During a payroll conference in Washington D.C. on March 20, a director at the IRS warned taxpayers to “think twice” about claiming the expired COVID-19 employee retention credit (ERC) as the Service is “actively auditing and conducting criminal investigations” relating to claims that are more frequently turning out to be false.

ERC tax relief for certain employers. The ERC was made available during the COVID-19 pandemic to encourage businesses to retain workers by offering a refundable tax credit against certain employment taxes equal to a certain percentage of the qualified wages (including allocable qualified health expenses) that an eligible employer paid to employees after March 12, 2020 and before October 1, 2021 (before January 1, 2022 for recovery start-up businesses) (see Payroll Guide ¶20,905).

Basics for qualifying. To qualify for the ERC, an employer must have had its operations subject to a full or partial suspension of operations due to governmental orders or experienced a significant decline in gross receipts during the pandemic. Additional federal legislation changed and extended this credit, which included adding a recovery startup business.

Possible to claim ERC and Paycheck Protection loan. First Draw and Second Draw Paycheck Protection Program (PPP) loan takers are allowed to claim the ERC if the employer is eligible for the ERC. However, payroll costs that are qualified wages for the ERC are not eligible for loan forgiveness if the employer elects to claim the credit for those amounts.

Eligible employers may still claim the credit. Employers used Form 941 to claim the COVID-19 tax credits and may currently use Form 941-X to make adjustments or corrections to these credits, which may include using this form to claim the ERC tax credit if eligibility was not initially determined (see Payroll Guide ¶4275).

IRS continues to sound alarm on ERC scams. On March 20, the IRS began its 2023 list of “Dirty Dozen” tax scams with the ERC after “blatant attempts by promoters to con ineligible people to claim the credit.” This action renewed a number of earlier alerts from the Service about promoters “touting refunds involving Employee Retention Credits” (IR 2023-49; IRS Kicks Off 2023 Version of Dirty Dozen Tax Scams With Employee Retention Credit Claims, 03/22/23; IRS Sounds the Alarm Again on Employee Retention Credit Scams, 03/08/2023).

Proceed with caution if claiming the ERC. “Anyone who’s considering claiming [the ERC] needs to carefully review the guidelines,” Daniel Lauer, IRS Director of the Small Business/Self-Employed Examination – Specialty, who kicked off the American Payroll Association’s (APA) Capital Summit on Monday, cautioned. He also explained that the IRS’s Office of Professional Responsibility is currently working on additional ERC guidance for the tax professional community that Lauer “hopes will be available in the near future.”

Biggest ERC examination issues. Not surprisingly, some of the more frequent issues that arise during an IRS examination is ERC fraud. Lauer exclaimed how “fraud is very prominent with the Form 941-X.” As of March 17, 2023, the IRS had a backlog of 788,000 unprocessed Forms 941-X, some of which cannot be addressed until the corresponding Form 941 is processed. The number of unprocessed Forms 941 is down to 655,000, notably lower than the 1.7 million unprocessed forms as of March 3, 2023.

The U.S. Treasury Department’s fiscal year 2024 revenue proposals include increasing the statute of limitations on the assessment of ERC credits from three to five years, giving the Service more time to conduct audits, as well as taxpayers more time to amend previously filed Forms 941 relating to certain COVID-19 tax credits.

Other prominent ERC examination issues discussed in Lauer’s presentation involve verifying the qualified wages and health plan expenses, whether the business’s shutdown was a government order or a “voluntary” cessation, and PPP loan forgiveness.

ERC audit procedures. Around three-quarters of the way through his presentation, Lauer, who has been with the IRS for 41 years, began discussing COVID-19 tax credit examinations and audit procedures for the ERC to illustrate what the Service’s more than 300 employment tax examiners trained on these credits are “looking at to make sure [the tax credits] are appropriate.” As Lauer went through his slides, he noted that the evidence the IRS will be focusing on regarding ERC credit examinations is “quite comprehensive.”

What the examiners want from employers? Among the copious amounts of information that may be requested, Lauer said that examiners will ask for a copy of the worksheets from the Form 941 instructions that employers or third-party providers used to compute the ERC. Worksheet 2 and Worksheet 4 were included in the Form 941 instructions to determine the ERC for wages paid before July 1, 2021 and before October 1, 2021 (before January 1, 2022 for recovery start-up businesses), respectively. The current version of the Form 941-X instructions continues to include both Worksheets 2 and 4 for claiming the credit for the above periods of time.

