The ERC Moratorium: What Accountants and Tax Pros Need to Know

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Blake Oliver: [00:00:04] Hey everyone and welcome back to the show. I'm Blake Oliver. Cpa here today with Rey Arellano, CPA. Ray, how are you doing?

Rey Arellano, CPA: [00:00:11] I'm doing great, Blake. How are you doing today?

Blake Oliver: [00:00:14] It's been a wild couple of weeks. I'm doing good, probably because I don't have any IRC clients and that's that's what we're here to talk about, right? The IRS put a moratorium on processing of the IRC applications. There's about 600,000 that are in this holding tank that are going to get probably really scrutinized and looked at. There's millions of filings that have already been done and paid out and the IRS is saying now we're going to go and take a look at those two. Could be thousands and thousands of audits. I let's let's say that I'm a preparer. I'm a professional. I'm a tax preparer. I'm a CPA. I've got clients that are involved in IRC. Whether or not I prepared it myself, they probably have filed for it. Some have gotten it. Maybe some are in process. What do we need to know now that this IRS scrutiny has come down? What are you doing in your practice, Ray?

Rey Arellano, CPA: [00:01:10] Well, I think it's a great topic to bring up. Like, I think every professional needs to be aware of the downstream implications of IRC and what's going on. It's a credit against wages paid in a prior period. So we're talking about 2020 or 20. 21 is when you go to claim the credit, that's where it shows up. And the way the IRS has come down is they've said you don't get to claim it in the year when you file your claim or receive your money, you have to go back and file an amended return for these prior periods. So this affects everybody. It affects tax preparers, it affects bookkeepers and accountants, and it affects auditors. It affects whether you're in public accounting or whether you're in the accounting department of a company that is or could be affected by IRC. So it's it's pervasive and I think there's a lot of professionals out there going, oh, this doesn't apply to me. I think think carefully because it could and I think hopefully we can dig into some of these deeper points along our conversation here.

Blake Oliver: [00:02:21] Yeah, even if you didn't do any of these amended payroll filings, if you did the tax return, if you signed the tax return, now you've got to go back and amend, right? So all the tax preparers are impacted whether or not they personally assisted with IRC. So why don't we start there? Let's start with the tax implications of all this.

Rey Arellano, CPA: [00:02:41] Okay. So the first place to start there is as the preparer, you are governed by circular 230 which says that you need to have a reasonable basis to, you know, to to put these numbers on the tax return and have your name at the bottom as the paid preparer. If you believe or you have reason to believe that the credit that the claim is fraudulent or bogus, it ain't right then. You can't you're not supposed to, you know, file that amended return the return or the amended return if there's if there's bad stuff on it. So. The fact that if it was one of these IRC mills whose inherently conflicted. Thatrillionight out of the gate gives you an extra hurdle to get over. How did, how could this conflicted service provider be sure that they didn't inflate the amount of credit that's being claimed or the credit at all that they're eligible for it at all. So once we. So now you've got to kind of poke around at the at the reason behind the credit and the accuracy of it and so on. And then once you get comfortable now, you can proceed with preparing the amended return for 2020 or 2021.

Blake Oliver: [00:03:59] Okay. Let me stop you there. How do I know whether or not this was a fraudulent claim? Like what is my obligation as a preparer to investigate this? You know, can I just say, like, I'm going to take my client at their word? Like, what do I actually have to do? Is there a standard for this?

