Tax Trap For Those Amending For Employee Retention Credit
If you are thinking about amending a tax return to claim the Employee Retention Tax Credit (ERTC), there is a tax trap that could impact you.
A vast number of employers have been amending their past payroll returns to claim the popular credit. Some are valid claims, some are filed by abusive ERC mills while others are just fraudulent. So here is where taxpayers can experience financial trouble.
Scenario One:
-
The ERC is claimed on an amended 941-X resulting in a refund of payroll taxes.
-
The IRS is overwhelmed with 941-X filings which will delay the refunds.
-
The amount of ERC reduces the payroll deduction on the business return.
-
Wages must be reduced by the amount of the ERC.
-
Thus the business entity return must be amended resulting in an increase in business income (or reduction in loss).
-
Thus the 1040 must be amended (as would the 1065 or 1120-S if increase in business income is from a flow through entity) and taxes paid on the increase in business income.
-
And the resulting increase in tax with the amended 1040.
-
There will be a delay between paying the tax with the 1040-X and receiving a refund from the 941X potentially creating a cash flow problem. Of course, the larger the ERC and longer the delay, the greater the cash flow problem.
-
Of course, the taxpayer can wait to amend for the additional tax liability generated by reducing their deductible wages until after they receive their ERC refund, which will generate late payment penalties (see later for penalty abatement).
Scenario Two:
-
Same as scenario one, except the IRS disagrees with ERC amount claimed and reduces it or worst case disallows it altogether. Keep in mind, the statute of limitations for assessment attributable to the ERC is:
Sec 3134(l) Extension of Limitation On Assessment - Notwithstanding section 6501, the limitation on the time period for the assessment of any amount attributable to a credit claimed under this section shall not expire before the date that is 5 years after the later of —
Sec § 3134(l)(1) - the date on which the original return which includes the calendar quarter with respect to which such credit is determined is filed, or
Sec § 3134(l)(2) - the date on which such return is treated as filed under section 6501(b)(2).
-
What if the IRS adjustment ERC is after the statute of limitations for refunds which is generally (See BB page 01.19.05 for a more detailed description of tr statute of Limitations for a refund) the later of:
-
Three years from the date the original return was filed or
-
Two years from the date the tax was filed.
-
-
Then it is too late to amend the business entity's return and take a full wage deduction!
IRS addressed potential relief from penalties arising when additional income tax is owed because the deduction for qualified wages is reduced by the amount of a retroactively claimed Employee Retention Tax Credit (ERTC), but the employer is unable to pay the additional income tax because the ERC refund payment has not yet been received:
IRS news release 2022-89 reminds employers that, consistent with the relief from penalties for failure to timely pay noted in Notice 2021-49, they may be eligible for relief from penalties for timely failing to pay their taxes if they can show reasonable cause and not willful neglect for the failure to pay. In general, taxpayers may also qualify for administrative relief from penalties for failing to pay on time under the IRS's First Time Penalty Abatement (FTA) program.
However, be aware Per IRM 20.1.1.3, Criteria for Relief from Penalties, penalty relief under Administrative Waivers, including FTA, is to be considered and applied before reasonable cause.
20.1.1.3 (10-19-2020) - Criteria for Relief from Penalties - Generally, relief from penalties falls into four separate categories. Unless otherwise specified in IRM 20.1, penalty relief will be considered and applied, if criteria are met, in the following order:
a. Correction of IRS error
b. Statutory and Regulatory exceptions
c. Administrative waivers
d. Reasonable cause
Deadline for Filing a 941-X
From the instructions for 941-X: Generally, you may correct over-reported (payroll) taxes on a previously filed Form 941 if you file Form 941-X within 3 years of the date Form 941 was filed or 2 years from the date you paid the tax reported on Form 941, whichever is later. Each of these time frames is called a “period of limitations.” For purposes of the period of limitations, Forms 941 for a calendar year are considered filed on April 15 of the succeeding year if filed before that date.
Thus generally the period of limitation ends for a 941 filed for:
-
2020 on April 15, 2024
-
2021 on April 15, 2025