A version of this article was published in the Orange County Automobile Dealers Association's Q3 Dealer Magazine on August 11, 2023.
The employee retention tax credit (ERTC) has proven to be a lucrative benefit for many qualified businesses. Dealerships may be able to claim the credit under one of two eligibility requirements:
- A significant decline in gross receipts
- A partial suspension of operations
This guidance comes well after the enactment of the ERTC and is based on a continuously evolving understanding of the credit, the nuances of the dealership industry, and an understanding of IRS ERTC claim substantiation and documentation requirements.
ERTC for Dealerships
Many dealerships aren’t eligible to claim the credit under the reduction of revenue test, largely due to increased manufacturer incentives and credits during the ERTC testing period. As a result, many dealerships may only qualify under the partial suspension test.
Under the California public health order dated March 19, 2020, Orange County dealerships were required to close all but their service and parts departments, which were deemed essential.
Many dealerships continued to operate their businesses in a limited capacity, in defiance of the order, until the tiered reopening beginning May 7, 2020. Many dealerships could be eligible for the ERTC for this period under the partial suspension rules, however, the IRS has differing rules regarding qualification for these periods. The IRS issued Notice 2021-20 to provide guidance on the ERTC, including additional information on what constitutes a partial suspension. According to the notice, an employer had a partial suspension if either of the following two circumstances occurred:
- More than a nominal portion of business operations are suspended
- The government order had a more than nominal effect on operations
For ERTC purposes, a dealership may be considered to have a partial suspension of operations if, under the facts and circumstances, more than a nominal portion of its business operations are suspended by a governmental order. A portion of a business would be considered more than nominal if during the same calendar quarter in 2019 either of these criteria are met:
- Gross receipts from the suspended nonessential portion of the business aren’t less than 10% of total gross receipts, determined using those of the same calendar quarter in 2019
- Hours of service performed by employees in that portion of the business that were suspended aren’t less than 10% of total employee hours, determined using the number of hours of service performed by employees in the same calendar quarter in 2019
Dealerships are likely to qualify under the partial suspension rules denoted above during the California public health order, if they closed their sales departments, but solely for the period covered in the first two public health orders between March 19 and May 7, 2020.
Given this is a short period, which could produce a small credit, there are promoters that have looked to some nuances in the IRS guidance with respect to supply chain disruptions, to try and find ways to obtain more credits for dealerships.
IRS Guidance on Supply Chain Disruptions
The IRS provided some additional guidance with Notice 2021-20, which indicated companies could qualify for the ERTC if a governmental order causes a supplier to a business to suspend their operations.
Given the supply chain issues with new car inventory during the COVID-19 pandemic, many promoters are selling to dealerships that they’re eligible for the credit for the entire covered period, and selling work for large refundable credits on a contingent fee basis. However, to meet the supply chain provision, a business must document all of the below in order to safely claim the credit:
- The suspended shipments were due to a US government order
- The business wasn’t able to find an alternative supplier
- The loss of revenue was more than a nominal portion of their business, meaning greater than 10% of total revenue or 10% of total labor hours
The above tests to meet the supply chain disruption are an extremely high bar for dealerships to demonstrate safely. While many dealerships did see large inventory disruptions, many of these issues weren’t specifically in response to a US government order.
Many of the supply chain issues that occurred in 2020 and 2021 were driven by the chip shortage, which was tangentially related to the pandemic, but doesn’t meet the tests that are required to safely claim the supply chain disruption provision. However, this hasn’t stopped many promoters from offering dealerships large credits under the guise of the supply chain provisions, and the IRS has taken notice.
IRS Scrutiny on Compliance Risk
On March 7, 2023, the IRS released a renewed warning to taxpayers about third-party promoters offering large credits on a contingent fee basis, and not adhering to the ERTC guidelines documented above.
Should the IRS deny the ERTC claim under the supply chain provisions due to a lack of documentation under the ERTC requirements, the taxpayer will need to return the refunded credit in full and may be subject to penalties ranging from 20%–75% of the claimed credits.
Given how slow the IRS can be in auditing credit claims, this may result in a penalty several years down the road, and many of these third-party providers may not be in business by the time an audit would be completed, which would leave taxpayers on the hook for the penalties, despite any verbiage in ERTC claim contracts.
In addition, taxpayers are required to amend the tax returns for the years in which the ERTC claims are sourced, not when the ERTCs are refunded to the taxpayer. For example, if you amend your 2020 941 in 2023, and receive the ERTC, you’re required to amend your 2020 tax returns to reflect the reduced wage deduction, which results in additional complexity and cost to taxpayers.
How to Handle ERTC Third-Party Companies
Many dealerships are being contacted with offers for credit work from these third-party promoters. If you’re considering working with these promoters to claim the ERTC under the supply chain provision, be aware of the eligibility requirements and the burden of substantiation in the event you’re audited. There’s a high probability of audit, and substantial underpayment penalties and interest that could come with it.
What if I Already Claimed the Credit Through a Promoter?
Have all the supply chain provision documentation handy in case of an IRS audit. Consult your tax advisor regarding your position and your documentation to determine what your exposure could be.
We’re Here to Help
To learn more about how the ERTC could impact you or your business, contact your Moss Adams professional.