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The Green Sheet Online Edition

March 28, 2022 • Issue 22:03:02

Tax credit or tax bite - which regs apply to you?

By Patti Murphy

The COVID-19 pandemic has shaken up the economic status quo. But it's not all bad news, as new federal tax benefits are available to help companies that have been financially hard hit by the pandemic. The irony is that many companies don't realize these benefits are available, or that they may qualify.

"The opportunity for pandemic-related tax credits is substantial," said Terracina Maxwell, president and co-founder of Clarus, a technology company that helps businesses secure employment tax credits. A recent survey of executives at 500 businesses, commissioned by Clarus, found fewer than half have taken advantage of key state and federal tax incentive programs.

The Paycheck Protection Program was a boon to small businesses, doling out close to $1 billion in government-backed loans to small businesses, with the majority of those forgivable. Now, many of those same businesses may qualify for refundable federal tax credits if they kept full-time employees on payroll despite challenges posed by the pandemic.

Keeping the economy humming

The pandemic forced many businesses to shutter in 2020 and 2021—about 800,000, according to Federal Reserve estimates. But it didn't put a halt to business startups. The U.S. Census Bureau reported nearly 5.4 million new businesses were created in 2021. That's more than any other year on record, the bureau said.

Meanwhile, the Fed noted in a 2021 economic report that business closure rates were lower than predicted at the start of the pandemic. While the Fed did not explain why, most economists credit the PPP with keeping the doors open at millions of small businesses. Many of those same businesses qualify for Employee Retention Tax Credits (ERTCs) and can receive refunds on payroll taxes paid in 2020 and 2021.

"A lot of businesses think these are too good to be true," said Tyler Kem, president of Strike Tax Advisory. They are not. Qualifying businesses can claim significant refundable credits on payroll taxes paid between March 13, 2020 and September 30, 2021. Kem estimated that 80 percent of small businesses have yet to take advantage of the ERTC.

Restaurants that were forced to close or scale back because of government-imposed lockdowns could be the biggest beneficiaries. Yet Clarus estimated that only about one third of restaurant owners have applied for ERTCs. One restaurant that did, with the help of Clarus, was Varsity Club Restaurant & Bar, in Columbus, Ohio.

"Without this help we were forecasting tough times to come this summer, with the possibility of closing our doors," Tony Mollica, the restaurant owner, said in a press release. Without the expertise of a company like Clarus, he added, "we would not have been able to manage or leverage this process on our own."

"For both large and small companies, the rules for pandemic-related tax incentive programs can be daunting and complicated," Maxwell said. "However, for most businesses the potential tax incentives are well worth investigating."

This has not been lost on tax consultants, and a small army of consultants has emerged to help small businesses benefit from this and related tax incentives created or bolstered by Congress in response to the pandemic. Many of these consultants are enlisting ISOs and merchant level salespeople (MLSs) to help with outreach. The payback: an ISO/MLS receives a percentage of the refunds the consultants collect for businesses.

"This is nothing like the PPP, where agents were getting $50 and $100 referral fees," said James Shepherd, president of CCSalesPro. "It's potentially a lot of money." It's not unusual for a business that paid payroll taxes on four employees in 2020 and 2021 to receive a refund in excess of $100,000, according to several experts. Typically, the consultancy securing that refund for the business takes a 30 percent cut, or $30,000 on a $100,000 refund. Kem said Strike pays referral partners 10 percent of the money collected.

Who qualifies for ERTC?

The ERTC was established by the CARES Act to help companies with 500 or fewer W-2 employees. It essentially refunds payroll taxes these businesses paid during the height of COVID. Eligible businesses can claim refundable tax credits equal to 70 percent of qualified wages paid to employees, up to $7,000 per employee per quarter. Qualified wages include salaries, tips, commissions and any other compensation subject to FICA tax.

Wages reported as being paid from forgiven PPP loans must be deducted from totals used to calculate ERTCs, and wages paid to the owner of a business and family members don't qualify. As originally written the CARES Act offered small businesses the option of taking out PPP loans or using ERTC credits, but not both. Subsequent legislation, however, broadened the ERTC qualification criteria significantly and made the tax credits available to some PPP loan recipients as well.

"This means that businesses can go back and refile for 2020 and 2021 to claim the credit. But, it's very complicated," said Shepherd, who is helping to connect ISOs and MLSs with tax consultants who handle the heavy lifting of filing for refunds.