Rey Arellano, CPA: [00:04:17] Well, there's not a set standard. And I think every practitioner kind of has different levels of comfort that they try to get in in preparing a return. My philosophy is always been I'm not doing anybody any favors by getting them a deduction for something that cannot be defended. So if you don't have good work papers or good documentation to support what you're trying to do, you know, you're getting you're skating on thin ice. So, you know, let's first let's get a copy of that 941 X that was filed. Do they have work papers to back it up as to where did these numbers come from? How did you calculate these? The claims that we filed, we've created a rather complex spreadsheet where we list out, you know, basically dump out of the payroll system. You go by quarter, you know, blah, blah, blah, all the steps you got to do to get to your number. Let's look for something like that. Do they have this spreadsheet? And unfortunately, a lot of these IRC mills didn't provide like the backup work papers as to where this came from. Okay. Then the practitioner, he's got to be kind of reasonable here and say, well, okay, look, we know there's only certain reasons why you could apply where you shut down by the government. If so, what were those dates? That's reasonably easy to find. The other one is a decline in gross receipts. So take the bookkeeping numbers, you do the quarter over quarter analysis and you see did they have that decrease in the qualify? If you can't come up with a basis according to the rules as to why they qualify, you got a bogus DRC claim and you should my opinion should not file the amended return. And now you should be going into a different phase, which is explain to the client what's going on in the risk they have and what are some of these new programs about self reporting, Bad claims.

Blake Oliver: [00:06:11] Got it. So at a minimum, in your opinion, and this is what you're doing in your practice is get the work paper. If there is no work papers to support these calculations, then that's a big red flag right there. Look at the work paper. And and and double check it. Right. Check the check the calculations, check the numbers. Make sure it's reasonable. I guess you don't have to have the work paper if there was like a shutdown because there's different criteria for getting the claim right. So it depends on what what how they're making the claim. You don't have to dig into that. But you're saying like, when do you need the work paper, I guess is my question.

Rey Arellano, CPA: [00:06:50] Well, for for the claims that we prepare, we create a very detailed work paper and explain everything in detail for every claim. Right. We document everything. Every, every claim. And you're hoping that other preparers of claims of the 941 X are doing the same, You know, and again, that's what I come back to. If they're not, then you almost have to I'm not going to say prepare the whole thing, recreate it, but you got to do enough. You know, back of the envelope. At least scratch something out to say, hey, why do I think this is okay?

Blake Oliver: [00:07:25] And what's the worst case scenario? Let's say I don't do this. Let's say I skip this Ray. I'm not as diligent as you are in your firm. What could happen to me as a preparer?

Rey Arellano, CPA: [00:07:35] Well, I mean, if this happens enough, the IRS has your, you know, your in your your identifying numbers that are registered with them. And there are situations where if the IRS sees a pattern among a preparer, they will go and audit. They'll select many more of your clients to audit with a similar fact pattern because they found that you're as a preparer, you're not doing something correctly. And that's that's a really bad place to be. I can't I can only imagine. I haven't You don't want to.

Blake Oliver: [00:08:06] You don't want to go down that path. No. Okay. Got it. You don't want to get on the the shit list at the IRS.

Rey Arellano, CPA: [00:08:11] That's. That's right.

Blake Oliver: [00:08:13] That's right. Fair enough. Okay, so work paper. You know what else? From a tax stamp? Point should we be thinking about here?

Rey Arellano, CPA: [00:08:20] So so let's assume that it is okay, right, that you've gotten comfortable. Either you have a work paper or you did the back of the envelope and you go, Yeah, it looks like they qualified. And this seems like a reasonable number. Now the next thing you got to do is you got to figure out, okay, what kind of taxpayer is it? Which form do they file? Are they a sole proper or a single member LLC? Well, that's a schedule C on a 1040. That's going to be a 1040 x. The the other problem there is as soon as you file an amended return, it's they're manually processed and there's a higher risk of audit. I've found a way higher audit rates on amended returns that I filed over the years than originally filed returns. So now you've opened up that entire 1042 audit. Not much you can do once the, you know, the the cows out the barn. I mean, you got it. You got to take this all the way to the end. That amended return needs to be filed. If it's a partnership or LLC, that's a 1065 X. Okay. Now we have the interesting one. If they're LLC or partnership, are they under the RR rules where all of the adjustments to tax are handled at the partnership level, they are not pushed through to an amended K one to the partners if they've opted out of that. Well, now you got to push amended k one to all the partners and all those partners got to file amended 1040 and that could be a lot. That could be a lot.

Blake Oliver: [00:09:46] That could be hundreds, right? It could be.

Speaker3: [00:09:49] Yeah.

