News

A moratorium on new Employee Retention Credit claims will allow the IRS to better protect the public from scams

September 18, 2023

To protect taxpayers from scams, IRS orders immediate stop to new Employee Retention Credit processing amid surge of questionable claims; concerns from tax pros, aggressive marketing to ineligible applicants highlights unacceptable risk to businesses and the tax system

[via IRS] IR-2023-169, Sept. 14, 2023

Moratorium on processing of new claims through year’s end will allow IRS to add more safeguards to prevent future abuse, protect businesses from predatory tactics; IRS working with Justice Department to pursue fraud fueled by aggressive marketing

WASHINGTON – Amid rising concerns about a flood of improper Employee Retention Credit claims, the Internal Revenue Service today announced an immediate moratorium through at least the end of the year on processing new claims for the pandemic-era relief program to protect honest small business owners from scams.

IRS Commissioner Danny Werfel ordered the immediate moratorium, beginning today, to run through at least Dec. 31 following growing concerns inside the tax agency, from tax professionals as well as media reports that a substantial share of new claims from the aging program are ineligible and increasingly putting businesses at financial risk by being pressured and scammed by aggressive promoters and marketing.

The IRS continues to work previously filed Employee Retention Credit (ERC) claims received prior to the moratorium but renewed a reminder that increased fraud concerns means processing times will be longer. On July 26, the agency announced it was increasingly shifting its focus to review these claims for compliance concerns, including intensifying audit work and criminal investigations on promoters and businesses filing dubious claims. The IRS announced today that hundreds of criminal cases are being worked, and thousands of ERC claims have been referred for audit.

The IRS emphasizes that payouts for these claims will continue during the moratorium period but at a slower pace due to the detailed compliance reviews. With the stricter compliance reviews in place during this period, existing ERC claims will go from a standard processing goal of 90 days to 180 days – and much longer if the claim faces further review or audit. The IRS may also seek additional documentation from the taxpayer to ensure it is a legitimate claim.

This enhanced compliance review of existing claims submitted before the moratorium is critical to protect against fraud but also to protect the businesses from facing penalties or interest payments stemming from bad claims pushed by promoters, Werfel said.

“The IRS is increasingly alarmed about honest small business owners being scammed by unscrupulous actors, and we could no longer tolerate growing evidence of questionable claims pouring in,” Werfel said. “The further we get from the pandemic, the further we see the good intentions of this important program abused. The continued aggressive marketing of these schemes is harming well-meaning businesses and delaying the payment of legitimate claims, which makes it harder to run the rest of the tax system. This harms all taxpayers, not just ERC applicants.”

“For those people being pressured by promoters to apply for the Employee Retention Credit, I urge them to immediately pause and review their situation while we look to add new protections and safeguards to stop bad claims from ever coming in,” Werfel said. “In the meantime, businesses should seek out a trusted tax professional who actually understands the complex ERC rules, not a promoter or marketer hustling to get a hefty contingency fee. Businesses that receive ERC payments improperly face the daunting prospect of paying those back, so we urge the utmost caution. The moratorium will help protect taxpayers by adding a new safety net onto this program to focus on fraudulent claims and scammers taking advantage of honest taxpayers.”

Taxpayers are encouraged to review IRS guidance and tools for helping determine ERC eligibility, including frequently asked questions and a new question and answer guide released today to help businesses understand if they are actually eligible for the credit.

The IRS is developing new initiatives to help businesses who found themselves victims of aggressive promoters. This includes a settlement program for repayments for those who received an improper ERC payment; more details will be available this fall.

In addition, the IRS is finalizing details that will be available soon for a special withdrawal option for those who have filed an ERC claim but the claim has not been processed. This option – which can be used by taxpayers whose claim hasn’t yet been paid– will allow the taxpayers, many of them small businesses who were misled by promoters, to avoid possible repayment issues and paying promoters contingency fees. Filers of these more than 600,000 claims awaiting processing will have this option available. Those who have willfully filed fraudulent claims or conspired to do so should be aware, however, that withdrawing a fraudulent claim will not exempt them from potential criminal investigation and prosecution.

