Demystifying the Employee Retention Credit: Guide, Qualifications, and Fraud Prevention

Welcome to the Profitable Painter Podcast. The mission of this podcast is simple: to help you navigate the financial and tax aspects of starting, running, and scaling a professional painting business. From the brushes and ladders to the spreadsheets and balance sheets, we've got you covered. But before we dive in, a quick word of caution. While we strive to provide accurate and up-to-date financial and tax information, nothing you hear on this podcast should be considered as financial advice specifically for you or your business. We're here to share general knowledge and experiences, not to replace the tailored advice you get from a professional financial advisor or tax consultant. We strongly recommend you seeking individualized advice before making any significant financial decision.

This is Daniel, the founder of Bookkeeping for Painters, and this is Richard, tax director of Bookkeeping for Painters. How's it going, Daniel? What's up?

What's going on? How you doing today?

I'm doing good. I'm doing good. It is a beautiful fall day. It's been raining all week, so my grass is nice and tall. And today we've gotten a little bit of a break, so I'm hoping to get out there and mow it. It certainly needs it.

So I hear in the news we have some, some big news on from the IRS in regards to the employee retention credit.

Yeah, yeah. So I believe it was September 15th this was announced. Same, same day as the S corp tax deadline, they are going to be pausing the processing of ERC credits. So it's not ending, but it is taking a little bit of a hiatus. And the reason is, is they are so backlogged that they cannot process the ones they have, let alone any new ones. So they will not be processing any new returns until January 1st, 2024 at the earliest. And they have also shifted their focus from, you know, basically cranking these out and getting the checks out as fast as possible to doing a little bit more verification on the front end and making sure that these claims are valid claims, they're appropriate, and then sending the money out.

So some folks might not know what the Employee Retention Credit is. So just just so that if you're listening, you have no idea what the Employee Retention Credit is, it's also referred to as the ERC, and it's a refundable payroll tax credit that's taken against your— taken against employment taxes that encourages businesses impacted by COVID-19 pandemic to keep their employees on payroll. So this is going back to when those shutdowns were happening, back in 2020 and maybe a little bit in 2021, kind of helping those small businesses that had to basically keep their folks employed during that period while also being shut down.

Yeah, it was designed to, you know, like you were saying, Daniel, to help businesses during COVID We are post-COVID now. Well, I mean, we're post-pandemic. I don't know if we'll ever be truly post-COVID, uh, but ironically, the IRS is receiving more claims now than they did during COVID Uh, the latest numbers are about 600,000 unprocessed claims as of September 15th, and 15% of those claims have come within the last 30 days. And the reason behind this, the driving force is— and you, if you have a business, you already, you've already seen this. It is the onslaught of advertisements from companies claiming to get you ERC. And I mean, I've, in my own home, I've seen mailers come in my mailbox. I've gotten voicemails on my phone. I've seen, you know, celebrities on TV. There's even—

Are you serious? You saw celebrities on TV? TV pushing the ERC.

Yeah, yeah. There's kind of a famous one with Ty Burrell, and believe it or not, you're not going to lose. There is a voicemail being left by what sounds like and claims to be Snoop Dogg to apply for the ERC. Now, it's almost certainly an AI fraud, but imagine getting a phone call from Snoop Dogg encouraging you to apply for the ERC. So yeah, this is, this is kind of jumped the shark. This is, this has almost become like a, like a pop culture meme. But the result is the IRS is getting flooded with claims. And you can imagine companies that will use, you know, deepfakes of celebrities to sell their products may not be very diligent in processing their claims. They may not be, you know, real accurate as to what qualifies and what doesn't qualify. And that could leave you, the business owner, on the hook if you received money that you weren't actually entitled to.

Yeah. And I think this, you know, came about— Congress had set aside a bunch of money to, for this program. So there's a whole big pot of money, it's like $400 billion, and, uh, and it's just, you know, basically there's certain rules. If you do qualify, you are absolutely, you are entitled to get that money. But I think, uh, you know, some of these firms or businesses are, are kind of bending the rules and, and, or just downright fraud, uh, to, to get access to that. So It's, it's definitely important to get what you're entitled for if you actually will go through the requirements here on the podcast of what it takes to qualify. But if you don't qualify, definitely don't recommend you trying to get this credit because the IRS is well aware of the fraud going on and they're most likely going to investigate it. So you want to be you know, on the right side of things here.

Absolutely. No matter how convincing Snoop Dogg may sound. No, no, absolutely. If you qualify, please, please take the credit. This, you know, this is what it's intended for. But let's be careful because, you know, there's a lot of shadiness going on. So should we talk a little bit about how we can know if we qualify for it and kind of, you know, set the standard there?