Rey Arellano, CPA: [00:09:49] Theoretically it could be. Right. I mean, not even theoretically, you know, practicality it is. Then you get into s corpse. Similar situation, right? The S corp is going to push out an amended K one. There you go. That's going to push into an amended 1042 Those S Corp owners, corporations themselves are going to file an amended return, a C corp's amended return. They pay tax at the corporate level, no big deal. And I was even I asked an IRS person at one of these IRS forums about non profits. And because it's a publicly available document, they want that to be accurate and Thai they want amended nine 90s for non profits. So pretty much any taxpayer that's out there if you ran payroll and you filed and you get an IRC claim you need to push it through with an amended return for the year that it applies 2020 or 2021 and that's going to trigger all kinds of other stuff.

Blake Oliver: [00:10:49] So this sounds like a lot of work. Ray Our work, how are you making sure that you get compensated for all this extra work you're doing? Do you have a set fee to do an amended return? How do you charge for it hourly?

Rey Arellano, CPA: [00:11:00] Because a lot of this is so new. I hadn't thought through fixed fee pricing on this stuff. So for the most part, we're doing we're doing we're doing fixed fee on I.R.S. claims because when we were doing PGP and they changed the rules to allow I.R.S., you just can't double count the wages immediately. I said, Well, let's go run this analysis real quick and see what makes sense here to optimize the PGP forgiveness side. And so we we kind of got a little jump on it on that side. And then once we knew if they qualified or not, I was able to kind of gauge what it was going to take to do the extra work. And we did a fixed fee pricing on the 941 ex And then interestingly, the amended income tax returns like we started out with with a couple of partnerships, they were the first ones to go through and that was a royal pain of amending a 1065 but not having it change the K one. And how does that even work? Well, they came out with this new form. It's kind of an in the weeds story, but they had this new form where you fill out this form and then you have to check a box in the software that says, Don't carry this to the face of the 1065, which is technically in conflict with another part that says this credit is to be claimed against the wages in the period that it applies to.

Rey Arellano, CPA: [00:12:27] So the IRS wants to see the salaries and wages number go down on the amended return, but R requires that it not go down so you don't get a new K one. So there's this form in the middle where you check a box and say, Hey, this is what's going on, this is what the wages were, this is what they should be. But it's not what it says on the face of the 1065 ex because of R, And then we're hoping that they're going to agree and figure that out because, again, there's no history, there's no guidance here. It's not like we can say, Oh, I've been doing it this way for years. Nobody, nobody knows what they're going to take.

Blake Oliver: [00:13:01] All right. So what's next on the tax front or are we ready to talk about the accounting for it?

Speaker3: [00:13:08] Um, I think that's.

Rey Arellano, CPA: [00:13:10] Pretty much it about the amended returns. I think on the accounting side, you've run into an interesting situation because. And in our practice, we really like it when the go, you know, we're a zero house primarily where it ties directly to either the audit report if they're an entity that gets audited us GAAP audit, independent CPA, or if it ties to a tax return. I don't like having to take the GL, export it to excel, manipulate it and then get it to tie to an audit or a tax return. You got to pick one, one or the other. So now all of a sudden you're making this prior period adjustment. And so what are you going to do? How are you going to how are you going to keep your goal to tie over these cross back looking periods a year or two years ago, three years ago now in some cases. So that's it's a decision that everybody has to be aware of. You have to make this is where I'm talking about the bookkeepers and the accountants. Okay, how are we going to book this? What's going to happen here? And so you just you have to be very aware and very conscious and make a conscious decision of how we're going to handle this in the books so that everything reconciles and ties out easily.

Blake Oliver: [00:14:33] So is it as simple as going back into these closed periods and making a journal entry at 1231 and and then reversing it on one one?

