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How Workforce Reductions Can Impact Your Company’s 401(k) Plan

Key Takeaways:

Partial 401(k) plan terminations occur when 20% or more of employees are involuntarily terminated, requiring full vesting for affected employees to comply with legal requirements. This can create a financial burden on your company.
To mitigate the financial impact, you can utilize forfeiture accounts to fund the full vesting requirements. This will reduce the immediate cash flow impact on the business, but vesting adjustments can be made regardless.
To avoid any plan disqualification or IRS penalties, you should implement oversight policies, document all terminations, monitor workforce changes closely, and be familiar with plan rules and forfeiture account management.

Employee turnover often triggers a wave of issues for your company and its human resources department. Even 401(k) retirement plans — one of the most sought-after employee benefits — can be impacted when a substantial number of your employees are involuntarily terminated. This can constitute a partial 401(k) plan termination, where full vesting of the affected employees must occur to satisfy legal and regulatory requirements. Yet, partial terminations are often easy to overlook.

How You Can Identify Partial 401(k) Terminations

One key element of your 401(k) management is understanding how workforce reductions can affect the plan itself. This is extremely important as the IRS can issue a complete disqualification of the plan when partial terminations go unnoticed or are mishandled.

According to IRS regulations, a partial 401(k) termination may occur upon the involuntary termination of 20% or more of employees who are plan participants at the beginning of the year. Odds are, some of your employees will be fully vested while others may not meet the plan’s requirements for 100% vesting of employer contributions.

As an employer, you should ensure your HR department monitors fluctuations in employee headcounts, as well as be on the lookout for events that can trigger a large workforce reduction that could result in a partial 401(k) termination. However — and this is the confusing part — the 20% workforce reduction count is cumulative and can span more than one plan year. It can also be triggered by things other than layoffs and plant closings. These include:

Business restructuring that decreases the size of the workforce.
Amendments to the 401(k) plan where the number of eligible employee participants decreases.
Employee turnover for positions that are not expected to be replaced.

The IRS calculates the turnover rate using a specific formula: 𝑇R = 𝐴 / 𝑋 + 𝑌. 𝑇R means the turnover rate equals the number of participants who were terminated (A) divided by the number of participants at the end of the prior year plus any added during the plan year (X+Y). For example, if 20 employees were terminated at a company that had 80 participants, the turnover rate would be 25%.

If it appears that your company’s workforce has dropped or is expected to drop by 20% or more, you, HR professionals, and plan administrators should closely scrutinize 401(k) plan documents and the laws and regulations governing such retirement plans.

Workforce Reductions and the 401(k) Plan

How does the termination of employee participants affect your company’s 401(k) plan? Between the complexity of 401(k) plan regulations and vigorous IRS oversight, it is crucial to understand that significant employee turnover and other workforce-related events can impact your retirement plan operations and forfeiture accounts.

If it is determined that a partial 401(k) termination occurred, your company must fully vest the affected employees regardless of plan requirements. For example, plan documents might require an employee to work six years to become fully vested in the employer’s contributions to the 401(k) plan. A layoff occurs which includes employees with less than six years of service. You must vest these employees at 100%, in part because they were not given the opportunity to meet that six-year benchmark. The same is true for other events, such as business restructuring and plan amendments that affect employee eligibility.

The immediate vesting of a large number of departing employees could potentially and negatively impact your business. The plan’s forfeiture accounts may be available to fund the vesting of employees without a significant immediate impact on cash flow. However, any required adjustments to vesting must occur whether the forfeiture accounts will cover the cost or not.

It’s important to identify and plan for any event that could jeopardize your 401(k) plan. Failing to recognize a partial 401(k) plan termination is common, but you can take the steps needed to enhance your monitoring procedures and increase awareness.

Avoiding Partial Termination Missteps

The IRS can completely disqualify your 401(k) plan if your vesting is not handled properly after a partial termination. Here are some of the practices you can consider to mitigate any risk:

Learn the rules. Rules and regulations surrounding partial terminations tend to be complex, so you should consider consulting with an employee benefit plan professional or ERISA attorney to understand the rules.
Know your plan. Become familiar with plan document provisions related to partial plan terminations, vesting provisions, and the use of forfeiture accounts.
Establish your oversight policies and procedures. You should be consistently monitoring employee voluntary and involuntarily terminations by the plan sponsor — and management should be ongoing. Don’t forget to consider turnover trends during the plan year, as well as across multiple years.
Document all your terminations. It may be necessary to prove to the IRS whether a departure was voluntary or involuntary for the turnover calculation. Note that the IRS could classify voluntary terminations as involuntary terminations if you can’t provide support for the nature of the employee’s departure.
Manage your forfeiture accounts. The balance of forfeiture account can include a variety of sources, including funds previously forfeited from participant accounts that are affected by a partial plan termination. The funds in the forfeiture account may be needed to reinstate the accounts of the affected participants.
Correct vesting failures. The IRS offers the IRS Employee Plans Compliance Resolution Systems that can be used to correct this compliance failure.

How MGO Can Help

Partial 401(k) terminations can bring additional challenges for your company. MGO can help you maintain the integrity of your plan, avoid penalties, and manage the financial impact of partial terminations.

Our team can assist in identifying potential partial terminations by monitoring your employee turnover and workforce reductions that could trigger these events. We can help you stay compliant with IRS rules to avoid plan disqualification and review your plan documents, vesting provisions, and forfeiture accounts to confirm they are aligned with current laws and regulations.

Reach out to our team today to learn more.

Essential Guide to Transfer Pricing for Your Multinational Business

his article is part of an ongoing series, “Navigating the Complexities of Setting Up a Business in the USA“. View all the articles in the series here.

Key Takeaways:

Implementing effective transfer pricing strategies is essential for regulatory compliance and optimizing your tax position in the U.S.
Transfer pricing helps intercompany transactions align with the arm’s length principle, preventing double taxation and mitigating tax risks.
Meticulous documentation and regularly updated policies are key to maintaining compliance with transfer pricing regulations.

