In this week's episode, Travis deep dives into your questions about the ERC!
In this week's episode, Travis deep dives into your questions about the ERC!
Hey everybody, Travis Watkins here for the weekly Q&A session on the Employee Retention Tax Credit. And we’ve got some good questions coming in today. If you have questions, go ahead and type them over there into the comment box. But let's get started here this week, this past week, I was speaking at an event for tax attorneys and CPAs and enrolled agents, and some of these questions came up during the presentation and I think they'll be very helpful for you to know what the answers are on that. The big thing that came up had to do with taxes or amended tax returns other than the 941X quarterly tax return where you make your Employee Retention Tax Credit claim. Now, retroactively, of course, since the quarters are technically gone, although the amendment period is still very much alive and well, but there is an obligation here, and the IRS is very keenly aware of it because they have been audited themselves by the Treasury Inspector General who pointed out some of these issues to them, and they are trying to work through them as we speak, but there are other returns that could be in need of amendment as a result of the employer taking the ERTC credit.
So, it begs the question, what returns need to be refiled and when do they need to be refiled? So, here's what we're talking about. The taxpayer must disallow the wage health plan expenses, et cetera, payroll related things that were used to calculate the Employee Retention Credit, and you have to do that on the appropriate tax returns for the tax year in which they were paid, not the year in which the ERC was applied for or received. Okay? So, what we're talking about here is you're going to have to go back as the employer once you get your money, and I don't recommend doing this at some time other than that, you know, in advance, for instance, before you actually get the ERC credit. But once you do get the credit, you need to be aware that you'll need to go in and amend more than likely your 1065 returns for LLCs, partnerships etcetera, or the 1120 return if you are a S corporation. And go ahead and take out that portion of the money that you used as an expense for payroll and for, you know, for wages, health plan expenses, et cetera, everything that the that the ERC would be and take that out of the federal tax return for the company, first of all. Now, what that'll do is that's going to raise the net income of the company for the employer, and it's more than likely going to spill over onto a what's called a K1. That's the report of monies that are attributed to the owners from the company.
That in turn will also, going since it's going from the company to the, to the owners via the 1, that's also going to affect that year's individual tax return for the owners, the 1040 tax return. So that's what we're talking about here. And that is the time that you should be doing it, is after you have received the credit. So this was the specific question that the tax professionals were asking here, and it's, it's a very, it's a very good one since you're going back in time and showing, oops, I didn't, you know, through this legal fiction, I didn't, I took too much expense for these payroll wage related things, and it's potentially added to added tax to the company, perhaps, and to the individual then, are there penalties that could be assessed by the IRS for this?
And the answer is not super clear from the IRS, go figure. But we've got to assume here that there, yes, there could be a couple of types of penalties that result from this that you need to be aware of. The first one is the failure to pay penalty, and that's, that penalty is exactly what it, it sounds like it applies to situations where tax due wasn't paid on time or not paid at all in this case, it'd be not paid on time. Since you're going back in time here and potentially adding more tax, there could be a tax that you didn't pay, and therefore you could be experiencing the failure to pay penalty. That penalty is 0.5% of the unpaid taxes for each month or part of a month that the tax remains unpaid. And remember, you know, the IRS has taken a long time in some circumstances on paying out these credits.
So due to the IRS's own fault in taking so much time to pay this thing, the penalties are racking up. Now, the penalty itself doesn't ever exceed 25% of the unpaid tax. So there is a cap on these things, but what everybody wants to know is what, what do we do about that penalty because it seems just inordinately unfair that based on the IRS's, you know, slowness, also the, the uncertainty and the time, the timing of how this legislation evolved and when it came out, you know, so it shouldn't be the business's fault that, they're just now, you know, getting the actual credit. And then that has been in some cases, many, many months since they applied for it.
So, what do you do? There's three things here in play that could help out with this type of failure to pay tax. And the first one is, the standard, which is called reasonable cause. And that's a very highly fact determinative inquiry, but it, it is an avenue that you can use here to have that tax abated. Probably the strongest one to have it abated or forgiven is what's called reasonable cause. Well, what's reasonable cause? Its what the IRS, which you can convince the IRS to believe on any given day, but, you’ve got some strong arguments here. I've already covered them, that it's not your fault that you have reasonable cause to have not paid this because you, you know, it wasn't really technically due you hadn't received the credit yet, and it was the IRS's fault and taking so long for this to get paid. Okay? The other one that we won't cover a whole lot here is called the statutory exception basis for penalty abatement.
It's like, it sounds, is there some statutory exception to this. And as of right now, there's nothing codified. In other words, there's no law, that would accept out ERTC failures to pay. So that's probably not one that's going to be benefit you. However, the third type of penalty abatement grounds could help an employer. That's the first time penalty abatement program. And what that is, is you tell the IRS that the taxpayer did not previously have to file a return or had no penalties for the three prior tax years. The taxpayer file all currently required returns or filed an extension of time to file and the taxpayer paid or arranged to pay any tax due. So in other words, we did everything that we could other than, you know, having this particular penalty on these periods come up.
In other words, we've been good boys and girls and paid our taxes when, when due. So cut us a break this one time and forgive all those. That's a great one. We use those in all kinds of circumstances as it relates to tax resolution. In other words, fighting tax balances, including penalties and associated interest with that. So it's in play here for the failure to pay penalty that could possibly arise in the filing of the amended return. And by the way, that's, that is one of the grounds that the Treasury Inspector General identify that some people are not doing here that they really need to do, and that's file their amended returns. Of course, I don't know how they could know since some of these are so far behind in
Here's the second type of penalty that could possibly be in play. It is the accuracy related penalty. And this type of penalty comes up typically in an audit. So, you know, without an audit, you're not going to see an accuracy related penalty. What it is, is essentially the employer failed to claim all income or tried to incorrectly claim credits or deductions. And what that means is a substantial under reporting of taxes due or credits claim in this circumstance of 10% or more. Again, this only comes up, nobody self-reports inaccuracy related penalty. So, it's only going to be seen in an audit context. And not every one of these is going to get audited, of course.
The avenue that you have here at your disposal is certainly reasonable cause. Same arguments as we talked about with the failure to pay penalty. In other words, this is all due to the fact that the that the IRS, you know, didn't give us any direction to speak of on this for many months. We were in good faith here in making the claim and maybe there was, you know, some disallowed in the amount of 10% of the credit or more so reasonable cause always in play. I don't believe that the first-time penalty abatement program includes the accuracy related penalty. I would certainly try it with the IRS regardless, because sometimes they don't even know, you know, the rules on that. And we've gotten away with, you know, it's a squishy thing. We've gotten away, making this argument before and they've used their discretion to go ahead and, and allow it. So, those are the, the penalties that you could possibly be looking at in this thing and the way out of them. All right. Okay, let's wrap this up here for today. But these are all very good questions, and we'll keep bringing you questions and, and clarification as we see more and more of this. All right. Thanks for tuning in.