Rey Arellano, CPA: [00:14:42] Well, this is where audit and tax rules get, you know, have their audits going to say, well, is it material. Right. They get to hide behind that tax. You do not get to hide behind materiality. So yeah, in our case, for a lot of our clients that are not being audited, we're just going back into the prior period making the adjustments, tying out to the amended return, and then you got to roll it forward as you go. Actually, interesting point back on some of the tax stuff real quickly. This gets very interesting when you talk about pass through entities and capital accounts. So the accumulated adjustment account or the capital accounts because remember, on pass passthroughs, all this net income is being pushed out and distributed to the owners. And this affects their their capital account, which affects, you know, down the road has tax implications. You want to be sure your capital accounts are accurate. This credit is going to going to muck that up and make a little mess for you. You got to you.

Blake Oliver: [00:15:39] Got to you got to go back and adjust for it. If you want the capital accounts to be.

Speaker3: [00:15:42] Right, you got to. Right. Yeah.

Blake Oliver: [00:15:44] Okay. So so extra adjusting entries for the tax preparers and the bookkeepers to fight over. Yeah.

Speaker3: [00:15:52] Yeah, right.

Rey Arellano, CPA: [00:15:53] And then we haven't even started with our triad yet, which is so then the bookkeepers, accountants and the tax people, they.

Speaker3: [00:16:01] All.

Rey Arellano, CPA: [00:16:02] Hash it out and figure out what they want to do, and then here comes skipping along the auditors.

Speaker3: [00:16:08] Yeah.

Blake Oliver: [00:16:09] So how does this affect them? I mean, they're already overworked, they're overwhelmed. They got too much on their plates, you know, Now we're handing them I.R.S. to deal with.

Speaker3: [00:16:19] Right, Right.

Rey Arellano, CPA: [00:16:20] So, you know, start with materiality. Is this going to be a prior period adjustment? I don't think anybody's going to want to restate the financial statements. But, you know, here you go. Then you get on the point of, okay, it's a receivable. If you did you get the money yet or not? Did you get if you haven't got it, it's a receivable. Well, is that a good receivable or not? Okay. Well, it is it a is it a valid claim or not? I mean, even if you got the cash and it's not a valid claim as an auditor, you want to know, is it a is it a is it a CRC claim from a mill? And they're going to get whipsawed back in 3 or 5 years under IRS audit.

Speaker3: [00:16:59] And Ray.

Blake Oliver: [00:17:00] This this might be a stupid question, but you've got to. I haven't actually I haven't made one of these entries. So remind me, is this is this revenue is this income the money?

Rey Arellano, CPA: [00:17:08] It's technically it's a reduction of an expense.

Blake Oliver: [00:17:12] Reduction of expense. Okay. Got it. Okay. And we're reducing the what expense are we?

Speaker3: [00:17:19] Reducing salaries.

Rey Arellano, CPA: [00:17:21] And wages.

Blake Oliver: [00:17:21] Salaries and wages. Okay.

Speaker3: [00:17:23] Yeah.

Blake Oliver: [00:17:24] All right. I'm getting the picture.

Speaker3: [00:17:26] So.

Blake Oliver: [00:17:26] So this is going to be weird. So because the audited financials are not going to get restated in most cases because it's not material. Right. So there's going to be this difference. Now, I guess there was always a difference between the tax and the GAAP, but but it just adds to that.

Rey Arellano, CPA: [00:17:41] It's going to be a footnote disclosure. What they're probably do from a from a GAAP perspective is they're probably just jam it through as an adjustment to retained earnings. They'll call it a prior period adjustment. They're not going to screw around with the prior years. They're going to debit receivable credit. You know, retained earnings or some account, which is where it would ultimately flow anyway if you went back in time and then just kind of go forward. I think that the auditors, that's the easier part. I think the harder part is figuring out what to do with bogus claims, because if there's all this extra focus on IRS audits, there's legislation about expanding the time they have to conduct these audits. They're pretty serious about this.

Speaker3: [00:18:32] Yeah.

Blake Oliver: [00:18:32] So let's talk about that, because this is giving me flashbacks to when all the scrutiny came down on a lot of companies and their advisers decided, you know, maybe it's best that we don't try to take this money and maybe we give it back or maybe we withdraw our application. Do you foresee. A good number of Ircc applicants giving the money back, withdrawing their applications.

Rey Arellano, CPA: [00:19:01] I think definitely withdrawing their applications. I think we're going to see a lot of that. That's that 600 and some odd thousand that are in the hopper right now.

