPMG, RSM, and Alvarez & Marsal, with legal support from some of the largest, most sophisticated law firms in the world to deliver comprehensive and thoughtful ERC advisory services that are unparalleled in the ERC service industry. Where many ERC providers offer a “one-size-fits-all” approach, Sagemont Tax provides a tailored, white-glove service that is demanded by business owners and management teams.
To learn how Sagemont Tax and its team of advisors stands out from other ERC firms, visit the Sagemont Tax Difference.
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Written by Kyle Morabito, Esq., Chief Legal Officer and Managing Director of Sagemont Tax
[1] See IRS Notice 2021-20, Question 11, which provides that “A portion of an employer’s business operations will be deemed to constitute more than a nominal portion of its business operations if either (i) the gross receipts from that portion of the business operations is not less than 10 percent of the total gross receipts (both determined using the gross receipts of the same calendar quarter in 2019), or (ii) the hours of service performed by employees in that portion of the business is not less than 10 percent of the total number of hours of service performed by all employees in the employer’s business (both determined using the number of hours of service performed by employees in the same calendar quarter in 2019).”
[2] See IRS Notice 2021-20, Question 18, which provides that “A governmental order that results in a reduction in an employer’s ability to provide goods or services in the normal course of the employer’s business of not less than 10 percent will be deemed to have more than a nominal effect on the employer’s business operations.”