As a multinational enterprise setting up operations in the United States, it is imperative for you to understand the complexities of transfer pricing and intercompany transactions. Effective transfer pricing strategies will help you meet regulatory compliance and improve your tax position.

Fundamentals of Transfer Pricing

Transfer pricing involves setting prices between related entities for transactions — such as the purchase or sale of goods, provision of services, performance of manufacturing activities, cost allocation, or use of intellectual property. This practice of “negotiating” prices between related entities ensures transactions are conducted at “arm’s length”, meaning the prices are consistent with those charged between independent parties. Proper transfer pricing can help you avoid double taxation, mitigate tax risks, and follow U.S. laws.

It is important to note that “related entities” for these purposes involve the concepts of both common ownership and common control. Many taxpayers who fail to understand these concepts also fail to properly address transfer pricing rules and regulations for various transactions.

Regulatory Requirements

IRS Guidelines on Transfer Pricing

The Internal Revenue Service (IRS) provides detailed guidelines on transfer pricing to promote fair pricing practices. These guidelines require businesses to apply the arm’s length principle and provide adequate documentation to justify pricing methods.

Documentation and Compliance

Compliance with U.S. transfer pricing regulations involves meticulous documentation. Companies must prepare and keep detailed records of intercompany transactions — including the rationale for pricing decisions, application of the best method, and evidence that prices meet arm’s length standards. Non-compliance can lead to substantial penalties and adjustments imposed by the IRS.

Setting Up Transfer Pricing Policies

Establishing effective transfer pricing policies requires a thorough understanding of the business model, industry standards, and regulatory requirements. Your company should develop policies that align with the arm’s length principle and keep consistency across all intercompany transactions. Additionally, you should continuously check and update these policies to adapt to any changes in business operations and tax regulations.

For further insights into developing robust transfer pricing strategies, explore our case study on global transfer pricing for a semiconductor leader.

Real-World Transfer Pricing Strategies

Examining real-world examples can offer valuable insights into effective transfer pricing strategies.

Example 1: Goods Transfer

A multinational company based in the United Kingdom sets up a U.S. subsidiary to handle distribution. To follow transfer pricing regulations, the company conducts a thorough analysis to decide proper prices for goods transferred to the U.S. entity, verifying the profitability of the U.S. entity is appropriate.

Example 2: Service Provision

A Japanese company provides technical support services to its U.S. subsidiary. By documenting the cost-plus method, where a markup is added to the costs incurred in providing the services, the company shows compliance with the arm’s length principle.

Example 3: Intellectual Property Licensing

A German firm licenses its proprietary software to a U.S. branch. The firm conducts a detailed analysis to decide the right royalty rate, confirming the transaction meets IRS guidelines and minimizes tax liabilities.

Optimizing Your Transfer Pricing Approach

For multinational businesses moving into the U.S. market, it is vital to understand and implement effective transfer pricing strategies to assist with regulatory compliance, improve tax positions, and support seamless intercompany transactions.

Even if your business is familiar with Organization for Economic Co-operation and Development (OECD) transfer pricing guidelines or currently operates in a country that mirrors them, you need to know the subtleties that may occur should the IRS review your related-party transactions. The IRS will generally abide by U.S. transfer pricing principles without consideration of OECD guidelines. Understanding the differences may help you avoid headaches and create a consistent approach throughout your organization worldwide.

If your business is navigating the complexities of transfer pricing, professional advice and tailored strategies are recommended. For detailed guidance and personalized support, reach out to our International Tax team today.

Setting up a business in the U.S. requires thorough planning and an understanding of various regulatory and operational challenges. This series will delve into specific aspects of this process, providing detailed guidance and practical tips. Our next article will discuss operational strategies for a successful expansion.

CFOs: Prepare Your Company for IRS Transfer Pricing Audits and Mitigate Risk

Key Takeaways:

Transfer pricing is an increasing area of focus for tax authorities, requiring CFOs to adopt more strategic audit preparation.
Proactive measures like pre-audit reviews, voluntary disclosures, and benchmarking are crucial for companies to defend transfer pricing policies and minimize risks.
Prioritizing high-value transactions, collaborating with tax professionals, and leveraging technology are essential to stay ahead of evolving transfer pricing regulations and potential audits.

In today’s global tax environment, transfer pricing has become a critical focus for tax authorities. With multinational companies operating across multiple jurisdictions, tax authorities are intensifying their efforts to scrutinize transfer pricing practices and confirm that profits are appropriately distributed and taxed in their jurisdictions. This growing focus requires chief financial officers (CFOs) and tax executives to shift from compliance alone to comprehensive audit preparation and strategic risk management.

From Compliance to Audit Readiness

While transfer pricing compliance has always been important, the increasing focus on audit enforcement is changing the landscape. It is no longer enough to simply have policies in place; your company needs to be prepared to defend them under rigorous examination. This shift highlights the importance of proactively managing transfer pricing risk and preparing for potential audits.

Risk management and audit preparation efforts include:

Pre-audit reviews — Conducting periodic pre-audit reviews is essential. These reviews offer an opportunity to examine your transfer pricing documentation and policies to confirm the pricing of all intercompany transactions is supported by clear agreements. It is important the documentation reflects an arm’s length standard and is presented in a way that would stand up to an audit. Showing gaps, inconsistencies, or potential weaknesses early on allows your company to address them before tax authorities intervene.
Voluntary disclosures — In cases where pre-audit reviews reveal potential issues, voluntary disclosures can be a valuable tool. If discrepancies are found, making voluntary disclosures to tax authorities can sometimes lead to more favorable outcomes as it shows good faith and a proactive approach to compliance. It also demonstrates your company has a level of sophistication in overall global financial hygiene. This strategy can help you avoid more severe penalties that may arise from issues discovered during an Internal Revenue Service (IRS) or foreign jurisdiction audit.
Benchmarking — Benchmarking and testing are also key components of audit preparedness. Your company should consistently review its transfer pricing policies and test them against current market conditions. This is particularly important when there are economic shifts or significant changes in business operations — such as the introduction of new products, services, or intangible assets. By regularly benchmarking intercompany pricing, your company can support alignment with the arm’s length principle and minimize risk during an audit.

