The Employee Retention Credit Is a Great Deal–But Beware ERC “Mills.”

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Filing for the ERC is complicated, and some CPAs won’t do it. That’s forced founders to opt for pricey alternatives, some of whom are more interested in fees than performance.

The Employee Retention Credit could be a lifeline to businesses still reeling from the pandemic. But that same credit could cause a headache if you’re not careful.

Congress created the Employee Retention Credit (ERC) under the $2.2 trillion coronavirus stimulus package known as the CARES Act, and the credit was initially intended to motivate hard-hit employers to keep workers on staff during the early months of pandemic, when unemployment rates skyrocketed.

The program allows eligible employers to claim up to $5,000 per retained employee during 2020. For 2021, employers can claim up to $7,000 per quarter for each employee they kept on, but only for the first three quarters of the year. But, there’s another nuance: businesses that qualify as recovery startup businesses can claim another $7,000 for the fourth quarter of 2021.

The credit counts against the employer share of employment taxes (including Medicare). That means employers can receive up to $26,000 per worker if they apply for both the 2020 and 2021 credit.

The credit is retroactive now, too–thanks to the American Rescue Plan Act, which President Biden signed into law in March 2021. That law both expanded and extended the credit, for which businesses have until April 15, 2024 to apply against their 2020 returns or until April, 15 2025 for 2021 returns.

While the offering sounds too good to pass up–and in truth, it is–in practice those applying for the credit say the tradeoff can be steep. Chiefly, not every accountant is equipped to help–and those that can help are charging dearly for the service.

In the last year, dozens of ERC-only outfits have cropped up to help business owners navigate the application process, which can involve refiling taxes for the years in question. Some firms may charge upwards of 25 percent of the total refund, whereas many CPAs will just charge a flat fee per filing. So let’s say a business with 15 employees applies for the credit against those 15 employees in both 2020 and 2021. If this business is able to claim the maximum amount, which clocks in at $390,000 total for $26,000 a head, $97,500 of that credit is wiped away in fees for an ERC-shop taking 25 percent.

That’s effectively how the arrangement worked for Michael Haft, co-founder of the Washington, D.C.-based Compass Coffee, which shut down six cafes during the earlier stages of the pandemic. After learning his CPA couldn’t handle the credit, Haft says he took his business to Newity, a Chicago-based marketplace that helps small businesses secure funding, including helping businesses seek out the ERC.

Haft says with Newity’s help, he applied to claim a credit for 95 employees in 2020, which he says amounts to a credit of approximately $300,000. The documentation that Haft sent Newity was expansive. It included a breakdown of employee compensation per pay period, along with financial statements that show business revenue and other associated expenses. If Compass does receive a flat $300,000 credit, tacking on Newity’s 18 percent fee means it’ll cost Haft $54,000 to do so.

For business owners like Haft, it’s hard to complain about getting hundreds of thousands in economic aid, but shelling out to the service provider still stings. After all, Haft says his business’s survival was hardly assured. He couldn’t keep every employee with Compass being down 85 percent during 2020, but the coffee chain got scrappy to keep its people employed. For one, it gave baristas the opportunity to learn construction since it opened a 50,000-square foot warehouse during the pandemic. The company also churned out 350 gallon batches of hand sanitizer, making 10,000 gallons in total. “There were many times during Covid where we were very close to going out of business,” Haft says. “We were struggling to pay the bills, and it was a very stressful time.”

Whatever their fees, outfits such as Newity are filling a market need–that’s what entrepreneurs do. Unlike Newity, though, plenty of ERC shops have cropped up that are exploiting the opportunity. “We see a lot of issues with what we call ERC mills,” says Linda Honey, a senior associate at LS Carlson Law, who mainly focuses on tax law. So-called ERC mills rubber stamp the applications of everyone that comes in with W-2 wages and provides a calculated credit. This could even include businesses that may not qualify for the credit in the first place.

This rubber stamp can backfire for founders. The IRS already has its antenna up for ERC funny business. And the statute of limitations for an audit has been extended to five years from three years, since the IRS expected some abuse, Honey explains. Plus, there is the possibility that some of these ERC shops may disappear in years to come as business recedes. Just as business owners know they need to keep all tax-related receipts, they’ll also need to be able to verify their ERC calculations, she adds. If you can’t, your credit could be clawed back, with interest. Or, worse, you could face penalties or even criminal liability, according to Honey.

The IRS has been quick to remind business owners that they are ultimately responsible for their tax returns. In October, the agency posted a release cautioning business owners about working with third parties that make promises about tax savings. Honey suggests ensuring you ask the third-party vendor what their rejection rate is for ERC applicants. For example, Newity rejects roughly 25 percent of applicants because they don’t meet the eligibility criteria. If a rejection rate is nonexistent or minimal, there is a chance that firms pre-qualify their clients.

Before selecting Newity, Haft says he got dozens of e-mails from companies, touting their services. “I do think it is difficult to separate the scams from reality,” he admits. When in doubt, the IRS encourages small companies to exercise increased caution, especially if anything seems too good to be true. Bottom line: stay on high alert and do your own due diligence when seeking out an ERC partner.