Just about any business with W-2 workers can qualify for ERTC, even if they were only marginally affected by the pandemic. Qualifying conditions include:

  • Partial or full shutdowns due to government edicts
  • 20 percent decline in revenue between 2019 and 2020
  • Supply chain interruptions
  • Inability to access equipment
  • Reduced operating hours
  • Investments in sanitation processes and equipment

It's worth noting that ERTCs are not just a way for ISOs and agents to make money by helping clients secure refunds. ISOs and others in the acquiring business may also qualify for ERTCs, noted Scott Talbott, senior vice president for government relations at the Electronic Transactions Association and an accountant by training.

Businesses have until three years following the calendar year when the credits were earned to file for refunds. That means, businesses have until 2024 to apply for ERTC refunds on 2020 payroll taxes and until 2025 to apply for 2021 refunds.

Credit for R&D investments

In addition to ERTC, businesses that have had to pivot, or reinvent themselves or their products because of the pandemic may qualify for research and development tax credits.

Favorable tax treatment for R&D investments has been available to U.S. businesses since the early 1980s. It's a step many countries take to encourage innovation and keep more high-paying jobs inside their borders, experts have noted. "If a company is developing or improving products, processes, technologies, inventions, patents—just about anything—they can qualify for an R&D tax credit," Kem said.

Examples include:

  • Restaurants, retailers and others that have had to build out ecommerce channels;
  • Medical offices that invested in telemedicine applications for remote consultations;
  • ISOs and financial technology firms that improve user interfaces or implement new customer relationship management systems;
  • Manufacturers of personal protection equipment or high-demand household consumables;
  • Software solutions needed to support a remote workforce; and
  • Manufacturers that redesign products and/or packaging in response to supply chain or consumer safety issues.

"A tax credit is more valuable than a tax deduction" since it's a dollar-for-dollar offset of an income tax liability, Talbot noted.

Unlike the ERTC, which is refundable, the R&D tax credit is not. R&D credits also must be amortized, over five years for U.S.-based investments; 25 years for non-U.S. investments. (The Tax Cuts and Jobs Act of 2021 changed some rules for R&D tax credits, including adding the amortization requirement, despite strong lobbying from business groups.) Costs that can be claimed to secure these tax credits include salaries, contractor fees, supplies and software.

Despite being available for decades to small and large companies, R&D tax credits are not widely used. The U.S. Chamber of Commerce estimated that fewer than three in 10 qualifying businesses claim R&D tax credits each year. Many of the same reasons given for not pursuing ERTCs—such as the need for detailed documentation and amended tax return filings—are at play.

Companies that want to pursue these tax credits should seek out CPAs who really understand the process. "About half the CPAs we talk with have never heard of the R&D tax credit," Kem said.

Clamping down on tax scofflaws

While tax credits diminish the tax burden on some small businesses, others may find Uncle Sam taking a bigger bite out of their revenues if they rely on person-to-person payment apps, like PayPal, Venmo and Square's Cash App.

Until now, businesses and gig workers that collect payments through these apps could avoid paying taxes simply by not reporting the income. The apps were required to only report payments for account holders who received payments exceeding $20,000, using IRS Form 1099-K, the same form payment processors use to file with the IRS for their business customers.

The American Rescue Plan Act lowered that threshold to $600, effective Jan. 1, 2022. So any income a business or gig worker receives through the apps this year exceeding $600 will be reported to the IRS.

The ETA's Talbott said the move targets tax scofflaws. "What hasn't changed is the treatment of income," he said. "The money has always been taxable to recipients. Now [these platforms] will have to report to the IRS when businesses receive more than $600 in transactions in a year. The goal is to eliminate tax evasion."

The IRS said the reporting rule won't apply to transactions involving family and friends. But it's not clear how distinctions will be made. PayPal, and its mobile payment app Venmo, now encourage users to tag transactions as being personal/friends and family or for goods and services, which is supposed to help. PayPal also has begun asking business users to provide their Employer ID numbers, or in the case of sole proprietors, individual tax ID numbers, if they use its platforms to collect payments for goods and services.

It's also unclear if the IRS has the resources or resolve to pursue businesses not properly reporting P2P transactions. A 2021 report by the U.S. Treasury Department's Inspector General revealed that in 2017, nearly 170,000 taxpayers did not report up to $29 billion of payments that had been reported to the IRS by three leading P2P platforms. end of article

Patti Murphy is senior editor at The Green Sheet and self-described payments maven of the fourth estate. Follow her on Twitter @GS_PayMaven

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