The Role of CFOs in Managing Transfer Pricing Risk

For CFOs, transfer pricing audits are a significant financial risk. These audits can result in tax adjustments and penalties. They can also lead to reputational damage if issues are not handled properly and with sufficient expeditiousness. CFOs together with their tax advisors play a significant role in mitigating this risk by taking a strategic approach to audit readiness and documentation.

Key areas of focus for CFOs include:

High-value transactions — A top priority for CFOs should be focusing on high-value transactions. Not all intercompany transactions carry the same level of risk, and those involving intangible assets, intellectual property, or complex financial arrangements tend to receive the most scrutiny from tax authorities. It is important to thoroughly document and benchmark these transactions to avoid potential challenges during an audit.
Tax professionals — Another critical element of risk management is collaborating with tax professionals. Transfer pricing rules can vary significantly across jurisdictions, and tax advisors are well-versed in the specific requirements and regulations in various countries. Working closely with these advisors enables your company to adapt its transfer pricing policies to standards and minimize exposure to risk.
Voluntary compliance programs — In some cases, companies may receive help by entering voluntary compliance programs — such as advance pricing agreements (APAs). These agreements allow your company to gain certainty over transfer pricing arrangements by agreeing to terms with tax authorities in advance. For high-risk transactions or operations in high-risk jurisdictions, APAs can provide a level of protection from future audits and disputes.

Proactive Risk Management in Transfer Pricing

The global tax landscape continues to evolve as regulatory authorities refine their approaches to transfer pricing audits and enforcement. For mid-market companies with limited resources, it is particularly important to strike the right balance between compliance and cost-efficiency. This requires a proactive approach to transfer pricing risk management that combines audit readiness with strategic planning.

Steps for proactive risk management include:

Audit-ready documentation — The first step in proactive risk management is building audit-ready documentation. This includes keeping detailed records of all intercompany transactions, agreements, and financial data that support the arm’s length nature of pricing decisions. Regularly reviewing and updating this documentation helps your company stay prepared for potential audits.
Regular market testing — Beyond documentation, CFOs should incorporate benchmarking and market testing into risk management strategies. By continuously checking how your pricing compares to the market, your company can stay aligned with the arm’s length principle and minimize exposure to tax adjustments. Regular testing can also help you find potential discrepancies before they become audit issues.
Automated solutions — Finally, using technology to enhance efficiency and accuracy in transfer pricing documentation and analysis is essential. Automated solutions and data analytics offer the ability to quickly find risks, prioritize compliance efforts, and streamline the process of audit preparation.

Keeping Your Company Ahead of the Transfer Pricing Curve

In an era of increased scrutiny and regulatory pressure, transfer pricing compliance is a priority for multinational companies. For CFOs and tax executives, the challenge lies not just in keeping compliant but in preparing for audits and managing the associated risks. Proactive risk management, strategic audit readiness, and a careful focus on high-value transactions are critical components in navigating this complex landscape.

By focusing on audit preparedness, keeping documentation up-to-date, and collaborating with local tax professionals, you can position your company to minimize tax adjustments, penalties, and disputes. As transfer pricing rules continue to evolve, staying ahead of the curve with a forward-thinking strategy is essential for supporting compliance and reducing financial risks.

How MGO Can Help

Our International Tax team is here to help you navigate the new transfer pricing landscape. We can assist you in both broad and focused areas, providing guidance to meet your specific transfer pricing needs. Our services include:

IRS Pre CheckUP — We help you identify and rectify potential weaknesses in transfer pricing and international tax documentation and practices before facing an actual IRS audit.
Review of:
Cross-border agreements for U.S. tax updates
Benchmark data sets
Transfer pricing documentation
U.S. tax returns to confirm consistency with transfer pricing documentation and policies, as well as withholding practices

Protect your company from costly adjustments and penalties — reach out to our team today.

IRS Releases Dual Consolidated Loss Proposed Regulations

Key Takeaways:

The Treasury and IRS released new proposed regulations affecting how dual consolidated losses (DCLs) are calculated and their interaction with the Pillar Two global tax regime.

A new set of rules for disregarded payment losses (DPLs) has been introduced — these apply to disregarded payments deductible in foreign countries, but not included in U.S. taxable income.

The proposed regulations expand the definition of a separate unit and address how foreign tax rules (under Pillar Two) may trigger foreign use restrictions on DCLs.

The Department of the Treasury and the IRS on August 6 released proposed regulations on the dual consolidated loss (DCL) rules and their interaction with the Pillar Two global taxing regime. The proposed regulations also make several changes to how DCLs are calculated and introduce a new disregarded payment loss rule.

DCL Rules

The DCL rules apply to ordinary losses of a dual resident corporation (DRC) or a separate unit. A DRC is either (1) a domestic corporation that is subject to an income tax of a foreign country on its worldwide income or taxed as a resident under the law of that country; or (2) a foreign insurance company that elects to be taxed as a domestic corporation under Internal Revenue Code Section 953(d) and is a member of an affiliated group, even if not subject to tax in the foreign country. A separate unit for purposes of the DCL rules is a foreign branch or hybrid entity that is owned by a domestic corporation. S corporations are not subject to the DCL rules, and domestic corporations will be treated as indirectly owning a separate unit that is owned by a partnership or grantor trust.

Under Section 1503(d), a DCL of a DRC or separate unit generally cannot be used to offset U.S. taxable income of a domestic affiliate (no “domestic use”). This means that the DCL may be used only for U.S. federal income tax purposes against the income of the DRC or separate unit that incurred the DCL.

Some exceptions apply to the domestic use prohibition; for example, a U.S. taxpayer may file a domestic use election and agreement (DUE) certifying that there has not been and will not be any foreign use of the DCL. Foreign use is defined making a portion of the DCL available under a foreign country’s income tax laws to reduce the income of another entity (one that is classified as a foreign corporation for U.S. income tax purposes).

