Financial and tax due diligence is important in all business transactions, but even more so when target companies have claimed the Employee Retention Tax Credit (ERTC). Purchasers should ensure they are taking steps to protect themselves from any liability that may exist for fraudulent ERTC claims of companies they are looking to acquire. Clark Schaefer Hackett has experts available to help you through that process.
ERTC and Potential Liability
The ERTC is a refundable tax credit that was created to help businesses keep their employees on payroll during the COVID-19 pandemic. With such a lucrative credit available, the market has been inundated with firms that have convinced companies to file ERTC claims, pushing the boundaries of qualification or simply conducting outright fraud. With the flood of potentially fraudulent claims, the IRS suspended processing ERTC claims on September 14th, 2023, and will be enhancing its audit procedures to identify erroneous claims. The suspension of claims processing will last through the end of 2023, at least.
Potential liability for invalid or fraudulent ERTC claims includes repaying the improperly claimed credit, and potentially penalties up to 75%. It’s important to note that just because an ERTC claim has already been “paid out” by the IRS, does not mean it has been subject to audit and should be considered “clean”.
Never Underestimate the Importance of Tax Due Diligence
Tax due diligence is essential for any business transaction but is especially important for stock or unit purchasers where the purchaser may be assuming liability for the target’s past actions. In the case of fraudulent or improper ERTC claims made by the target, the purchaser could be economically liable for repayment of tax, interest and penalties resulting from those claims.
Prior to any acquisition, you should be taking steps to protect yourself from potential hidden ERTC liability. Among other tax due diligence, these steps include:
- Determine whether the target company has claimed the ERTC. This may require obtaining tax records from the IRS.
- If the target has claimed an ERTC, require the target to provide you with all documentation related to its ERTC claim.
- Require target to provide you with all original and amended tax returns for the relevant years.
Clark Schaefer Hackett has experts available to review ERTC claims of target companies, as well as other tax risks, and help determine the potential liability and risk that may exist with target companies. Even though the IRS has paid the claim, that doesn’t mean risk is eliminated. Review allows purchasers to mitigate, eliminate or transfer those risks prior to closing a deal.
Protecting Your Company from ERTC Liability
If there are concerns about a target’s ERTC claims, steps should be taken to mitigate the risks. Some considerations include:
- Structuring the deal to ensure liabilities remain with the seller
- Requiring an escrow or holdback (but that may not be feasible for recent claims given the expanded 6 year statute of limitations for payroll tax returns involving ERTC claims)
- The IRS recently provided pathways for taxpayer’s who have claimed the ERTC credit to pay back the credit if the taxpayer discovers it is an improper or fraudulent claim (prior to an IRS audit)
- Ensuring the target company realized the corresponding reduction of wage expense on the Federal income tax return equal to the amount of the credit and in the year the credit was generated (i.e. a $200K ERTC credit generated in 2020 should have resulted in a $200K reduction in the 2020 wage expense on the income tax return, creating additional taxable income.)
- Indemnification from the seller or insurance could also be an option for you to consider with your attorneys, along with all appropriate representations and warranties.
Lean on a Qualified Professional
No matter the deal structure, if the target has claimed the ERTC, you should be working with qualified professionals to assess potential risk and weigh the options available to respond to that risk. It’s always a good idea to do your due diligence in mitigating unforeseen vulnerability, especially when the IRS is involved.
Don’t hesitate to reach out to our experts at Clark Schaefer Hackett, who are here to help you each step of the way.