As part of the wider compliance effort, the IRS is working with the Justice Department to address fraud in the ERC program as well as promoters who have been ignoring the rules and pushing businesses to apply.

The IRS has trained auditors examining ERC claims posing the greatest risk, and the IRS Criminal Investigation division is actively working to identify fraud and promoters of fraudulent claims for potential referral for prosecution to the Justice Department.

IRS Criminal Investigation (IRS-CI) investigates a variety of COVID fraud allegations ranging from fraudulently obtained employee refund tax credits to falsified Paycheck Protection Program loans. To date, IRS-CI has uncovered suspected pandemic fraud totaling more than $8 billion. As of July 31, 2023, IRS-CI has initiated 252 investigations involving over $2.8 billion of potentially fraudulent Employee Retention Credit claims. Of those, fifteen of the 252 investigations have resulted in federal charges. Of the 15 federally charged cases, so far six matters have resulted in convictions, four of those cases have reached the sentencing phase with the average sentence being 21 months.

Criminal Investigation’s work is in addition to ERC audits that have started. The IRS has already referred thousands of ERC cases for audit.

ERC: A complex credit designed to help during the pandemic; taxpayer risk growing amid aggressive marketing and potential to have to repay improper claims

When properly claimed, the ERC – also referred to as the Employee Retention Tax Credit or ERTC — is a refundable tax credit designed for businesses that continued paying employees during the COVID-19 pandemic while their business operations were fully or partially suspended due to a government order or they had a significant decline in gross receipts during the eligibility periods. The credit is not available to individuals.

The ERC is a complex claim with precise requirements to help businesses during the pandemic, and the IRS has received approximately 3.6 million of these claims over the course of the program.

“As we move nearly two years beyond the 2021 eligibility date for the program and beyond the end of the pandemic, the reality that we’re seeing and hearing from tax professionals and others is that many of the affected businesses have already come in,” Werfel said. “This means we must increase our safeguards to protect against fraud and revenue loss.”

Although promoters advertise that ERC submissions are “risk free,” there are significant risks facing businesses as the IRS increases its audit and criminal investigation work.

The IRS reminds anyone who improperly claims the ERC that they must pay it back, possibly with penalties and interest. A business or tax-exempt group could find itself in a much worse financial position if it has to pay back the credit than if the credit was never claimed in the first place. This underscores the importance of taxpayers taking precautionary steps to independently verify their eligibility to receive the credit before applying through a promoter. Taxpayers should take particular precautions because a promoter can collect a contingency fee of up to 25% of the ERC refund.

Advice for taxpayers: What to do as IRS works to help businesses facing questionable ERC claims

For those currently awaiting an ERC claim. For those who currently have an ERC claim on file, the IRS will continue processing these claims during the moratorium period but at a greatly reduced speed due to the complex nature of these filings and the need to protect businesses from being improperly paid. Normal processing times could easily stretch to 180 days or longer. The IRS cautions that many applications will be facing additional compliance scrutiny, which means the payments could take even longer to be processed. While the IRS works on compliance measures during this period, the agency cautions businesses to expect extended wait times due to the large volume of claims and the complexity of the applications

Due to the large volumes and the need for compliance checks to protect against fraud, the IRS is unable to expedite individual claims. The IRS believes many of the applications currently filed are likely ineligible, and tax professionals note anecdotally that they are seeing instances where 95 percent or more of claims coming in recent months are ineligible as promoters continue to aggressively push people to apply regardless of the rules.

For those currently with a pending application at the IRS, they should review the options below to see if any of those could help with their current situation

For those who haven’t filed a claim yet, consider reviewing the guidelines and waiting to file: For those considering filing a claim, the IRS urges businesses to carefully review the ERC guidelines during the processing moratorium period. The IRS urges businesses to talk to a trusted tax professional – not a tax promoter or marketing firm looking to make money generating applications that takes a big chunk out of the ERC claim. The new question and answer guide can also help. A careful review of the rules will show that many of these businesses do not qualify for the ERC, and avoiding a bad claim will avoid complications with the IRS.