DCLs and Interaction with Pillar Two

The proposed regulations address the coordination between foreign use under the DCL rules and Pillar Two, including expanding the definition of a separate unit to include certain hybrid entities subject to an income inclusion regime (IIR) and foreign branches subject to a qualified domestic minimum top-up tax (QDMTT) or an IIR. More specifically, the proposed rules provide that an income tax for purposes of the DCL rules may include a tax that is a minimum tax computed based on financial accounting principles, such as an IIR or QDMTT. Subject to an exception under the duplicate loss arrangement rules when a double deduction is denied, foreign use could occur if a deduction or loss included in a DCL were used to calculate net GloBE income for an IIR or QDMTT or, alternatively, used to qualify for the transitional CbCR safe harbor. The result of a foreign use would be that no DUE would be permitted to be made to allow for the DCL to be used in the U.S. The proposed rules provide no guidance on the undertaxed profit rules (UTPR).

The proposed regulations also address the concept of “mirror legislation.” The mirror legislation rule under the current DCL rules essentially provides that if the foreign country has its own DCL-type rule that “mirrors” the U.S. rule and that foreign country’s DCL-type rule applies to the loss at issue, then for purposes of the U.S. DCL rules, a foreign use of the DCL will be deemed to occur. The proposed regulations clarify that foreign law, including the GloBE rules, that deny deductions due to the duplicate loss arrangement rules, does not constitute mirror legislation as long as the taxpayer is allowed a choice between domestic or foreign use.

To address legacy DCLs, the proposed regulations provide a transition rule that, subject to an anti-abuse rule, extends the relief given in Notice 2023-80 by treating DCLs incurred in tax years beginning before August 6, 2024, as legacy DCLs and allowing the DCL rules to apply without regard to Pillar Two taxes.

Inclusions Due to Stock Ownership

Under the current DCL rules, U.S. inclusions arising from a separate unit’s ownership in a foreign corporation (such as Subpart F or GILTI) are treated as income and attributable to that separate unit for purposes of determining the income or DCL of that separate unit. This rule also applies to other types of income, such as dividends (including section 1248) and gains from the sale of stock. Under the DCL proposed regulations, with limited exceptions, these types of income (as well as any deductions or losses, such as section 245A dividends received deductions (DRD), attributable to these income items) would be excluded for purposes of calculating a DRC’s or separate unit’s income or DCL.

New Disregarded Payment Loss Rules

The proposed regulations introduce a new set of disregarded payment loss (DPL) rules, which operate independently of the DCL rules. To address certain deduction/non-inclusion outcomes, the DPL rules would apply to some disregarded payments (interest, royalties, and structured payments) that are deductible in a foreign country but are not included in U.S. taxable income because the payments are disregarded.

The DPL rules would require a consenting domestic owner of a disregarded payment entity to include in U.S. taxable income the amount of the DPL of the disregarded payment entity, subject to certain calculation requirements, if one of the following triggering events occur within 60 months: (1) a foreign use of the disregarded payment loss; or (2) failure to comply with certification requirements during the 60-month certification period. A disregarded payment entity is generally a disregarded entity, DRC, or foreign branch.

Since no express statutory authority exists for the new DPL rules, under the proposed regulations, Treasury would implement the DPL rules in coordination with the entity classification election rules under Treas. Reg. §301.7701-3(c), which means that when a specified eligible entity either elects to be disregarded for U.S. tax purposes or defaults to a disregarded entity under the general rules of Treas. Reg. §301.7701-3(b), the domestic owner would be deemed to consent to the new DPL rules. A specified eligible entity is an eligible entity (whether foreign or domestic) that is a foreign tax resident or is owned by a domestic corporation that has a foreign branch. This deemed consent rule would also apply in a situation where a domestic corporation directly or indirectly acquires an interest in a preexisting disregarded entity, as well as a domestic corporation that owns an interest in a disregarded entity by reason of a conversion from a partnership.

The DPL consent rules would apply to new entity classification elections filed on or after the date the proposed DCL rules are finalized and existing entities starting 12 months after the date the proposed regulations are finalized, which would allow taxpayers to restructure their operations before the DPL rules enter into effect.

Intercompany Transactions

The Section 1502 consolidated return regulations provide rules for taking into account certain items of income, gain, deduction, and loss of members from intercompany transactions, essentially treating consolidated group members as separate entities for some purposes and single entities for other purposes. The purpose of the regulations is to provide rules to clearly reflect the taxable income (and tax liability) of the group as a whole by preventing intercompany transactions from creating, accelerating, avoiding, or deferring consolidated taxable income (or consolidated tax liability).

The proposed regulations modify the existing regulations and generally shift application of the regulations to separate-entity treatment. More specifically, if a member of a consolidated group is a DRC or a U.S. member that owns a separate unit, the proposed regulations state that despite Section 1503(d) requiring certain treatment of the member’s tax items, the counterparty consolidated group member’s income or gain on the intercompany transaction will not be deferred. For example, if one member has intercompany loan interest expense that the DCL rules prevent from being deducted, the counterparty member’s interest income would still be included in income.

Additionally, under the proposed regulations, the Section 1503(d) member has special status in applying the DCL rules, which means that if a Section 1503(d) member’s intercompany (or corresponding) loss would otherwise be taken into account in the current year, and if the DCL rules apply to limit the use of that loss (preventing it from being currently deductible), the intercompany transaction regulations would not redetermine that loss as not being subject to the limitation under Section 1503(d). A Section 1503(d) member is an affiliated DRC or an affiliated domestic owner acting through a separate unit.

Books and Records

Under Treas. Reg. Section 1.1503(d)-5, a separate unit’s income or DCL calculation is based generally on items reflected on the separate unit’s books and records as adjusted to conform to U.S. federal income tax principles. As a result, certain transactions, such as transactions between the separate unit and its U.S. owner, are disregarded for purposes of calculating a separate unit’s income or DCL. The proposed regulations clarify that items that are not (and will not be) on the books and records of the separate unit are not included in the separate unit’s income or DCL calculation. This clarification was provided, according to the Treasury, to address positions taxpayers have taken that allocate income on the books and records of the U.S. owner to the separate unit, although those items are not on the books and records of the separate unit.