Information Document Request. If there is an information document request (IDR) from the Service, the taxpayer will also need to provide: a list of employees paid wages for ERC claimed, if any employees who received wages included in the ERC are related individuals, and the amount of wages paid to each employee for the ERC. IDR’s are authorized by Code Sec. 7601 and issued by the IRS with Form 4564 during a tax audit to request information from the taxpayer. An IDR may be issued at the beginning of the audit but may issue additional IDRs as the audit continues.

Other documentation requests. Other documentation the IRS may request during an ERC tax credit examination, if applicable, may include: how the taxpayer determined qualified health plan expenses that the employer allocated to the ERC, the application for the PPP loan forgiveness, a copy of the employer’s forgiveness letter, received from the loan provider or the Small Business Administration (SBA). Lauer added that examiners may need to ask for additional information based on the specific issue or as a follow up to the information provided by the taxpayer.

Resources to help. Lauer noted that while an ERC audit can be quite involved, there are resources for taxpayers and he encouraged consulting the IRS’s COVID-19 webpage for all related notices, revenue procedures, instructions, and publications before meeting with an IRS examiner.

ERC examinations will be focus for some time. Before answering questions, Lauer concluded his presentation by explaining that he and the SB/SE specialty examiners will be “primarily focused” on ERC credits and working their way through the unprocessed Forms 941, which could be over the course of the next “year and a half.”

For more on the ERC, see Checkpoint’s Federal Tax Coordinator ¶H-4687.5.

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Document Title:IRS Director: ‘Think Twice’ Before Claiming Expired COVID-19 Employee Retention Credit (03/23/2023)
Checkpoint Source:Federal Tax Updates
© 2023 Thomson Reuters/Tax & Accounting. All Rights Reserved.

A SEP-IRA is a traditional IRA that holds contributions made by an employer under a SEP plan. You can both receive employer contributions to a SEP-IRA and make regular, annual contributions to a traditional or Roth IRA. Employer contributions made under a SEP plan do not affect the amount you can contribute to an IRA on your own behalf.

Because a SEP-IRA is a traditional IRA, you may be able to make regular, annual IRA contributions to this IRA, rather than opening a separate IRA account. However, any dollars you contribute to the SEP-IRA will reduce the amount you can contribute to other IRAs, including Roth IRAs, for the year.

Example 1: Nancy’s employer, JJ Handyman, contributes $5,000 to Nancy’s SEP-IRA at ABC Investment Co. based on the terms of the JJ Handyman SEP plan. Nancy, age 45, is permitted to make traditional IRA contributions to her SEP-IRA account at ABC Investment Co., and she contributes $3,000 in 2019. If Nancy also wants to contribute to her Roth IRA at XYZ Investment Co. for 2019, she can contribute $3,000 ($6,000 maximum contribution less the $3,000 already contributed to her SEP-IRA) by April 15, 2020.

Example 2: Nancy, age 45, is the owner and sole employee of JJ Investment Advisors. Nancy contributes the maximum allowable amount to her SEP-IRA for 2019, or $56,000. Nancy may also make regular, annual IRA contributions to her SEP-IRA, if her SEP-IRA allows this, or contribute to her Roth IRA at XYZ Investment Co. Her total traditional IRA and Roth IRA contributions cannot exceed $6,000 for 2019 and may be made in addition to her SEP contributions.

by Patricia M. McDermott, Esq.

Arkansas Governor Asa Hutchinson has signed legislation that cuts the top individual income and corporate tax rates; conforms with IRC § 179, which provides an income tax deduction for the expensing of certain property; and provides an inflationary relief income tax credit for full-year Arkansas residents. (L. 2022, S1 (3rd Extra. Sess.) (Act 2), effective 08/11/2022 and as otherwise noted.)

Rates. The top individual income tax rate in Arkansas is reduced from 5.5% to 4.9% for tax years beginning on or after January 1, 2022, and the corporation income tax rate imposed on both domestic and foreign corporations is reduced from 5.9% to 5.3% for tax years beginning on or after January 1, 2023. The change accelerates rate reductions that originally were scheduled to take effect in the 2025 tax year.

