Congress presses IRS on ERTC processing and tax penalty relief

Lawmakers are asking the Internal Revenue Service to expedite the processing of Employee Retention Tax Credits and not to penalize small businesses for incorrectly paying their estimated quarterly taxes as they await their claims.

During a hearing Thursday before the House Ways and Means Oversight Subcommittee, Rep. Carol Miller, D-West Virginia, asked IRS Commissioner Charles Rettig about the tax credits. She acknowledged that in the bipartisan infrastructure bill that Congress passed last November, the legislation prematurely ended the ERTC in the third quarter, on Sept. 30, for most businesses, when it was originally supposed to last through the end of the year. Miller introduced bipartisan legislation last December to reinstate the tax credit for the fourth quarter, but it has yet to advance. Meanwhile, many small businesses have been waiting for their ERTC claims to be processed from last year, even those dating back before the fourth quarter.

“The ERTC was unfairly cut short in the fourth quarter of 2021 and many of the small businesses and nonprofits are still waiting on relief from the third, the second and even the first quarter of last year while processing was delayed eight to 10 months,” said Miller. “When Congress authorized this program, it was designated to be emergency relief. Receiving the advance payment of this credit could mean life or death for small businesses and the nonprofits in every single congressional district. So, Mr. Rettig, when the IRS created successful processes to ensure individuals could receive direct payments during the pandemic, explain why the IRS handles ERTC processing like a normal piece of correspondence and you do not have the procedure to prioritize these credits?”

Rettig responded that the IRS isn’t able to automate the processing. “We do have procedures in place in fact, but we do not have the ability to automate our systems,” he said. “That’s one of the differences, to automate our systems in order to process it.” He offered to meet with Miller or her staff to discuss the matter.

Miller pressed him on publicly committing to expedite the ERTC processing. “Can you commit to the committee today that the IRS will prioritize the ERTC processing, including creating a dedicated mailbox, phone line and updated timeline as to when to expect these refunds, specifically for the small businesses and nonprofits that are attempting to claim the credit?” she asked.

Rettig discussed his background in being sympathetic with small businesses. “I come from a small business environment personally,” he said. “My dad had a truck. I am very committed to helping small businesses, all taxpayers. Small business taxpayers in many senses are the backbone of the country.” He noted that many of them previously didn’t face the challenges that the pandemic presented to them when they needed to turn to the IRS for help.

Miller pressed her case, pointing out the delays at the IRS were hurting small businesses. “You know, anytime a business opens its door, whether it’s a truck, a glass door or any, they are putting themselves at risk,” she said. “They are taking a gamble by being in business and the speculation that the ERTC was eliminated in Q4 2021 within the infrastructure bill because members did not think employers were taking advantage of the relief — Congress couldn’t have the accurate information due to the processing delays at your agency.”

She asked for the number of claims the IRS processed from the previous quarter amendments before Q4 2021 and how many have been processed since that time.

Rettig noted that Congress itself cut short the ERTC. “I just want to be clear that the IRS is not the one that got rid of the Employee Retention Tax Credit. It was Congress,” he said. “We follow the law.”

Miller agreed. “I know that, and I look forward to continuing to work with you, and I also urge all my colleagues on the committee to co-sponsor my bipartisan bill to reinstate the ERTC for the fourth quarter of 2021,” she said. “It’s H.R. 6161 and it will deliver our promise of relief to the small businesses and nonprofits in your communities.”

Another congressman, Rep. Kevin Hern, R-Oklahoma, followed up by asking Rettig further about the ERTC. “I was in small business for 35 years and certainly understand the importance of the relief that Congress gave and unfortunately much of that relief didn’t get to the businesses that had exposure to the tax,” he said. “They were struggling and we’ve talked to accountants and companies about the ERTC issue. The main issue companies are faced with now is the amended quarterly tax return, the Form 941. Companies are filing their 941 on time and then filing the amended 941 because payroll companies don’t have the bandwidth to get the information needed in time for the 941 filing. In these cases, companies will be filing their April 2022 returns with reduced wages, but they still have not received the checks for the ERTC credit. Ultimately what this means is taxpayers are paying tax on income they have never received. Not only are small businesses liable for the tax on reduced wages, but they’re also liable for the safe harbor on their estimated taxes, which is inflated due to the reduced wages. We’ve even heard shocking instances of companies having to take out short-term loans to pay their quarterly estimates for their liability that’s due until they receive their credits from the previous year, from 2021.”

In some cases, Congress was again to blame because many small businesses filed the amended returns when Congress changed the law and began allowing small businesses last year to claim both the ERTC and the Paycheck Protection Program.