Applicability

The proposed regulations would generally apply to tax years ending on or after August 6, 2024, except for the intercompany transaction regulations, which would apply to tax years for which the original U.S. income tax return is due without extensions after the date the final DCL regulations are published in the Federal Register. This means that if the final regulations are published by April 15, 2025, they would apply to calendar year 2024. Deemed consent under the DPL rules would apply to tax years ending on or after August 6, 2025.

Once the proposed regulations are finalized, taxpayers can choose to apply them retroactively to open tax years, subject to some consistency requirements.

Insights

The DCL proposed regulations are lengthy and complex and include significant changes that taxpayers should consider now, since many of the changes will apply retroactively to calendar year 2024 once the proposed regulations are finalized.

Taxpayers affected by the proposed regulations should consider the impact these rules may have on their DRCs or separate units, especially since the transitional Pillar Two relief is expected to end soon for many calendar-year and fiscal-year taxpayers.

Taxpayers may need to make adjustments to their DCL calculations going forward to take into account the new rules regarding removing items from the DCL calculation that are not on the separate unit’s books and records and U.S. inclusions, among others. The removal of these items could have a significant effect by unintentionally creating a DCL or increasing the amount of any existing DCL, among other possible upshots.

How MGO Can Help

If the Treasury and the IRS finalize these proposed regulations and you have a multinational company, you may lose the ability to take a U.S. deduction for losses incurred by foreign hybrid entities and foreign branches. If you are affected by the interaction of Pillar Two and the new proposed DCL rules, MGO’s team of experienced international tax advisors can discuss the potential of restructuring to minimize any negative tax consequences. We can also mockup OECD Pillar Two modeling and assist with planning for the overall minimization of your worldwide taxation with income or direct taxes. Our compliance services can help you with your foreign compliance calendars too. Trust us as we dive into the details and limit your global tax rate and overall exposure.

Transfer Pricing Compliance Checklist for Your Business

Key Takeaways:

Businesses operating internationally should regularly review transfer pricing practices — including documentation, benchmarking, and IRS reporting requirements.

Understanding the classification of inter-company transactions, learning from past audits, and considering Advance Pricing Agreements can improve tax compliance and strategy.

Regular assessment of transfer pricing practices can help maintain compliance, mitigate risks, and potentially reveal cost-saving opportunities.

For today’s global businesses, understanding and managing the complexities of international tax and transfer pricing can be a challenge. That’s why it is important to regularly review your practices against critical standards to maintain compliance and improve tax strategies.

To help you determine if your company is compliant or if consultation may be needed, use this straightforward checklist based on key questions about your operations:

Does your company need transfer pricing documentation? Transfer pricing documentation is essential to show your company’s pricing policies follow local and international arm’s length standards. This documentation should include detailed analyses of inter-company transactions, the methods used to set prices, and how these follow applicable tax laws. Having robust documentation can help you prevent disputes with tax authorities, avoid potential tax penalties, and make audits run smoother.

Do your inter-company transactions need to be benchmarked? Benchmarking is the process of comparing your inter-company transactions with those of similar transactions by unrelated parties to confirm the inter-company pricing is at arm’s length. This process involves gathering data from uncontrolled comparable companies and transactions to justify your pricing strategies. Effective benchmarking helps maintain compliance and supports your transfer pricing documentation.

Do your inter-company transactions need to be reported on an IRS form? Certain inter-company transactions must be reported to the IRS to follow regulations and avoid penalties. For instance, transactions with foreign affiliates often require filling out Form 5472. Regularly reviewing which forms are applicable and accurately reporting transactions can help you stay compliant and avoid fines. In addition, your company may have offshore investments that may require reporting on IRS Forms 5471 and/or 8621.

Are your inter-company transactions “regarded” or “disregarded”? (Consider if some are regarded and others are disregarded.) The tax treatment of inter-company transactions can vary, with some being regarded and others disregarded. Understanding which transactions fall into each category is vital for proper tax planning and compliance as it affects income allocations and taxable earnings calculations.

Have your inter-company transactions come under IRS or state audit in the last five years? If your transactions have been audited, it’s important to review the outcomes and learn from them. An audit history can show potential areas of risk in your transfer pricing practices. Reviewing and adjusting practices based on past audits can help reduce the likelihood of future audits and potential penalties.

Does your company have an Advance Pricing Agreement (APA) in place? An APA is an agreement between a taxpayer and tax authorities that pre-approves transfer pricing methods the taxpayer will apply for future inter-company transactions. Having an APA can reduce uncertainty in tax matters, prevent disputes, and provide clarity on how transactions will be treated. If you don’t have an APA, it might be time to consider whether it could help your operations.

Could your company benefit from a “health check” on its international tax or transfer pricing practices? A tax “health check” involves a comprehensive review of your company’s tax and transfer pricing practices to find areas for improvement and potential risks. This proactive approach can help your company improve its tax strategies, verify compliance, and potentially uncover cost-saving opportunities.

Is Your Business Meeting Transfer Pricing Compliance Standards?

By answering the questions above, you can identify areas where your company may need to improve its transfer pricing and international tax practices. Addressing these key areas will help you develop more effective strategies to mitigate your risks.

How MGO Can Help

We are committed to helping you navigate the complex world of international tax and transfer pricing. With our comprehensive approach, we address each area of potential concern — from correct documentation and effective benchmarking to navigating IRS reporting requirements and understanding the tax implications of every transaction.

Whether you are looking to set up an APA or simply need a thorough “health check” of your current practices, our team is here to provide the support and insights necessary to improve your tax strategies and enhance your operational efficiency. Reach out to our team today.

How to Prepare Your Company for the New IRS Audit Era

Key Takeaways:

Invest in secure cloud storage and cybersecurity measures for proper data retention and compliance with IRS requirements.

Maintain accurate records and document policies and procedures to prevent disputes and keep all financial documents organized and accessible.