Withdraw an existing claim for businesses that have already filed: For those who have filed and have a pending claim, they should carefully review the program guidelines with a trusted tax professional and check the new question and answer guide. For example, the IRS is seeing repeated instances of people improperly citing supply chain issues as a basis for an ERC claim when a business with those issues will very rarely meet the eligibility criteria. Under any scenario, if a business claimed the ERC earlier and the claim has not been processed or paid by the IRS, they can withdraw the claim if they now believe it was submitted improperly – even if their case is already under audit or awaiting audit. More details will be available shortly

Wait for the IRS ERC settlement program to be finalized: If a business has already received an ERC that they now believe is in error, the IRS will be providing additional details on the settlement program in the fall that will allow businesses to repay ERC claims. The settlement program will allow the businesses to avoid penalties and future compliance action. The IRS is continuing to assess options on how to deal with businesses that had a promoter contingency fee paid for out of the ERC payment.

Warning flags to watch out for; help for properly claiming the ERC

The IRS has a list of red flags to watch out for aggressive marketing and questionable ERC claims.

The ERC is an incredibly complex credit, and there are very specific eligibility requirements for claiming the ERC.

Employers can claim the ERC on an original or amended employment tax return for qualified wages paid between March 13, 2020, and Dec. 31, 2021. However, to be eligible, employers must have:

Sustained a full or partial suspension of operations due to orders from an appropriate governmental authority limiting commerce, travel or group meetings because of COVID-19 during 2020 or the first three quarters of 2021,
Experienced a significant decline in gross receipts during 2020 or a decline in gross receipts during the first three quarters of 2021, or
Qualified as a recovery startup business for the third or fourth quarters of 2021.

More information is available on IRS.gov/erc

KRESTON PR, LLC

1509 FD Roosevelt Avenue Suite 303 / Guaynabo, PR 00968-2612

PO Box 193488 / San Juan, PR 00919-3488

Tel. (787) 646-4611 / Fax (787) 764-8688 Web: www.krestonpr.com / www.kreston.com

Email Taxes: fsanchez@krestonpr.com

IMPORTANT DISCLAIMER: This bulletin and its content do not constitute advice. It is intended for information purposes only and should not be regarded as specific advice. Accordingly, no person, entity or corporation should act or rely upon any matter or information as contained or implied within this publication without first obtaining advice from an appropriately qualified professional person or firm of advisors and ensuring that such advice specifically relates to their particular circumstances.

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Tax Alert: Act 52-2022 – Technical Amendments – 2011 Puerto Rico Internal Revenue Code

February 7, 2023

Act 52: AMENDMENTS TO THE 2011 PUERTO RICO INTERNAL REVENUE CODE

On June 30, 2022, the Governor of Puerto Rico signed Act No. 52-2022 (Act 52) to introduce various technical amendments to certain provisions of the 2011 Puerto Rico Internal Revenue Code, as amended (PR Code).

Following is a summary of the technical amendments:

ENGAGED IN TRADE OR BUSINESS (Remote Worker Provisions)

For taxable years beginning after December 31, 2021, the term “engaged in trade or business in Puerto Rico” excludes activities performed by a remote worker, as long as the employer:

1) at no time during the taxable year had an office or other fixed place of business in Puerto Rico;

2) at no time had an economic nexus with Puerto Rico;

3) is not registered as a merchant for sales and use tax purposes;

4) the remote worker is not an officer, director or majority shareholder of the taxpayer;

5) the services rendered are for the benefit of clients or businesses of the taxpayer that do not have a connection with Puerto Rico; and

6) wages paid to the remote worker are reported on a Federal Form W-2 or on a Form 499R-2/W-2PR.

Remote worker is an individual who performs services as an employee for the benefit of a non-resident person that complies with the above requisites. For these purposes, the term non-resident person includes: 1) an individual who is not a resident of Puerto Rico; 2) a trust whose beneficiary(ies), settlor(s) and trustee(s) are not residents of Puerto Rico; 3) an estate who’s deceased, heir(s), legatee(s) or executor(s) are not or have been residents of Puerto Rico; or 4) a foreign entity.

Wages paid to a remote worker are not subject to income tax withholding at source, nevertheless, the remote worker is required to pay estimated taxes.