Blake Oliver: [00:19:13] And to be clear, I think the the IRS has said they're going to have a process for this. Yes. I haven't seen anything yet as we record this. That's right. On September 27th, I haven't seen anything about it. But they say there's going to be one.

Rey Arellano, CPA: [00:19:25] I was in a continuing ed session last Friday where the IRS national liaison was there, and he confirmed that the program has not come out yet, but they are working diligently on it. And he expected it out within a couple of weeks or so. Okay.

Speaker3: [00:19:42] So and then.

Blake Oliver: [00:19:43] There's the other matter, which is a little harder, which is giving the money back.

Speaker3: [00:19:47] Right.

Blake Oliver: [00:19:48] Because that's also going to be some sort of program is the IRS will have some sort of I don't know, what do you call that kind of program? It's like a forgiveness. Reverse forgiveness.

Speaker3: [00:19:58] Yeah, It's yeah, it's.

Rey Arellano, CPA: [00:20:00] It's.

Blake Oliver: [00:20:01] It's not a safe harbor. What do you call that kind of thing? It's like when you remember when you had, like, a foreign bank account and every now and then you can, like, plead for mercy.

Speaker3: [00:20:08] Right, right, right, right.

Rey Arellano, CPA: [00:20:09] Oh, I know, I remember. I can't think of that.

Blake Oliver: [00:20:11] I forget the word right now. We'll think of it, right.

Rey Arellano, CPA: [00:20:13] We'll think of it. This is a common thing where they they give you a time period to come clean and they're not going to hit you so hard with penalties and stuff like that. And one of the things that's being talked about here, Amnesty.

Speaker3: [00:20:26] Amnesty.

Rey Arellano, CPA: [00:20:27] Exactly. Great. Great is that if you self-report that, okay, you tell them they don't have to find you, that they're going to be some kind of break on the penalties. They can't do much about interest because it's time value of money. And the money was where it was. But there's discussion about being able to exclude. The the fee that you paid to the mill because if you can show that that you paid that, right. So $100,000 credit, the fee was 30,000 bucks. You received 70 show that you can document all that and they're only going to look to you for the 70. Again, this has not been written out or documented yet. This is all speculative, but I think that's incredibly generous of the IRS to do that, because technically they don't have to do that.

Speaker3: [00:21:22] Well, I'm a little.

Blake Oliver: [00:21:22] More cynical, Ray, and I think they're doing it because they know they don't have a chance in hell of of actually auditing the millions of claims that have been filed so far. So far, according to the IRS announcement that came out with the moratorium, 252 claims have been referred for criminal prosecution. Only 252 No, no, 252 are under investigation and only 15 have resulted in prosecutions. And they said thousands are under audit. But we're talking thousands, you know, in the low, thousands out of millions. So realistically, what are the odds that a specific one claim of your one client are going to get audited? I really wish we I guess I guess it depends on how sophisticated the IRS is in picking which ones to audit.

Rey Arellano, CPA: [00:22:22] They're going to I my feeling is they're going to do big data analysis. They're going to they're going to test they're going to gather information on these first couple of waves of what they're auditing. They're going to look for patterns and then they're going to they're going to.

Speaker3: [00:22:38] They're going to put them.

Blake Oliver: [00:22:39] All into ChatGPT.

Speaker3: [00:22:40] And ask.

Blake Oliver: [00:22:41] Openai to tell them which ones to audit. That might be their best bet, honestly.

Speaker3: [00:22:46] Which are the higher risk ones? Absolutely.

Rey Arellano, CPA: [00:22:48] There you go.

Blake Oliver: [00:22:49] They got to get around that ten megabyte attachment limit.

Rey Arellano, CPA: [00:22:53] Yeah, it's going to be a huge a huge database.

Blake Oliver: [00:22:56] It's truly big data. Truly big.

Rey Arellano, CPA: [00:22:57] Data. Right, right, right, right.

Blake Oliver: [00:22:59] Hopefully not on the mainframes, you know, I think they have that on some other more advanced system.