Collaborate with tax professionals and maintain relationships with IRS liaisons and taxpayer advocates to navigate complex tax controversies effectively.

The landscape of tax resolution and advocacy is rapidly evolving. As the Internal Revenue Service (IRS) adopts advanced technology and increases its workforce, companies need to be more prepared for potential audits and examinations.

Getting Your Company Audit-Ready

Here are five practical steps to help prepare your company for an audit:

Invest in data management — Proper data retention and management are crucial. Your company should transition from traditional storage methods, such as USB drives, to more secure options like cloud computing. However, it’s vital to implement strong cybersecurity measures to protect sensitive information.

Maintain accurate records — All your financial records and documents used in tax return preparation need to be organized and easily accessible. This includes keeping work papers from third-party tax preparers and documenting the rationale for any deductions or claims made on tax returns.

Document policies and procedures — Having clear policies and procedures for financial transactions and deductions is essential. This can prevent disputes with the IRS over the legitimacy of claimed deductions.

Train your team — Your staff, especially those involved in financial reporting and compliance, are well-trained and aware of the latest tax laws and regulations. Avoid having untrained personnel handle critical discussions with IRS auditors.

Collaborate with professionals — Given the complexity of modern tax issues, such as those involving cryptocurrency, it’s crucial to involve specialized practitioners. For example, if your company deals with digital assets, consider consulting with professionals who are knowledgeable in cryptocurrency and digital asset taxation.

Anticipating Increased IRS Scrutiny

With the IRS focusing on closing the $7 trillion tax gap, your business should expect more scrutiny — especially in areas like international transactions, digital assets and employment taxes. The recent resurgence of automatic notice generation by the IRS means your company needs to be vigilant about its tax filings and ready to respond promptly to any notices you receive.

Building Your Tax Network

Having access to a knowledgeable network of tax professionals can enhance your ability to navigate tax controversies. This includes relationships with IRS stakeholder liaisons, local taxpayer advocates, and other tax professionals. These connections can offer valuable insights, assist in resolving disputes, and help you understand new IRS initiatives.

Enhancing Your Internal Capabilities

To keep pace with the IRS’s increased technological capabilities, your business must also enhance its internal processes. This includes upgrading software and research tools to streamline the preparation of tax appeals and audit responses. Investing in technology will help minimize the time and effort needed to compile comprehensive responses to IRS inquiries, ultimately reducing the cost and duration of your audits.

Leveraging Industry Insights

Staying informed about tax law changes, industry trends, and IRS focus areas can help your company be prepared for what’s to come. Your tax team should regularly communicate with you, offering insights into the IRS’s evolving approach. This knowledge enables you to understand potential audit triggers and develop proactive strategies to address them.

Proactively Managing Your Tax Compliance

As the IRS continues to evolve its enforcement strategies, your mid-market company must stay proactive in its approach to tax compliance. By investing in technology, keeping thorough records, training staff, and maintaining a strong network of professionals, your business can better manage the complexities of the current tax environment.

How MGO Can Help

We are here to help you navigate the ever-changing landscape of tax resolution and advocacy. For detailed questions or advice tailored to your specific situation, reach out to our team today.

Are Your Employee Retention Credit (ERC) Claims at Risk? What You Need to Know

Key Takeaways:

Employers should promptly respond to IRS notices regarding ERC claims to avoid disallowance and potential legal action.

Accurate documentation is essential, particularly regarding qualifying government orders and the eligibility period for ERC claims.

Understanding IRS-identified risks, such as overstating claims and calculation errors, is crucial to avoid costly compliance issues.

UPDATE (AUGUST 2024):

The IRS is advancing its processing of Employee Retention Credit (ERC) claims while extending the moratorium on new claims to January 31, 2024. The IRS will now start processing claims filed between September 14, 2023, and January 31, 2024. This shift allows the IRS to expedite payments for legitimate claims and crack down on improper filings. What this means is that taxpayers who filed ERC claims after the prior moratorium date of September 14, 2023, and have been waiting for them to be processed, should now see progress on these claims in the coming months. This is a very positive development for taxpayers who have submitted pending claims.

Recently, 28,000 disallowance letters were sent, potentially saving $5 billion in erroneous payouts. The agency’s actions reflect a careful balance between protecting taxpayers and ensuring eligible businesses receive due funds. The IRS also recently reported that it has identified 50,000 valid ERC claims and is quickly processing them and sending refunds in the weeks ahead.

For those taxpayers who have received denial letters or believe their claims were wrongly rejected, there are several paths to address these issues. Consulting with a tax controversy advisor is advisable to determine the best course of action, including the possibility of appealing the decision. In some cases, taxpayers may consider pursuing legal action through tax court, U.S. District Court, or the Court of Federal Claims, either as an alternative to an appeal or following an unsuccessful one. Engaging an attorney early in the process is recommended to explore all available options.

To combat a wave of frivolous Employee Retention Credit (ERC) claims, the IRS has sharply increased compliance action through audits and criminal investigations, with more activity planned in the future. In this heightened enforcement-focused environment, employers are advised to act swiftly when responding to IRS notices regarding ERC claims.

Immediate Action Required for Employers Receiving IRS Audit Notifications

Employers must be aware that failing to respond to IRS notices within the time frame specified can lead the IRS to disallow the entire ERC claim and issue a notice of disallowance. Once the IRS formally disallows a refund claim, the taxpayer may be permitted to first file a protest with the IRS Office of Appeals or, in some cases, the taxpayer may decide to file a lawsuit in federal court to litigate the issue. Both scenarios subject employers to the necessary defense of an often burdensome and costly refund claim controversy, further delaying the much-needed ERC relief promised by Congress.

The successful defense of any ERC examination will depend greatly on an understanding of the risks and eligibility criteria to avoid the costly repercussions of noncompliance, including the potential for general examination. In Notice IR-2024-39, the IRS highlighted warnings signs that ERC claims may be incorrect, urging businesses to revisit their eligibility.

Key Examination Risks Identified by the IRS

Claiming Too Many Quarters: It is unusual for employers to qualify for the ERC in all available quarters. A meticulous review of eligibility for each quarter is advised to avoid overstating claims.