SUBSTITUTE TO THE 4% EXCISE TAX ON FOREIGN AFFILIATED ENTITIES

Act 52 extends indefinitely the validity of the 4% Excise Tax imposed by Act 154 of 2010. However, incentive laws covering manufacturing activities (such as Act 135 of 1997, Act 73 of 2008, and Act 60 of 2019) were amended to introduce a new optional fixed tax rate in substitution of the Excise Tax and the special sourcing rules that apply to members of a controlled group that requires, in some instances, filing an income tax return.

To this end, exempt manufacturing entities may choose to pay taxes over the sale of the manufactured products to foreign affiliates at an “alternate tax rate” of 10.5%, instead of the current income tax rate set forth in their tax exemption decrees. As of the effective date determined for the election, no member of a controlled group of the exempt business, who has chosen to pay taxes at the optional 10.5%, will be subject to the Excise Tax and the requirement of filing an income tax return.

COMPLIANCE CERTIFICATES – ACT 60-2019

Act 52 expands and clarifies the existing compliance rules under Act 60-2019. The Department of Economic Development and Commerce (DDEC), as part of the monitoring of whether tax incentive grantees comply with the terms of the grant, will issue a Compliance Certificate. The certificate will be valid for two years and will be the only legal document that will validate that the taxpayer has complied. If the taxpayer does not have a valid Compliance Certificate, the taxpayer’s tax grant will be suspended until the taxpayer can satisfy the requirements highlighted by the DDEC.

This provision establishes the concept of the “Compliance Professional” who will be the person responsible for issuing the Compliance Certificate following the guidelines/requirements imposed under regulations issued by the DDEC. Section 6011.04, of the Act 60, indicates that the Compliance Professional will be a CPA or Licensed Attorney authorized to perform its professional activities in Puerto Rico.

ADDITIONAL CHANGES TO PUERTO RICO INCENTIVES CODE

New Credits System: Act 52 authorizes the Secretary of the PR Treasury to create a tax credit management system (Tax Credit manager or TCM) as part of the PRTD’s electronic platform. There will be interagency coordination to register the tax credits in the TCM system. Under the new provisions, any unused tax credits granted before the TCM implementation date will be limited to a three-year use period after the TCM implementation date (unless the credits expire before that date). Tax Credits granted after the TCM implementation date must be registered in the TCM for taxpayers to claim the credits. The system will be implemented at a future date as determined by the Secretary.

AUDITED FINANCIAL STATEMENTS

For taxable years beginning after December 31, 2019, a member of a group of related entities with a volume of business of three million ($3,000,000) dollars or more must submit audited financial statements (“AFS”) when the combined volume of business of the group is equal to or greater than ten million ($10,000,000) dollars.

Disregarded entities will not be required to file AFS for income tax purposes. The volume of business of a disregarded entity, however, should be attributed to its owner.

Act 52 establishes a sunset to the requirement to file the supplemental schedules for most type of entities. For tax years commencing before January 1, 2023, taxpayers that must file AFS or that elect to file AFS must continue submitting the supplemental schedules. Effective for years commenced after January 1, 2023, and thereafter, the requirement to file supplemental schedules is limited to only three circumstances: certain construction businesses, hospital units operating under Act 168-1968, and certain financial institutions.

CORPORATIONS

Estimated Tax Payments: Corporate taxpayers with an income tax liability, including AMT, greater than one thousand ($1,000) dollars will be subject to estimated tax payments.

For taxable years beginning after December 31, 2022, Corporations with Grant of Tax Exemption pursuant to Act 60-2019, or any other previous law of similar nature, may elect to pay the first income tax estimated installment with the second installment on or before the fifteenth (15th) day of the sixth (6th) month of the taxable year.

Alternative Minimum Tax: The Puerto Rico Treasury Department (PRTD) clarified that for taxable years beginning after December 31, 2018, the alternative minimum tax rate of twenty-three (23%) percent applies solely to corporate taxpayers with a volume of business equal to or greater than ten million ($10,000,000).

PARTNERSHIPS

Optional Tax for Partnerships Rendering Services: For taxable years beginning after January 1, 2023, taxpayers (partners) may elect the optional tax even if there is a balance due with the partnership income tax return (withholding is due on the distributable share of income).

