The employee retention credit: Which fear motivates you?

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Fear of missing out (FOMO) is a powerful motivator. You are likely familiar with FOMO. Its technical definition (based on a quick Google search) is “the feeling or perception that others are having more fun, living better lives, or experiencing better things than you are.”

FOMO is most often associated with social media. It is characterized by comparing your normal experience to the highlights of others’ experiences. Unfortunately, FOMO has been found to lead to increased stress, unhappiness, and dissatisfaction with life. FOMO can also lead to extreme or dangerous behavior in an attempt to “catch up” with the observed experiences of others.

These factors make the recent rise in FOMO cases among not-for-profit leaders concerning. The focus of these FOMO cases is COVID relief funding and the idea that an organization missed out on some form of cash relief from which other similar organizations benefited.

Chief among these is the Employee Retention Credit (ERC). There is a surge in ERC-specific FOMO amongst not-for-profit organizations. This surge is occurring right now for several reasons:

• Not-for-profits are moving past the other COVID relief funding sources they received over the last 30 months. The alphabet soup of relief programs is winding down, giving not-for-profit leaders a chance to look around for other items they might have missed during the COVID disruption.
• Not-for-profit leaders (and people in general) have been getting together in-person more frequently as industry conferences and events have moved to “post-COVID” formats, exposing participants to the highlights of other organizations’ experiences through casual conversation and informal information sharing.
• Providers of ERC consulting services have more recently focused their attention on not-for-profit employers as a business opportunity, resulting in the expenditure of marketing dollars and effort. Not-for-profits are specifically being targeted for these services.

Why is ERC creating so much FOMO? Because there is potentially a lot of money involved. When the organization down the street tells you they received multiple millions of ERC dollars, on top of their other COVID relief funds, that gets your attention.

But is it really that simple? No. That brings us to the second powerful motivator related to ERC: fear of the IRS.

Some theorize that the IRS encourages some level of fear because fear is the most cost-effective way to get a high percentage of taxpayers to comply with tax law. Whether that is true or not, most people would agree that avoiding an IRS audit and, in particular, an IRS audit that finds issues or previously unknown liabilities and penalties, is desirable.

What is the risk specific to IRS audit of ERC claims? We don’t know yet. The IRS has only recently started audits of these claims. The delay is, in part, because the IRS is behind on many of its more traditional responsibilities due to numerous (pre-COVID) years of budget reductions coupled with a surge in activity during the COVID era.

Another factor is that the total ERC funds claimed or to be claimed is unknown. ERC claims are processed through IRS Form 941, or through amended Form 941X. Form 941X can only be filed on paper; there is no e-filing option. This means that the thousands of 941Xs paper-filed to claim ERC must be hand-processed by IRS personnel. Many of these claims are, and have been, sitting unopened at IRS processing facilities in the backlog of IRS mail. Also, consider the numerous 941Xs that have yet to be filed. We won’t know how much total ERC claims will be until these returns are hand-processed.

It is likely that once the ERC claim total becomes known, it will be substantial on the scale of the largest COVID relief programs (such as PPP or enhanced unemployment benefits). Quantifying the national scale of ERC at this level will elevate ERC’s profile with federal authorities and most likely focus attention and resources on audit and enforcement actions. COVID relief legislation specifically gives the IRS five years to audit Forms 941 (or 941X) that include an ERC claim instead of the normal three-year window to conduct audits of these returns. There are signs that the IRS is gearing up its hiring and training activities for this purpose.

As if that isn’t enough, there are specifically harsh rules associated with non-payment of payroll taxes, and since ERC is processed as a credit against payroll taxes, those rules could apply in cases where ERC claims are found to be inappropriate or incorrect. These rules can include personal liability of corporate officers in some cases.

These factors considered together support the fear of compliance and audit from the IRS.

How do you reduce both FOMO and IRS fear at the same time? The most common way to feel better about both of these fears is to engage a professional advisor to help you consider the opportunity as well as the compliance requirements. But with the surge in marketing efforts by service providers offering to help you make an ERC claim, how do you select an advisor? Carefully consider the proposed consultant arrangement on these three criteria:

• Contingent fees: Is the advisor’s proposed fee based on their level of effort or a percentage of the credit claimed? Fees contingent on the credit claim amount encourage aggressive positions, elevating IRS fear.
• Risk consideration: Does the advisor agreement focus on you paying them upfront? What if the consultant concludes you are eligible, but you or your other professional advisors do not agree? Does the agreement require that your organization absorb all of the IRS compliance risk while the consultant takes on none of that risk? Also, if the consultant talks only about benefits without mentioning risks, or actively downplays risks and re-directs the conversation away from the topic of risk entirely, you may be exposed to undue IRS compliance risks.
• Eligibility: Does the provider focus on establishing and documenting your organization’s eligibility for ERC? The fact is that many organizations are not eligible for ERC. If the advisor doesn’t talk about establishing eligibility or promises that your organization will be eligible before they have any facts or data about your organization, that leaves an exposure item in terms of IRS compliance. Ask the advisor what percentage of organizations they find to be ineligible. If the answer is zero or close to zero, that should be considered a red flag. Also understand that eligibility has to be specific to your organization. If you are not getting a deliverable that documents information about your organization’s eligibility specifically, your IRS compliance risk is elevated.

The idea that some potential vendors of ERC consulting services may be over-promising on how much ERC they can “get” for you and then stretching the rules to meet those promises is not just a theory. The recent Internal Revenue Service Criminal Investigation Division raid of a Houston-based firm that is focused on tax-credit claim services, coupled with other legal actions involving tax credit claims, demonstrate the risk associated with the selection of an advisor on tax credit claims.

Remember that FOMO can lead to extreme or dangerous behavior. In the context of ERC, that could mean inappropriately downplaying factors that would indicate your organization is not eligible or agreeing that your organization should take unduly aggressive positions. To avoid succumbing to this symptom of FOMO, make sure that others in your organization, including the Finance Committee and Board, understand what’s happening and share your assessment of the risk before you proceed with a consultant or file an ERC claim with the IRS. Ask your attorney and/or CPA firm to review the contract prior to signing it.

By way of disclosure, as the author of this article and also a Partner at The Bonadio Group, our Firm has advised hundreds of organizations on ERC claims, including eligibility, claim calculations, and preparing Form 941X. Our experience indicates that ERC can be complicated and getting it right requires focused attention. If you’re not familiar with ERC, or want some background on eligibility, see the article I wrote in the RBJ in December 2021, available on-line for subscribers.

Two final thoughts. First, keep in mind that some organizations will not be eligible for ERC. If you look into it for your organization and conclude that you are not eligible, allow that conclusion to alleviate both your FOMO and your IRS compliance fear. Concluding that you don’t need to fear either of these things is a win, even though it’s not as financially satisfying.

Second, if you’ve already claimed ERC, make sure that you’ve got your eligibility documented clearly. The IRS has five years to contact you about an audit of your claim. The documentation must be clear enough that whoever is sitting in your seat five years from now can access it, understand it, and use it to support the organization’s claim.

Jeff Paille is a CPA and partner at the Bonadio Group and has consulted with tax-exempt organizations for almost 30 years.