Sagemont Tax CEO Kenneth Dettman, CPA, and Andrew Rubin, Director of Tax Insurance at WTW, join Eric Green of the Tax Rep LLC Network to discuss the latest developments on ERC audits and related tax topics including the role of “tax insurance” to protect your ERC claim.
Here are some highlights from their conversation:
Can a claimant ultimately blame the ERC mill who prepared their claim for penalties in money and interest?
Kenny: “The IRS recently released their fourth warning on ERC mills, stating that the taxpayer/employer is ultimately responsible. According to the IRS, due diligence requires you to understand the position that you rely on for the purpose of eligibility and to ensure that you are working with a professional and reputable provider that has the requisite credentials to be providing [a specialized tax] service.”
What else makes working with an ERC mill a very costly mistake?
Kenny: “Many of these ERC mills are charging exorbitant fees that range from 25% – 35% of the credit claimed. There’s a very low chance that fee is going to be returned to you in three to five years when the IRS is looking at your filing and making an unfavorable adjustment.”
How do you substantiate partial suspension?
Kenny: “The IRS requires the claimant to highlight the sections of the executive order(s) that led to restrictions and modifications on which they are basing their claim. One avenue allows you to claim an ERC based on a suspension of a part of your business that represents more than 10% of revenues or service hours while looking back to 2019 as a testing period; This can be proven out very objectively with financial data. The “more than nominal effect” avenue to eligibility is more complicated. Here the IRS is asking you to prove that due to the restrictions and modifications under governmental order(s), there was a more than nominal effect on the ability of the business to provide the same services. ‘Nominal’ is probably the most important and the most challenging word within the notice as it relates to partial suspension and the effect on the ability of an employer to provide goods or services and is a confusing process for most businesses to determine. We can measure the output, look at revenues, and review key performance indicators (KPIs), but how do we also calculate the ability? A lot of times it’s really just detailed qualitative descriptions of what a business did. For example, let’s look at a doctor’s office that had to shut down their waiting room. Doctors offices’ spaced out their appointments by an extra 10-15 minutes. Now, we have a quantitative measure. If they were doing three appointments per hour and now they’re only doing two appointments per hour, then they reduced their ability to service patients by 33% (i.e., a reduction of 1/3rd). Then you add the final step of proving their waiting room was closed. Those are the three pieces that you’ve got to put together to prove a “more than nominal effect”.”
Where will the government be focusing its fraud efforts?
Kenny: “The IRS will obviously be looking for blatant intentional fraud, but they will also be focused on the gross abuse of partial suspension eligibility. I think the IRS is going to draw a hard line with businesses that continued to operate by pivoting to other means of service, such as a telework platform. In these situations, the taxpayer may not be able to prove that productivity was not reasonably equivalent to pre-pandemic productivity. Furthermore, I don’t think that the IRS is going to accept generalized facts and circumstances-based arguments. In connection with many facts and circumstances-based tests, the IRS often complements such tests with “safe harbors”, a legal provision to reduce or eliminate liability and uncertainty in subjective tests by providing a supplemental definition of a test/rule that relies on quantitative, objective measurements. The IRS is going to want to at least see an effort that businesses tried to prove out these safe harbors and if those don’t exist, or if there’s no documentation at all, it’s going to lead to a proposed adjustment.“
Are there resources beyond the IRS’s guidance that will help businesses document and substantiate their claim?
Kenny: “Our firm has produced probably the best practical guide out there on what is needed in terms of meeting the substantiation requirements for ERC. This guide looks at the Information Document Request (IDR) and the actual quantitative and qualitative materials that would be used to substantiate and meet these requests. The IRS came out with their own training manual for their examiners that was really just a compilation of the original three IRS notices – so nothing new. Then they later came out with eight to nine hundred slides that they use to train their auditors – again, really nothing new. Our guide mirrors what we are asking our clients to provide according to what the IRS says it is going to ask for. I strongly recommend [for employers claiming the ERC] to be prepared and have these items on standby.”
Access Sagemont Tax’s “The Practical Guide to Avoiding an ERC IRS Audit”
How does tax insurance work?
Andrew: “Tax insurance overall is meant to protect the taxpayer against financial downside in the event of an IRS audit. What does financial downside include? If your claim is adjusted, the IRS is going to give you a bill not only for the tax, which is the reclamation of the credits, but also for interest and penalties, and you’re going to have to expend your own costs to pay the same. So, the tax insurance policy is fulsome. It will also cover any contest costs if you decide to dispute an audit and what we call tax gross-up, which essentially means if you do get paid out from the policy those proceeds may be taxable to you as a taxpayer. Overall, the tax insurance policy really makes a taxpayer whole in the event of an IRS auditor challenge.“
Learn more about Sagemont Tax’s Tax Refund Guarantee
When do you buy tax insurance?
Andrew: “Optimally, we would place it at the time the claim is filed with the IRS. So, when you send in 941-Xs in, you would also buy the insurance policy. However, if you’ve already filed your claim and you’ve received the refund, or you’re waiting to receive the refund, you can still place the tax insurance policy and it will be effective in the event the claim is denied. There is still an opportunity to obtain tax insurance if you are under audit, but the policy in this situation will most likely be more expensive.”
Is it fair to say that the insurance company will require a business who worked with an ERC mill to work with a new firm to fill in the gaps?
Andrew: “That’s fair to say. We’ve had people come to us where there’s been a limited analysis on the first go round. That’s where we see the biggest gap right now. After reviewing and vetting Sagemont Tax’s process, I can say Kenny’s company is doing a great job of thoroughly conducting second look analyses. Everyone knows what the orders are, but how those orders actually applied to your business and caused a more than nominal effect, can be difficult to quantify. We’re hearing from the IRS that they are digging in on this and they’re asking companies to have an analysis ready to go. If you have that analysis ready to go, and even if you don’t, you can consult with us [WTW] and we’ll work with you. That’s what makes a good broker. We know what the insurance market looks like right now and what they don’t like. In order to get the best pricing and even to generate terms overall, come to us and we can guide you through the insurance process.”
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