Non-Qualifying Government Orders: The IRS has clarified that not all government orders related to COVID-19 qualify for the ERC. Orders must have directly affected the employer’s operations, and mere guidance or recommendations do not suffice. Businesses must be able to document and substantiate the impact of qualifying government orders.

Employee Counts and Calculation Errors: Thanks to changes in the law throughout 2020 and 2021, employers must now be vigilant in their calculations, adhering to the dollar limits and credit amounts for qualified wages.

Supply Chain Disruptions: Qualifying for the ERC based solely on supply chain issues is rare. Employers must demonstrate that their supplier was affected by a qualifying government order.

Overstating the Eligibility Period: Claiming the ERC for an entire calendar quarter is possible only if the business was impacted for the full duration of the quarter. Employers are entitled to claim ERC only for wages paid during the actual suspension period and must maintain accurate payroll records.

Navigating Refund Claim Controversies Amid Increased IRS Action

Employers should seek guidance from trusted tax professionals to maintain compliance and effectively manage the challenges of the IRS’s ongoing enforcement actions.

How MGO Can Help

MGO can assist you in navigating IRS audits and ERC claims — helping you meet compliance standards, provide accurate documentation, and address tax controversies. For detailed assistance, visit our Tax Advocacy and Resolution services.

Is Your Company at Risk for Transfer Pricing Penalties?

Key Takeaways:

The IRS has intensified enforcement of transfer pricing regulations, significantly increasing potential penalties.
Organizations can reduce exposure to transfer pricing penalties by ensuring adequate documentation and applying global transfer pricing policies consistently.
In cases where penalties are imposed, businesses can seek penalty abatement by demonstrating reasonable cause and good faith, substantial compliance with transfer pricing rules, and leveraging effective representation from knowledgeable tax advisors.

The Internal Revenue Service (IRS) implemented transfer pricing penalties to ensure the intercompany pricing reported on your income tax return is determined in a manner consistent with the arm’s length standard.

Until recently, penalty assessments were rare — not because improper transfer pricing between related parties was rare, but because IRS examiners tended to accept inadequate documentation. That leniency appears to be a thing of the past.

The IRS has indicated it will focus on applying Internal Revenue Code (IRC) Section 6662 penalties where proper documentation is lacking. This trend warrants serious attention if your company engages in cross-border transactions.

Imposing Transfer Pricing Penalties

The IRS can impose penalties when allocations under Section 482 result in substantial or gross increases in taxable income or where there are substantial or gross valuation misstatements concerning the transfer prices themselves.

These penalties can be severe, ranging from 20% to 40% of the tax underpayment, depending on the degree of non-compliance and the taxpayer’s disclosure of relevant information.

Historically, you could avoid these penalties by demonstrating you had reasonably used a transfer pricing method outlined in Section 482 or another method to more reliably determine transfer prices. Taxpayers must also provide contemporaneous documentation within 30 days of a request from the IRS.

The IRS’s Shift Toward Increased Penalty Assertion

The IRS Advisory Council’s 2018 Report noted that, although some transfer pricing documentation quality possibly fell short of the Section 6662 requirements, the IRS had not consistently asserted the penalty. Since then, the IRS has produced guidance addressing common flaws in transfer pricing documentation and best practices, and the agency is now expressing a renewed commitment to applying penalties more frequently and vigorously.

Holly Paz, commissioner of the IRS Large Business and International Division, spoke at several tax practitioner events in late 2022 — including the AICPA’s National Tax Conference, the American Bar Association Section of Taxation’s Philadelphia Tax Conference, and a Bloomberg Tax event. During these events, Paz noted the IRS has had success in litigating transfer pricing cases and is taking a closer look at economic substance and sham transactions — even in cases with transfer pricing documentation — to determine where it is appropriate to assert penalties.

Mitigating Exposure to Transfer Pricing Penalties

In 2020, the IRS published Transfer Pricing Documentation Best Practices Frequently Asked Questions (FAQs). These FAQs point to several features of proper documentation IRS agents look for when determining whether the agency should audit an organization’s transfer pricing methods.

Incorporating these features into your documentation may help reduce your risks:

Sensitivity analysis – Assess the impact of removing a comparable company from the dataset and determine if such removal alters your position relative to the arm’s-length range. Evaluate how different profit-level indicators might change the results.
Segmented financial data analysis – Examine if the segmented financial data accurately reflects the arm’s-length nature of the intercompany transaction. Detail the methodology used in constructing this data.
Profit allocation in intercompany transactions – Analyze profit distribution among entities in the transaction. Ensure equitable economic outcomes for all parties, not just the tested party.
Description of risks and related-party allocations – Describe associated risks in each intercompany transaction. Explain how profits and losses are allocated among related parties.
Atypical business circumstances – Identify any unusual business conditions affecting the intercompany transaction. Discuss challenges in the economic analysis due to specific business results for the year.

To navigate this heightened scrutiny, taxpayers must take a proactive approach to document pricing transfer decisions. Steps you can take to avoid commonly seen inadequacies include:

Providing a detailed description of your business and industry to help IRS agents understand operations and the larger marketplace in which you operate.
Avoid using a checklist format. Instead, opt for a comprehensive analysis linking facts to the analysis. Base the analysis on well-supported facts, avoiding broad assumptions about the business.
Ensure consistency in risk allocation with intercompany agreements. Align risk allocation with the comparable companies used in the economic analysis, and clearly explain any adjustments made to comparable companies for risk considerations.
Prepare a best method selection analysis that justifies rejecting alternative methods for analyzing the intercompany transaction and provides a rationale for the chosen method.
Clearly outline any adjustments to comparable data, such as working capital or location savings adjustments.

If you believe you have valuation misstatements or understated income tax in previously filed returns, it’s not too late to correct them. Filing a qualified amended return before the IRS contacts you about a transfer pricing audit is a defense against penalties. However, you must pay all taxes associated with the amended returns.

