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Tom Talks Taxes - March 8, 2023
How long does the IRS have to challenge employee retention credit claims?
Employee retention credit (ERC) noncompliance is rampant, and the IRS has begun ERC examinations. How long will the tax community be dealing with ERC tax issues?
If you know me, I’m a statute of limitations nerd. While many tax practitioners refer to the “statute” as one limitation, there are three main statutes of limitations in the tax law: assessment, collection, and refund.
To understand how these provisions interact with the ERC, I’ll first set the table by describing these statutes of limitations provisions and then apply them to several ERC examples.
Generally, if a tax return is filed, the assessment statute of limitations is three years from the filing date under §6501(a). For the 3rd and 4th quarters of 2021, and only these two quarters, §3134(l) extends the assessment statute of limitations to five years with respect to the ERC.
For a timely filed Form 941, Employer's Quarterly Federal Tax Return, the deemed return filing date under §6501(b)(2) for any period ending with or within a calendar year filed before April 15 of the following calendar year is April 15 of the following calendar year.
If an amended tax return is later filed, it does not restart the assessment statute of limitations period determined by the original return. See Northern Anthracite Coal Co., 21 B.T.A. 1116 (1931); the IRS applied the same rule for the refund statute of limitations in Rev. Rul. 72-311.
However, under §6501(c)(1), if the return is a “false or fraudulent return with the intent to evade tax,” there is no assessment statute of limitations. In Allen v. Comm, 128 T.C. 37 (2007), the Tax Court held that the assessment statute of limitations is indefinitely extended when the tax return preparer commits fraud:
Nothing in the plain meaning of the statute suggests the limitations period is extended only in the case of the taxpayer's fraud. The statute keys the extension to the fraudulent nature of the return, not to the identity of the perpetrator of the fraud. Nor do we read the words "of the taxpayer" into the statute to require the taxpayer to have the intent to evade his or her own tax.
A subsequently filed amended return to remove fraudulent items does not start the assessment statute of limitations per Badaracco v. Comm., 464 U.S. 386 (1984). However, in City Wide Transit v. Comm., 2013 PTC 27 (2d Cir. 2013), rev'g T.C. Memo. 2011-279, the Second Circuit held that an accountant triggered the indefinite assessment statute of limitations when he fraudulently amended Form 941 returns that the company had already filed.
Once the IRS assesses a tax during the limitations period, the IRS generally has ten years from the date of assessment to then collect that tax under §6502(a).
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The closing of the assessment statute of limitations does not end the IRS’s ability to recover erroneous ERC claims. Once the assessment statute of limitations has expired, the IRS can then use its more limited erroneous refund authority to attempt to claw back incorrect ERC claims.
§7405 gives the IRS the general authority to recover erroneous refunds. §6532(b) provides for an erroneous refund limitation period of two years from the issuance date, which is extended to five years if it appears that any part of the refund was induced by fraud or misrepresentation of a material fact.
In U.S. v. Southland Oil Co., 339 F. Supp. 2d 764 (S.D. Miss. 2004), the Court held that the taxpayer themselves did not have to commit fraud to have the five-year erroneous refund limitations period:
Under a plain reading of §6532(b), Defendant need not have "committed" fraud or have fraud "imputed" to it for the Government to have the benefit of the longer period to investigate and recover erroneous refunds. §6532(b) does not require that Defendant or any agent of Defendant be the one who committed the fraud or misrepresentation. In this case, Nunn engaged in a fraud upon Defendant that caused Defendant to misrepresent the amount of tax-exempt sales of gasoline to the IRS. Any fraud committed by Nunn does not have to be imputed to Defendant in order to extend the statute of limitations to 5 years.
Internal Revenue Manual (IRM) 21.4.5, Erroneous Refunds, provides detailed procedural information on the erroneous refund process. There are two specific IRM provisions of note:
IRM 188.8.131.52(1) (10-01-2016), Examples and Causes of Erroneous Refunds, includes “a credit refund of any type if the taxpayer is not entitled” as an example of an erroneous refund.
