2022 Employee Retention Credit IRS Penalty Relief

New Jersey and Pennsylvania-area employers hit with IRS penalties over failure to pay income taxes related to the Employee Retention Credit (ERC) may have some relief on the way. Unfortunately, many companies have been waiting months to receive ERC refunds processed on Forms 941-X – some going back to the first quarter in 2021. The result? Incorrectly withheld estimated taxes, which would otherwise trigger penalties.

Since the IRS has not been able to work through the backlog of amended payroll returns, businesses are being assessed late fees and penalties for incorrect or missed tax payments. The good news is the IRS recently announced relief to those facing this challenge, the details of which we have summarized below.

The Problem with Paper 

As of March 2022, the IRS still had approximately 20 million backlogged tax returns. In addition, there will still be four million unprocessed Forms 941 from 2020, at least some of which have ERC claims.

Two scenarios played the most significant role in why the IRS is now offering ERC penalty relief:

• Mailed-in amended payroll tax returns
• Q4 2021

Amended returns had to be mailed to an agency already dealing with a historic backlog of returns and correspondence. In addition, more employers could claim the ERC retroactively as eligibility was changed with new legislation. This meant mailing in a paper return to claim previous credits.

IRS Commissioner Charles Rettig commented to Congress that the IRS lacks the technology to automate processing paper returns.

One Congressman said, “Companies are filing their 941 on time and then filing the amended 941 because payroll companies can’t get the information needed for the 941 filings. 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. So small businesses are 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.”

Then, when Congress eliminated the tax credit early for most employers – September 30, 2021, instead of December 31, 2021 – processing and filing problems compounded. Employers that had either counted on the fourth quarter refund and already filed Form 941 or those whose budgets no longer factored in the additional tax were stuck.

Some had already received the refund check for the fourth quarter by the time ERC was terminated. (In those cases, employers had until the due date of their employment tax return to refund the advance.) Others already reduced employment tax deposits, anticipating the refund. Usually, that would trigger a penalty.

2022 ERC Penalty Relief

A month after IRS Commissioner Rettig testified in Congress, the IRS issued a news release alerting taxpayers that penalty relief was available. In the release, they said, “Treasury and the IRS are aware that this situation may arise, in part, due to the IRS’s backlog in processing adjusted employment tax returns (e.g., Form 941-X) on which the taxpayers claim ERTC retroactively.” If an employer receives a notice indicating they are subject to IRS fines and/or penalties related to the ERC, the IRS advises following the notice’s instructions. In some cases, penalty relief can be granted over the phone.

Employers need to show reasonable cause and not willful neglect to pay to obtain penalty relief. In this situation, the reasonable cause would “establish that [the taxpayer] used all ordinary business care and prudence to meet Federal tax obligations but [was] nevertheless unable to do so.” Lack of funds on its own is not a reasonable cause in the eyes of the IRS, but the underlying reason for it – failure to receive the ERC refund, for example – could be.

The IRS indicates that interest charged on a penalty can be reduced or removed when the penalty itself is reduced or removed. However, interest would continue to accrue on any unpaid balance.

Employers can also qualify for administrative relief from penalties for failure to pay under the First Time Penalty Abatement program. To qualify, the employer must have:

• Not had any penalties in the last three years,
• Filed all required returns on time or timely requested an extension, and
• Paid or arranged a payment plan for any tax due.

This isn’t the first time the IRS issued penalty relief related to the ERC. When it was retroactively terminated for the fourth quarter in 2021 and employers were already counting on refunds, the IRS granted leniency under safe harbor relief for failure to deposit. However, penalty relief was only available for deposits until December 20, 2021.

The backlog at the IRS has caused unexpected complications for those who claimed the ERC. However, the recently announced relief program should help certain taxpayers facing unexpected fines.

Contact Us

If you have questions about the information outlined above, need assistance claiming the ERC, or filing an amended return, Klatzkin can help. For additional information, click here to contact us. We look forward to speaking with you soon.

©2022 Klatzkin & Company LLP. The above represents our best understanding and interpretation of the material covered as of this post’s date. The content is provided for informational purposes only and does not constitute accounting, tax, or financial advice. Please consult your advisor concerning your specific situation.