Yeah, there's basically, you'll, first of all, you have to have employees in 2020 or 2021, but no more than 500. So pretty sure everyone listening here is probably under that. You may, but if you have subcontractors, for example, but no employees, you would not qualify. So that's the first thing. You have to actually have employees during 2020 or 2021. And then you have to have a couple of— one of the, one of the following things need to have happened. One, the first possibility thing is that you had a reduction in your tax basis revenue relative to a reference quarter or like a prior year. So for example, your, your tax basis revenue went down in 2020 compared to 2019, or in 2021 it went down compared to 2019. Basically, did your revenue go down compared to pre-COVID? Um, so that if, if that happened to you, you could potentially qualify for this. The— now in the painting industry, a lot of folks didn't have this happened. They had a lot, a lot of folks had their income, their revenue go up in 2020 and 2021. So we saw that influx of people just hanging out at their house and like, hey, we should paint the, you know, paint the exterior of our house. It looks, you know, and so there's actually an influx of those home improvement things going on. So, but it might apply to you. So that's the first thing. The second one is that you'll have to have some sort of full or partial government shutdown, and because of that shutdown that impacted you in a more than nominal way, impacted your business in a more than nominal way that prevented you from doing your normal operations. So you know, and it— there has to be a government order associated with that, that government shutdown. So it has to either impact your business directly because you literally couldn't go out and do painting, you couldn't do interior painting, for example, um, because there was a shutdown in your, in your county that said that there was to be no interior painting or no contractors allowed to go inside of buildings for a period of time. Or it could be because your vendor was shut down and you were unable to get the resources that you needed to do your job. So maybe you went, you know, PPG, the only local paint shop was PPG and they were shut down and you were unable to get paint. The key being that there was no other paint stores that you could have got paint at. So there cannot have been a replacement. So, so basically, number one, did you have your tax basis revenue go down relative to like 2019, or did you have some sort of full or partial government shutdown that impacted your operation so you couldn't do interior painting, for example, or one of your service lines or you were unable to get, you know, paint or some sort of product that you need from your supplier because of that shutdown.

Yeah, I think where people can sometimes get tripped up is what is a government shutdown? And you mentioned, Daniel, that it needs to be an actual order and it needs to be, you know, from a governmental official, whether that's the governor of the state or the mayor of your county. and it can't just be a suggestion. You know, we, we are encouraging people to stay at home is not a shutdown, or we are requiring people to wear masks when they go outside is not a shutdown. So these shutdowns did occur mostly in the second quarter of 2020 when COVID was at its prime, and most of them were lifted. You know, relatively, you know, quickly. And we kind of moved into that, that yellow area of, well, use caution and wear, you know, a mask, but you can go outside. So, you know, we want to make sure that we can actually document the, you know, the executive order or the document that shows the shutdown.

Yeah. And there's If you go online, and I might put this in the show notes, but there's, there's some resources out there. If you're not, you don't remember if there was a government shutdown, there's some websites that have kept track of what counties and states had those shutdowns, and they have the actual document that says, because you'll actually have to find the document, and then there's usually some sort of appendix that specifies all the types of businesses that are shut down or not shut down. And so just to take an example, for Pennsylvania, they did have a shutdown that shut down building finishing contractors for a period of time, and they were unable to do work in that area. So that— you'll have to find the government order and then the appendix that shows that, okay, building finishing contractors or painting contractors were unable to do work for this period of time. So those, you can either go to your state website or there's some like natlawreview.com has some lists of those shutdown orders.

Now, if you don't have a government shutdown but you have that decline in revenue you were speaking about, that could also work if the decline in revenue is sufficient enough. And if my memory serves, it's actually different depending on what quarter we're talking about. So I think for the, the 3 quarters in 2020 where this was available, so that's Q2, Q3, and Q4, or like April through December of 2020, you need to show a 50% or greater decline in gross revenue from the same quarter in 2019. If you can show that, you could qualify for ERC in 2021, uh, for like January through the end of September. The decline wasn't— it wasn't actually— it was actually less strict. So, uh, 20% decline was sufficient to show, um, you know, that you qualified for ERC. But again, it's, it's quarter by quarter, so You know, if you qualify for one quarter, you may not qualify for the other quarters. So you only want to apply for those quarters in which you did have the decline or the government shutdown.

Mm-hmm. Yep. So decline in revenue, you meet those percentages, you might be good to go, or you had a government shutdown that you can show. And it might, might be both things. You might have had a reduction in revenue in one quarter and then a government shutdown in another quarter as well. So there's, there's definitely ways to qualify for this. It's just you just need to make sure what you're trying to qualify for is actually what happened and making sure you have the right documentation to prove that.

Right. That's kind of a common problem we've been seeing is that, that people maybe qualify for one or two quarters but they're pressured into applying for all 6. And that could be something that, that turns around to kind of bite them in the end. You know, another issue we're seeing is making sure that, that you properly account for the number of employees that you have. If you are a more than 50% owner of the business, you may be a shareholder employee. But if you're more than a 50% owner, then you can't be qualified as you know, one of the employees that the ERC is calculated on. And then, of course, they do need to be actual employees and not contractors. So they need to be paid on a W-2, not a 1099, to qualify for the ERC.

Yeah. So we talked— we kind of talked about who qualifies. We've mentioned some of the pitfalls like don't try to overclaim, you know, make sure you have the documentation. Documentation meaning you can prove with your revenue, like you have financial statements that can basically show that you did have a decrease by the stated percentages we talked about, 50% and 20%, or you have that government order to back up the ERC claim. What are some other pitfalls that we should be looking out for, for this ERC stuff?