Individual income tax bracket adjustments. The legislation recalculates the bracket adjustments based on the reduced tax rates. Every resident, individual, trust, or estate having net income greater than or equal to $84,501 but less than $89,100 (previously, $90,600) will reduce their income tax due by the appropriate bracket adjustment amount.
Deduction for depreciation and expensing of property. The legislation conforms with IRC § 179 as in effect on January 1, 2022, for the purpose of computing Arkansas income tax liability for property purchased in tax years beginning on or after January 1, 2022. This raises the Arkansas depreciation deduction limitation for the expensing of certain property from $25,000 to $1,000,000. Furthermore, prior to amendment, Arkansas reduced the deduction available in any year based on the amount by which the cost of property placed into service by the business during that year exceeded $200,000. Under IRC § 179, the threshold is $2.5 million.

For the tax year beginning January 1, 2022, a resident individual taxpayer who files an Arkansas full-year resident income tax return, other than a joint return, having net income up to $101,000 is allowed an individual income tax credit. The top credit amount is $150 for individual taxpayers with net incomes up to $87,000. The credit gradually decreases and fully phases out for individual taxpayers with net incomes of $101,001 or more.

Spouses filing separately: Spouses filing separately on the same income tax return each may claim one credit against the tax on the return of each spouse.

Joint returns: For the tax year beginning January 1, 2022, resident individual taxpayers who file a joint Arkansas full-year resident income tax return having net income up to $202,000 are allowed an individual income tax credit. The top credit amount is $300 for taxpayers with net incomes up to $174,000. The credit gradually decreases and fully phases out for individual taxpayers with net incomes of $202,001 or more. Spouses filing jointly on the same income tax return will only receive one credit against their aggregate tax.

Claiming the credit: The credits cannot be claimed by a taxpayer for any tax year other than the tax year beginning on January 1, 2022, or who files a nonresident return or a part-year resident return. The amount of the income tax credit that may be claimed by the taxpayer in a tax year must not exceed the amount of income tax due by the taxpayer.

 

In our current economic environment, I got to thinking about the parallels to the early 1980’s. Having graduated from high school in the Rust Belt, my economic ideas were heavily influenced by the recession, stagflation and gasoline crisis of the times.

Inflation is caused by an imbalance of supply and demand or when you have too many dollars chasing around items of limited supply. I don’t buy all the current rhetoric of supply chain crisis, labor shortages, etc. and started to look at what my hero Paul Volcker did at the Fed to beat down the last inflation. He constricted the money supply and raised interest rates.

I looked at the Fed M2 growth and saw some startling data. The M2 which is a broad measure of the dollars that our in our banking system grew by 36% from the start of the pandemic March 2020 until this year. Compare that to the same time period prior to the 1981 recession, when monetary growth was only 13%.

The solution is obvious, but painful, we must limit money supply growth going forward and look to higher interest rates. Pain is on it’s way.

If you think you can benefit from the combined features of using an LLC to own and operate your small business and then having it be taxed like an S corporation, the possibility exists to establish your business as an LLC, but then make the election to have it treated as an S corporation by the IRS for tax purposes. You’ll have to make the special election with the IRS using Form 2553. Here are some things to remember:

• From a legal standpoint, your enterprise will be an LLC rather than a corporation. Therefore, you will have the benefit of ease of administration—fewer formal meetings and record-keeping requirements. I can hear your sigh of relief!
•  From a tax perspective, your enterprise will be treated as an S corporation. You’ll still have the pass-through of income, avoiding double taxation, same as if your LLC was treated as a proprietorship or partnership.
• The business entity can pay wages and salaries to you or to other owners. This amount will be subject to FICA tax and other withholding requirements. But then, it can distribute the remaining net earnings to you and the other owners as passive dividend income, not subject to SECA tax.
• Being treated as an S corporation may provide opportunities for tax planning to minimize the overall tax liability for your business and you.

Obviously, you need to carefully consider the pros and cons of different forms of business organizations and the different ways these organizations can be taxed. Seeking professional advice from a CPA or tax attorney is always a wise practice when making choices like this that can affect your business for many years to come.

But setting up an LLC and then electing treatment as an S corporation may just give you the best of both worlds—the ease of administration of the LLC and the tax planning opportunities of the S corporation. Talk to your professional advisor today.

by Patricia M. McDermott, Esq.