Conversion to Corporations: A pass-through entity that chooses to revert its election and wishes to be taxed as a corporation will be treated as if it contributed all the assets and liabilities to a new corporation on the last day of the taxable year treated as a pass-through entity. Immediately thereafter, the pass-through entity is liquidated by distributing the shares to the new corporate partners. The tax consequences of this election are governed by Section 1034.04(b)(5) and 1073.01 of the PR Code.

Sale of Partnership Interest: For taxable years beginning after June 30, 2022, any gain derived by a foreign corporation or non-resident alien individual from the sale, direct or indirect, of an interest in a partnership which is engaged in a trade or business in Puerto Rico, will constitute income effectively connected with a trade or business in Puerto Rico in an amount equal to the distributable share of the foreign corporation or non-resident alien on the gain the partnership would have generated had it sold all of its assets at market value. The gain will be subject to the 15% withholding tax at source to be effectuated by the purchaser.

DISREGARDED ENTITIES (DRE)

Act 52 introduces the disregarded entity concept (DRE) for income tax purposes. Under this provision, an entity treated as DRE is not required to file a separate income tax return from its single member. Instead, the member must include the DRE’s income and expenses in its own tax return using the same tax year and accounting methods as the DRE. In this instance, the owner must comply with the audited financial statements requirements imposed by the PR Code. Under the general definition of limited liability companies (LLCs), the legislation states that DRE treatment is available to LLCs owned by a Puerto Rico resident individuals for tax years beginning after December 31, 2021.

For tax years beginning after December 31, 2022, LLCs with one sole member that taxes as DREs in the United States or their place of organization outside of Puerto Rico will be disregarded in Puerto Rico and will not be eligible to be taxed as corporations.

DREs must comply with other filings such as Property Tax and the Volume of Business Declaration.

INDIVIDUALS

Foreign Financial Account Reporting Requirements: Puerto Rico resident individuals must file, together with their individual income tax return, a declaration detailing financial accounts maintained outside of Puerto Rico or the United States with a value that exceeds ten thousand ($10,000) dollars during the tax year. Financial accounts include bank accounts, crypto assets accounts, certain insurance policies or investment accounts. Taxpayers with a financial interest in foreign financial accounts must report the name of the institution, maximum value of the account during the tax year and the account number. The Secretary of the PR Treasury may request additional information through regulations. Taxpayers should file the form with their income tax returns. Failure to report a foreign financial account may result in a $10,000 penalty and a misdemeanor.

Optional Tax for Self-Employed Individuals: The optional tax on services may now be paid on the filing date of the income tax return, without extensions. This change is effective for the taxable year 2022 in case of individuals.

SALES AND USE TAX

Act 52 amends various sections of the PR Code to incorporate the term digital products as a taxable item, and to establish the sourcing rules for the sale of digital products.

Digital Products: Includes items that can be acquired through streaming, either by purchase or subscription; video, pictures, electronic equipment applications, games, music, computer programs or any other item of a similar nature that is delivered to the buyer electronically or digitally; Specific Digital Products and Other Digital Products. “Specific Digital Products” includes: any transferred digital audiovisual work, digital audio works, or other digital products, to the extent a digital code is provided to the purchaser with the right to obtain the product, including non-fungible tokens (“NFT”). “Other Digital Products” include greeting cards, images, video or electronic games, memberships in electronic groups to obtain exclusive electronic or audiovisual data, including, but not limited to theatrical products, musical products, including concerts or videos, audiovisual material with adult content, news or information products, digital storage products, computer software applications and any other product that could be considered a digital product, whether electronic or digitally delivered, transmitted or accessed.

Sales and Use Tax Sourcing Rules: For the sale of digital products, the source of income will be the buyer’s physical address. If the buyer’s physical address is not available, the source of income will be the postal address. If physical or postal addresses are not available, the bank account or credit card of the buyer or of the financial institution branch where the bank account is registered should be used. If the bank account cannot be attributed to a specific branch or location, the source of the charges will be the headquarters of the financial institution.

EFFECTIVENESS

This Act was effective immediately after the Governor’s signature, except when specifically provided otherwise, as mentioned above. Note that some of the provisions have retroactive effect, therefore, taxpayers must evaluate the need to amend any tax return or form.