PEOS MUST PROCEED WITH CAUTION WITH EMPLOYEE RETENTION CREDIT

As a result of the COVID-19 pandemic, Congress enacted the Employee Retention Credit (ERC), to help taxpayer businesses weather the storm. But despite the genuine benefit that ERC provides to qualifying businesses, the IRS has been faced with many fraudulent and questionable claims.

As a result, the Service has initiated aggressive enforcement actions centered on this credit.

The wave of IRS audits, inquiries and assessments has spurred concern for taxpayers across the country and has even resulted in firms selling ERC insurance. Importantly, several Professional Employer Organizations (PEOs) have found themselves in a precarious situation (beyond ERC processing times) as IRS audits have started to hit their clients.

PEOs file ERC on behalf of their clients. Typically, these PEOs file Form 941s in aggregate under its own Employee Identification Number (EIN). These filings should include a Schedule R that describes aggregated wages and credits claimed for each of the PEOs clients.

As PEOs claimed ERC on behalf of their pool of clients, several issues of liability began to come into question. For example, the IRS stated in 2023 that it has the authority to satisfy a PEO’s tax liability with amounts of the PEO clients’ ERC claims.

Now, another concern has come into play. This issue rears its head when the IRS audits a PEO’s client (or client base) and finds ineligible ERCs. In this case, the IRS has made its stance clear: the PEO is jointly on the hook with its clients’ for ERC liabilities.

Although there is disagreement in terms of whether or not PEOs are liable for their clients’ claims, and the issue likely will continue to play out before the agency and in the courts, the IRS made its position clear in Chief Counsel Memorandum 2024-001.

According to the Service, when “improperly claimed credits are claimed by a PEO for its client, and the credit claim is based on the wages paid by the PEO to the client’s employees and reported on the PEO’s employment tax return, both the PEO and its client are liable for any underpayment of tax resulting from the improperly claimed credits.”

This burden has put certain PEOs, who simply cannot afford the liability for their client base in total, in a quandary.

The truth is that, for PEOs who already find themselves on the hook for an ERC liability, options might be limited. The IRS opened a supplemental claim process, offering a way for PEOs to exclude improper client claims or correct miscalculated claims, and the deadline for filing this supplemental closed on December 31, 2024.

PEOs who find themselves faced with an ERC audit should immediately seek out tax counsel to help navigate their path forward.

The reality now is that the IRS has begun to roll out ERC audits in full force as the agency has issued several rounds of tax credit denials while identifying more and more areas of high risk.

However, for those PEOs who have submitted ERC claims on behalf of their clients and are not in the midst of an IRS audit, the path forward should be tread lightly.

First, if a PEO has not yet submitted what would at this point be an amended ERC claim, it is imperative that the firm have their CPA, or a reputable firm specializing in the credit, review the underlying ERC claims for accuracy. There is still a short but open window to file a supplemental claim and correct the ERC errors.

This review should verify that the ERC claims have each been calculated correctly and that they can be substantiated should the IRS initiate an audit. Doing this sort of analysis will inevitably minimize the time and expense of dealing with a potential IRS audit down the line.

However, if a PEO firm has already claimed the ERC on behalf of its clients, it should without a doubt still conduct an extensive review of the claims before paying out credit monies received to its clients.

The statute of limitations for the final eligibility quarters for ERC, Q3 and Q4 of 2021, isn’t until April 15, 2027. The tax credit is incredibly valuable and PEOs shouldn’t shy away from claiming it. But they must do so with a critical eye and evaluate positions taken

The IRS has made clear that the number of its ERC audits will continue to grow. And again, PEO firms could very well be liable should these audits impact their clients. PEOs should take this notion to heart and conduct a thorough risk assessment to ensure they are compliant with ERC requirements.

Organizations such as NAPEO continue to work diligently on behalf of the industry when it comes to challenges surrounding ERC, and while these issues continue to play out PEOs should proactively assess their tax situation. If imposed, the ERC liability at issue will not go away. And failing to address the situation head on could be costly.

This article is designed to give general and timely information about the subjects covered. It is not intended as legal advice or assistance with individual problems. Readers should consult competent counsel of their own choosing about how the matters relate to their own affairs. Want to learn more about the ERTC and view NAPEO resources on the issue? Visit this page.