Hern echoed Miller about the problems she was describing. “Like my colleague Miss Miller pointed out, this program was meant to provide emergency assistance to small businesses,” he said. “This might seem like an innocent timing difference to the IRS, and I certainly understand your passion, but it’s true that the small businesses are hurting and shouldn’t be penalized for doing the right thing. I understand there are massive backlogs at the IRS and there are procedures in place to address these issues, but the small businesses that have kept their doors open need certainty that they will receive these credits in a timely manner and need assurances that they will not be penalized. We have reports of penalty notices going out automatically to taxpayers who have filed on time, but have returns stuck in the backlog. Groups like the AICPA have asked the IRS to consider penalty relief, and my only question is are you considering this type of relief for taxpayers that didn’t do anything wrong, particularly as it relates to the ERTC.”

Rettig insisted the IRS has curtailed many of the automated tax notices after hearing complaints from Congress and groups like the AICPA (see story). “All automated notices stopped months ago,” he said. “We have addressed virtually everything. Nothing is off the table for us to consider. We have regular meetings with people all over.”

“All the businesses are asking for is not to be penalized on the liability and the estimates on money they haven’t received yet,” said Hern. However, he was not able to get a commitment from Rettig on providing penalty relief.

Many accounting firms have found the ERTC to be a lifeline for both small businesses and nonprofits during the pandemic.

“Obviously taxpayers are still feeling the ripple effects of the global pandemic, and all of these regulatory changes add complexity to the whole system,” said Lucia Valenzuela, director of R&D tax services at the accounting firm MCO (Macias Gini & O’Connell). “It did end early on September 30. However, what you’re seeing now is a lot of folks are going back to the 2020 tax year into 2021 to actually claim refunds, and that’s where you see the backlog with the ERTC. The last number I saw was 4 million unprocessed Forms 941, which could potentially be ERTC claims. Right now the wait for the IRS refunds is close to a year, if not over a year. Basically what’s happened is that taxpayers that missed the original ERTC timely filing have to amend, and a lot of these are cash strapped because COVID is still a real thing for a lot of these businesses and their not being able to get their refund for about a year is creating a lot of issues. I don’t necessarily know if the ERTC is going to come back, but it was one of the most beneficial COVID credits. In my lifetime and my career, I’ve been doing R&D credits my whole career and the ERTC credit proved to be one of the most impactful tax credits the IRS ever provided taxpayers with.”

Changes with R&D tax credits and expenses

Valenzuela has also been seeing changes with the way the IRS has been processing R&D tax credits, asking for more documentation now to back up the claims for refunds. “The R&D credit has been around since the Eighties, and we’ve seen a few changes here and there,” said Valenzuela. “A lot of it has come out of court cases and litigation, but this is the first time we’ve seen some major changes from a legislative perspective. Basically it only applies to retroactively amended applications. Essentially now after January of this year, taxpayers pretty much are going to get one shot. There’s a 30-day grace period the first year while it’s being implemented, but taxpayers are going to get one shot at making valid refund claims for R&D purposes, and there’s a list of requirements that needs to go along with the application. That’s something we haven’t seen in the past. Essentially, the purpose of that is to make sure that the IRS isn’t overburdened with refund requests which they can’t audit, and they go unaudited or unreviewed, but don’t necessarily qualify, but this also increases the burden on the taxpayers because you have to get all that documentation together at the forefront, which I guess from the IRS perspective you should already have if you’re claiming those credits. Basically this is the first time we‘ve seen anything like this for a refund claim.”

Another recent legislative change involves amortization of R&D expenses after a provision in the Tax Cuts and Jobs Act of 2017 took effect this year (see story). “This is an interesting one because it doesn’t affect folks that are filing for R&D tax credits, but it also is one of the largest changes that we have seen to the R&D tax regime in general,” said Valenzuela.

“Starting this year innovative U.S. companies basically lost the ability to immediately write off the full value of their investments in R&D, and this is something where everybody is crossing their fingers and hopeful that Congress will restore the immediate expensing for R&D,” she added. “Unless it changes, I believe that the taxpayers are starting to plan for alternative decision making. Are we going to keep our investments in the U.S.? How is this going to affect our planning strategies? Especially life science companies are seeing a lot more tax liability. Something actually came out of the Joint Committee on Taxation that basically said this new treatment of R&D costs is estimated to cost taxpayers $8 billion in new tax liabilities. This goes against the entire purpose of the R&D credit, which is supposed to incentivize people to get their U.S. innovation going, especially when we’re now making taxpayers put the burden of paying these huge tax liabilities.”

There was some hope that the omnibus spending bill that Congress passed last week would restore the tax break, or at least further delay the TCJA provision from taking effect, but it wasn’t included.

“It would be great if it was restored, and I think it generally has bipartisan support, but it’s just a matter of getting it pushed through,” said Valenzuela. “Even if it’s a matter of temporarily restoring [Section] 174, I think taxpayers would be more comfortable, but some taxpayers are choosing to wait and hope, and some folks are being proactive and actually planning. That’s just the general landscape of where tax compliance is today. Folks who are appropriately and proactively managing their tax obligations and responsibilities are actually going to reduce inefficiencies and improve opportunities down the road, but like any other tax year, that requires a level of investment out of the gate. Both on the tax preparer side and on the taxpayer side, does the client actually have the cash flow and capabilities to get ahead of these changes as opposed to being reactive?”