Arkansas Governor Asa Hutchinson has signed two identical tax cut bills, which will gradually reduce the top individual and corporate income tax rates. The legislation also amends the income tax tables and brackets, increases the annual standard deduction for individuals by the cost-of-living adjustment, provides an income-based personal income tax credit, provides for income tax due under the Elective Pass-Through Entity Tax Act, updates the exclusions from gross income, and changes the name of the Long Term Reserve Fund to the Catastrophic Reserve Fund (reserve fund). (L. 2021, S1 (2nd Extra. Sess.) (Act 2), effective 12/09/2021, and as noted below; L. 2021, H1001 (2nd Extra. Sess.) (Act 1), effective 12/09/2021, and as noted.)

Corporate income tax. The top corporate income tax rate will be reduced from 5.9% to 5.3% for tax years beginning on or after January 1, 2023, and ending January 1, 2025, if the state doesn’t have to transfer money from the reserve fund. The top rate is 5.7%, effective January 1, 2023, and, dependent upon whether the state must tap into the reserve fund, 5.5%, effective January 1, 2024, and 5.3%, effective January 1, 2025. If money is transferred from the reserve fund, the reduced rates for tax years 2024 and 2025 will not take effect. The legislation similarly reduces the top foreign corporation income tax rate for tax years beginning or after January 1, 2023.

Individual income tax. The top individual income tax rate will be reduced from 5.9% to 4.9% by January 1, 2025, dependent upon whether the state must tap into the reserve fund. The top rate is 5.5%, effective January 1, 2022, and 5.3%, effective January 1, 2023. If on or after July 1, 2022, but before January 1, 2024, no funds are transferred from the reserve fund, the top rate will be reduced further to 5.1%, effective January 1, 2024, and 4.9%, effective January 1, 2025. If money is transferred from the reserve fund, the reduced rates for tax years 2024 and 2025 will not take effect. The legislation requires the Secretary of the Department of Finance and Administration to notify the public and the Bureau of Legislative Research about whether the 2024 and 2025 tax rate reductions take effect.

Income tax tables and brackets: The legislation restructures and consolidates the lower and middle-income tax tables into one standard income tax table so that there are only two income tax tables for tax years beginning on or after January 1, 2022. The income tax brackets are divided into smaller income ranges. The applicable income brackets are adjusted annually to reflect changes to the consumer price index. For tax year 2022, individuals with net taxable income of more than $84,501 but less than $90,601 will reduce their income tax due by the appropriate bracket adjustment amount. The bracket adjustments for tax years 2023, 2024, and 2025 and following are adjusted annually to reflect changes to the consumer price index and the reduced income tax rates.

Standard deduction: Effective for tax years beginning on or after January 1, 2022, the Secretary of the Department of Finance and Administration will increase annually the standard deduction for individuals provided under Ark. Code Ann. §26-51-430(b) by the cost-of-living adjustment for the current calendar year, rounding the amount to the nearest $10.

Personal tax credit: Effective for tax years beginning on or after January 1, 2022, a nonrefundable income tax credit is provided for individual taxpayers with net incomes up to $24,700 who timely file their income tax returns. Taxpayers with net incomes up to $23,600 will receive a $60 credit against their income tax due, with the credit reduced for every $100 of additional net income. The table providing the applicable credit amount will be adjusted annually to reflect changes to the consumer price index.

Income tax due under the Elective Pass-Through Entity Tax Act: Currently, a tax of 5.9% is levied on the net taxable income of an affected business entity, including any applicable basis adjustments, to the extent that the income is reported to the secretary as business income derived from the affected business entity. Effective for tax years beginning on or after January 1, 2022, the legislation amends the tax so that the pass-through entity tax rate reflects the reductions in the income tax rate. The tax will be equal to the top marginal income-tax rate.
Exclusions from gross income. The definition of “gross income” does not include payments received under the Coronavirus Food Assistance Program 1 or Coronavirus Food Assistance Program 2, as it existed on January 19, 2021, or under any successor program or programs.
Long Term Reserve Fund name change: The bill renames the Long Term Reserve Fund to the Catastrophic Reserve Fund and updates references to the reserve fund throughout the Arkansas Code.

Document Title:Arkansas Governor Signs Income Tax Cut Measures into Law (12/13/2021)
Checkpoint Source:State Tax Updates
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