Speaker3: [00:23:03] Right. The old.

Rey Arellano, CPA: [00:23:04] Vax machines. Yeah. But it's a big issue. It needs to be addressed. I really hope that they can and that they can set some examples here to say, hey, you know, come down on people pretty hard and say, don't do this. Yeah, it's a bad, bad thing. And then if people if you can make this amnesty, amnesty program palatable, hopefully more people will self report. And this is where the legit practitioners who are filing those amended returns can help give the feedback to people they might not might not even realize.

Speaker3: [00:23:36] Oh yeah, they probably have. It's bogus, right?

Blake Oliver: [00:23:38] I mean, you got we got these phone calls. You know, David, my co-host, got a phone call from Snoop Dogg that we played on another on a recent episode of the accounting podcast. And it was a it had to have been a deep fake. And, you know, that was an email there. And that got got his attention. And how many business owners were taken in by those phone calls? Promises of free money.

Rey Arellano, CPA: [00:24:02] Right, right, right. So I'm glad it's getting attention. It it really needs to hopefully we can get this cleaned up a little bit. But it's a big issue, I think, for the entire profession. As we talked about, from tax preparers to bookkeepers and accountants to auditors, public accounting, private industry, you know, it's all over the place. It's still a valid program, by the way. Right.

Blake Oliver: [00:24:29] The moratorium doesn't mean it's been shut down.

Speaker3: [00:24:31] That's right.

Rey Arellano, CPA: [00:24:32] That's it's legislation. Right. They'd have to pass a new law to say, no, this doesn't work. And and so if you have a legitimately valid claim, you're still allowed to file. They've never said you can't file a new claim. Just you're just going in knowing that you have a higher level of scrutiny to pass. That's right.

Blake Oliver: [00:24:50] And they're not going to look at it until 2024 and it could take 180 days. That's right. So, yeah, they're very they're trying to discourage us. It seems like that's how it.

Speaker3: [00:25:01] Right. Right.

Rey Arellano, CPA: [00:25:03] And I and I, I think in fairness, they're they're they're trying to discourage us to to the point of saying, look, if it's not legit don't even try. Yeah. And that's.

Speaker3: [00:25:16] That's the way it should.

Blake Oliver: [00:25:17] Be, honestly.

Speaker3: [00:25:18] Yeah, that's right. Well that's right.

Blake Oliver: [00:25:20] Ray, thank you so much for coming on the show and clarifying these questions for our listeners. If they want to follow you online, what's the best place for them to do that?

Rey Arellano, CPA: [00:25:31] Linkedin, I use my full name, so Reynaldo Arellano, CPA. I think I even through the cgma on my thing, I got to clean that up. But right now it's my full name. Reinado Last name Arellano on LinkedIn.

Blake Oliver: [00:25:49] Follow Ray on LinkedIn, you can see him stream live. Occasionally. I'm talking about all sorts of really fascinating topics, so definitely be sure to follow. Ray. Thanks, Ray, for all your expertise.

Rey Arellano, CPA: [00:26:01] Thank you, Blake. Thanks for the opportunity and thank you for everything you're doing for our profession. We really appreciate it.

Creators and Guests

Reynaldo E. Arellano CPA PFS CGMA
Reynaldo E. Arellano CPA PFS CGMA
Reynaldo Arellano is a Certified Public Accountant (CPA) with professional designations as a Personal Financial Specialist (PFS) and Certified Global Management Accounant (CGMA). In addition to providing traditional CPA services such as bookkeeping, accounting, and taxes (planning, compliance, and representation) his Firm also offers tactical CFO services and strategic business advisory services. Mr. Arellano started in the financial profession as a Big 8 auditor, then an accounting software consultant, then a Controller eventually becoming a CFO, and held NASD and life insurance licenses (presently inactive). Mr. Arellano has consistently proven to have the highest levels of integrity, intelligence and innovation. He has held numerous managerial (C-suite) and leadership (board of directors) positions within corporations and non-profit organizations.
The ERC Moratorium: What Accountants and Tax Pros Need to Know
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