Well, if you do apply for ERC and you get the credit, uh, you have a responsibility then to amend your business tax returns for the year that you received ERC. Now this can get kind of confusing sometimes because it may be 2023 when you receive the checks, but those credits are actually tied to wages that were paid in 2020 or 2021. So because you received a credit for those wages, you can't also deduct those wages on your 2020 and 2021 returns. So now you have to go back and amend those returns, removing the wage deduction that you received the credit for. When you do that, your profit goes up because your expenses have been reduced. When your profit goes up, your taxes go up. So while the ERC itself is not taxable, the effect it has on previous years' tax returns will probably result in some tax being owed. It's going to be much less than the ERC itself. You will come out ahead, But you're going to want to make sure that you amend those returns and pay those taxes so that you can avoid an examination.

Good, good to know. Yeah, I think a lot of people miss that piece. It's not just submit for the ERC, get the check, and you're good to go. You got to go back and do some legwork there. Now, what happens if maybe you you've already submitted for the ERC and you're listening to this now, you're like, oh crap, I submitted for all 6 quarters and now I'm getting a $200,000 check in the mail from the IRS, but I probably only qualified for half of it or something. What, what, what should folks do in that situation?

Yeah, if, if you think you may have, you know, applied for more than you actually qualify, it's not the end of the world. You do have an opportunity to fix it. So in that situation, one, I would suggest, you know, finding, you know, some competent help, you know, a competent accountant, enrolled agent, CPA who can, you know, help walk you through the process, make sure that you actually got your numbers right. And then at that point, you can amend your payroll tax returns again showing the proper amount of credit and then paying back the excess that you received. Now, if you do this, if you take a proactive approach to it and you get to it before the IRS does, then there may be a little bit of interest, but there won't be, you know, significant penalties if you wait for the IRS to catch it. And while the IRS normally has 3 years to figure these things out with the ERC, that's actually been extended. To, I believe, 5 years. So they have extra time. If you let the IRS catch it, then you run the risk of accuracy-related penalties, higher interest. It's much worse if the IRS catches it.

Yeah.

So if you're in that situation, my recommendation is be proactive, amend the returns, pay back the excess, and you'll sleep better at night.

Yeah. Yeah. And I think in the— you can correct me if I'm wrong here, but I think the worst case scenario would actually be fraud, potential fraud. If you just blanket apply for everything and you have no nothing to back that up, you could be— the IRS could come after you for fraud on that. So that would be you know, a lot worse penalties as opposed to just like an accuracy, oh, you just miscalculated something.

Yes. Um, so it's, it's hard to know exactly, I mean, to say exactly what constitutes fraud and what, and what constitutes, um, you know, an accuracy-related penalty. But if the IRS believes that fraud has been involved, then that 5-year timeframe gets extended to basically forever. So if they, if they claim fraud, they have, they have as much time as they want to come after you. And there will probably be some people who, probably not anyone listening to our podcast, but there are going to be some companies who, who really get the book thrown at them. The IRS has already done 250 criminal prosecutions for ERC fraud, and they are just getting started. So, you know, the IRS and Congress knows that this program has been abused, and they are definitely putting it under a magnifying glass. They will go after the bigger fish, the low-hanging fruit, first. But if you, if you think that, you know, maybe your small company has accidentally taken a little bit more than it should, I would advise, you know, trying to get that rectified you know, nip it in the bud. If you catch it before the IRS does, things go a lot better for you.

Yeah. Yeah.

Okay, cool.

Well, is there— I guess to end on a happy note. Yeah, I'm happy now. But yeah, not to scare people away from the RC, you can definitely— if you qualify, there's nothing to be afraid of. If you get the docs to support it, proof and totally qualify for this and be completely fine. It's just you got to make sure you go in knowing, you know, knowing the pitfalls and making sure you're covered.

Yeah, yeah, it's a good program. And the people who deserve it and are entitled to it should absolutely apply for it. The people who are getting criminal prosecutions are the ones who have no employees, who are just making things up. And, you know, and scamming the government. And we should want to see these people prosecuted because it's our taxpayer money that's being abused and we want it to be, you know, put to the right use. So if you qualify, by all means, go and get your credit. If you haven't filed yet, be patient. I say go ahead and get it in. Don't wait till next year. Just realize it's going to take a while for it to get processed. If you've already got your credit, and you have gotten the correct amount, make sure you amend your 2020 and/or 2021 returns so that you kind of tie up that loose end. And if you are in the unfortunate situation where you think you may have taken too much, go ahead and fix that, amend those returns. And so, you know, this is, this is not doom and gloom. There is a way forward in any of these situations. We just kind of wanted to let people know what's going on and give them that, that path forward, uh, depending on which situation they find themselves in.

Yeah, absolutely. And so just to wrap things up, I'd love to hear from, from you all. If you go to Facebook and type in Grow Your Painting Business, you can join the conversation. If you have any basic questions about the ERC, love to hear them. Or ideas for future podcasts. And with that, we'll see you next week.

Yeah, thanks for listening, and we will see you next time.