IRS Warns Employers About This One Tactic to Claim Pandemic Tax Credit

A lot of federal money is riding on what counts as a government order, and the Internal Revenue Service and tax firms are preparing for legal fights about that crucial definition.

Employers can claim a pandemic-era tax credit worth up to $26,000 per worker if a government order fully or partially suspended their operations. Some employers and tax advisers say they can rely on guidelines from the Occupational Safety and Health Administration encouraging ventilation, physical distancing and other measures.

Nope, the IRS says.

The IRS argument, detailed in a recently published memo, is the latest sign of the tax agency’s tough line in audits of the employee retention credit, or ERC. The credit has cost the government at least $230 billion, roughly triple earlier estimates, after a cottage industry of firms popped up to help employers claim it. The IRS says fraud and ineligible claims are rampant, and it is now giving auditors a road map for denying refunds.

The IRS detailed its argument on OSHA guidelines more than three years after Congress created the credit in 2020.

“What we are seeing right now is the IRS is basically taking a position to disallow everything,” said Eric Stenson, co-founder of Arizona-based Stenson Tamaddon, which has worked on about 4,000 ERC claims. “They say you can bring it up on appeal or litigate it if you don’t like it.”

Even before the memo, the IRS had halted processing of new ERC refunds, started thousands of audits and promised tougher scrutiny of unpaid claims. It will soon announce a program to let employers repay credits they now regret claiming.

To qualify for the ERC, employers have two routes. They can show a minimum specified revenue drop, an easy metric for the IRS to verify. Or they can show that a government order suspended their operations.

Some orders are obviously orders, such as a governor’s closure of indoor dining. Others are gray areas.

Those making the argument for using OSHA guidelines note that employers can be fined for failing to protect workers and that many employers had to make meaningful changes to operations to comply.

In the memo, IRS attorney Rachel Leiser Levy disagrees.

“The OSHA communications explicitly do not command or mandate any employer to take any specific action, leaving it outside the ordinary meaning of the term ‘orders,’” she wrote.

The memo says employers may qualify for the ERC if a state or local government required compliance with OSHA guidelines. The memo generally doesn’t apply in healthcare settings.

Firms using the OSHA argument, at least in part, include Synergi Partners of South Carolina and Stenson Tamaddon. In standard language for clients, Synergi says “the OSHA directives, standing alone, constitute a ‘governmental order’” for the ERC because they are enforceable with penalties. Still, the firms often don’t rely solely on that argument, combining it with Centers for Disease Control and Prevention guidance and local orders.

“We take great pride in our meticulous approach to assessing whether an employer may be eligible” for the ERC, said Ashley Hogsette, chief legal officer of Synergi, which existed before the pandemic. “Our review process involves a thorough analysis of multiple criteria, extending well beyond OSHA and CDC.”

Stenson, co-founder of the Arizona-based firm, which launched in February 2020, said the OSHA guidance “would not be our go-to order for most of the claims,” but he said the combination of various laws and regulations can create the basis for an ERC claim. He worries that IRS field agents will misinterpret the guidance and not consider anything OSHA-related.

It is not known how many claims rely solely on OSHA guidance. Larry Gray, a partner with AGC CPA who reviews ERC claims for other accounting firms, said he has seen the use of OSHA guidance as the basis for ERC claims increase over the last six months.

IRS Commissioner Danny Werfel said Tuesday that the memo addresses an area where taxpayers have aggressively stretched definitions. “For example,” he said, “simply wearing gloves and practicing routine hygiene practices like handwashing don’t translate into a serious impact on a business to qualify for the credit.”

Some employers will hear about the IRS memo and decide that they don’t want to take a stance contrary to the tax agency’s litigating position. That may lead them to withdraw claims or repay refunds.

“If you’re basing it on an OSHA statement, you should sprint to go get somebody to review what you’ve done,” said Dean Zerbe of tax consulting firm Alliantgroup.

Others will push into court, said Josh Ungerman, a tax lawyer at Meadows Collier in Dallas.

“Every time you have something like this,” he said, “there are absolute die-hards who are not conflict-averse and who have high risk tolerance and who see this as: ‘We must be onto something good if the IRS is trying to shut it down.’”

Write to Richard Rubin at richard.rubin@wsj.com and Ruth Simon at Ruth.Simon@wsj.com