IRM 184.108.40.206.5(3) (10-01-2019) states that an erroneous refund can only be recovered by lawsuit, refund offset, or voluntary repayment if the assessment statute of limitations is closed. Levy and lien actions are not permitted to claw back the erroneous refund.
We'll need to talk briefly about what exactly is a fraudulent return or claim. While the tax community often refers to certain ERC claims as fraudulent, are these dubious refund claims truly fraudulent or simply unreasonable positions?
Fraud is a facts and circumstances determination related to intent that weighs various factors, which are often known as badges of fraud. The burden of proof is with the IRS, and such proof must be made by clear and convincing evidence, which is a higher standard than a preponderance of the evidence (i.e., more likely than not).
IRM 220.127.116.11, Indicators of Fraud, provides many examples of actions that could indicate fraud. Indicators listed that are potentially relevant to the ERC include:
Proof that the tax return was incorrect to such an extent and in respect to items of such magnitude and character as to compel the conclusion that the falsity was known and deliberate.
Submission of tax returns with false claims of withholding (Form 1099-OID, Form W-2) or refundable credits (Form 4136, Form 2439) resulting in a substantial refund.
Providing false or altered documents, such as birth certificates, lease documents, school/medical records, for the purpose of claiming the education credit, additional child tax credit, earned income tax credit (EITC), or other refundable credits.
Multiple sets of books or no records.
Failure to keep adequate records, concealment of records, or refusal to make records available.
False entries, or alterations made on the books and records; back-dated or post-dated documents; false invoices, false applications, false statements, or other false documents or applications.
False statement about a material fact pertaining to the examination.
Failure to make full disclosure of relevant facts to the accountant, attorney, or return preparer.
Here are some examples of the application of the above rules to the ERC:
Example 1. The IRS issues a $45,000 ERC refund on January 5, 2024 for the 2nd quarter 2021 Form 941. The claim is not fraudulent, but it is incorrect. The assessment statute end date (ASED) is April 15, 2025. If the IRS assesses $45,000 in additional tax to reverse the ERC by April 15, 2025, it has ten years to collect that assessment.
After April 15, 2025, the IRS can attempt to claw back the refund until the erroneous refund statute end date (or ERSED) of January 5, 2026, which is two years from the date the IRS issued the refund.
Example 2. The IRS issued a $100,000 ERC refund on November 5, 2021 for the 3rd quarter 2021 Form 941. The claim on the original return was fraudulent. As such, the IRS can assess $100,000 in additional tax to reverse the ERC at any time. The IRS then has ten years to collect that assessment once it is made.
Example 3. The IRS issued a $125,000 ERC refund on December 15, 2022 for the 3rd quarter 2021 Form 941. The amended return took unreasonable positions that may rise to the level of fraud.
If the amended return was not fraudulent, the IRS must rely on the five-year assessment statute of limitations under §3134(l). If the IRS assesses $125,000 in additional tax to reverse the ERC by April 15, 2027, it has ten years to collect that assessment.
If the IRS misses the April 15, 2027 ASED, it could take the position that the five-year ERSED applies if there was a misrepresentation of a material fact. In this case, the IRS can attempt to claw back the refund until December 15, 2027.
If the amended return was fraudulent, the IRS could take two positions:
There is an indefinite assessment statute of limitations for the returns, or
It has until December 15, 2027, or five years from the refund date, to attempt to recover the erroneous refund.
In conclusion, the IRS has many tools to reverse incorrect or fraudulent ERC refunds, and longer periods of time than normal to use some of those tools. Examinations are certain to increase with taxpayers having exposure to significant penalties and interest accruals on top of the tax owed. Practitioners with a deep knowledge of ERC rules who are skilled in taxpayer representation will be in high demand over the next five years (or more).
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