Seeking Penalty Abatement

In instances where penalties are assessed, it may be possible for taxpayers to seek abatement by demonstrating high-quality transfer pricing documentation. You may have a reasonable chance of having penalties abated if you:

Demonstrate reasonable cause and good faith. Establish that the underpayment was due to reasonable cause, and you acted in good faith.
Substantial compliance. Show that, despite any errors, you substantially followed the transfer pricing rules.

How We Can Help

The resurgence of transfer pricing penalties is an opportunity to reassess your transfer pricing strategies and compliance mechanisms.

For personalized guidance and assistance navigating these complexities, contact MGO today. Our team of professionals is equipped to help you mitigate risks, confirm compliance, and effectively manage any disputes with tax authorities. Act now to safeguard your business against the pitfalls of transfer pricing penalties.

State Transfer Pricing Audits Are on the Rise – Here’s How to Protect Your Business

Executive Summary

State tax authorities are escalating audits of intercompany transactions, as transfer pricing crackdowns in several states are generating millions in tax revenue.
These state initiatives indicate growing regulatory emphasis on transfer pricing, which may encourage more aggressive audits (especially if budgets tighten).
Companies operating across state borders should take proactive steps, like conducting transfer pricing studies to validate policies and strengthen defenses before audits strike.

A recent Bloomberg article affirms state tax authorities are ramping up audits of intercompany transactions at multistate corporations. The report points to an increase in audits in three “separate-reporting” states following transfer pricing settlement initiatives as a beacon of audit activity to come across other states that take this approach.

While not ideal for multistate operators, this development may not come as a surprise to companies with international operations who have dealt with a myriad of cross-border tax issues in recent years. Close observers of state and local tax (SALT) developments have been predicting for many years the potential that states will be adopting similar positions with respect to transfer pricing. In a 2022 article focused on SALT transfer pricing enforcement, we highlighted several key indicators that more state transfer pricing audits could be on the horizon – including state budget deficits, a surge in auditor and consultant hirings, and renewed interest among states in collaborating on multistate audits.

With confirmation that state-driven transfer pricing audits are on the rise, it is imperative for corporations operating across state borders to assess your transfer pricing risks and fortify your documentation and audit defense strategies.

Surge of Transfer Pricing Audits in Separate-Reporting States

According to the Bloomberg Tax report, the recent spike in transfer pricing audit activity has predominantly affected Southeastern states categorized as separate-reporting states. Currently, there are 17 separate-reporting states in the United States. With the exception of a handful of states like Indiana, Pennsylvania, Iowa, and Delaware, most separate-reporting states are located in the Southeast region.

How separate-reporting states differ from other states in their taxation approach to corporations:

In separate-reporting states, each corporation within an affiliated group is required to file its individual tax return. This treatment considers them as separate entities with independent income, recognizing intercompany transactions, and allowing for varying tax liabilities.
In contrast, combined-reporting states require or allow affiliated corporations within a corporate group to file a single tax return, treating them as a unitary business with shared income, often eliminating intercompany transactions.

Notably, two Southeastern states, Louisiana and North Carolina, have recently concluded audit resolution programs that significantly boosted their state revenues. Louisiana’s program generated nearly $38 million, while North Carolina’s efforts resulted in more than $124 million. Meanwhile, New Jersey, a Mid-Atlantic state that abandoned separate reporting in favor of combined reporting in 2019, is in the midst of a transfer pricing resolution program that has already collected almost $30 million. The success of these programs in collecting tax revenue is likely to motivate other states to explore similar initiatives.

The success and subsequent expansion of these programs signify a growing emphasis on transfer pricing at the state tax authority level. State tax agencies are enhancing their knowledge and enforcement activities in this domain, giving auditors more confidence to adjust returns in transfer pricing disputes. This increasing competency may be viewed as a valuable tool by states – both those requiring separate and combined reporting – that are seeking ways to augment revenue streams.

Strengthen Your Transfer Pricing Defenses Before State Audits Strike

To preemptively safeguard your business from a state transfer pricing audit, a proactive approach to validating pricing policies is essential – and a comprehensive transfer pricing study is your primary defense.

Here are three key advantages of conducting a transfer pricing study:

Document Your Transfer Pricing Policy: A transfer pricing study provides robust documentation that can counter inflated tax assessments by identifying key intercompany transactions, referencing benchmark data, and highlighting any deviations that necessitate policy adjustments. Even if your company has undertaken prior studies, annual updates are indispensable to align with evolving business landscapes and provide tax penalty protection.

Mitigate Your Risk: Beyond reducing audit risks and potential liabilities, these studies also play a pivotal role in supporting major corporate events like mergers and acquisitions (M&A). By demonstrating pricing compliance, they ensure that domestic affiliates have robust documentation and effective cost allocation analysis, thus preventing over-taxation or under-taxation.

Ensure Consistency: Minimize uncertainty by achieving uniform entity-specific compensation across state agencies and affiliated entities. Swift collaboration with advisors when audits arise enhances dispute resolution capabilities.

As states continue to gain confidence in challenging transfer pricing, multistate corporations must take proactive measures to ensure the resilience of their intercompany transactions under intensified scrutiny.

Get Ahead of the Game with a Transfer Pricing Study

If your company engages in substantial intercompany transactions across state lines, initiating a review of your current pricing policies, preparing your transfer pricing policies, and ensuring compliance with U.S. transfer pricing rules should be a top priority. Proactive measures can help you stay ahead of potential issues before state auditors come knocking. We have a robust transfer pricing team that works closely with our State and Local (SALT) Tax and Tax Controversy practices. Through a combined effort we can support you through every stage of managing a transfer pricing audit. Talk to our transfer pricing professionals today to find out how we can help you minimize your exposure to transfer pricing audits.

IRS Takes Drastic Measures to Combat Fraudulent Employee Retention Tax Credit Claims

Executive Summary

The Internal Revenue Service (IRS) instituted a moratorium on the processing of new Employee Retention Tax Credit (ERTC) claims due to an influx of fraudulent and exaggerated claims — primarily stemming from unscrupulous ERTC mills.
As of July 31, 2023, the IRS Criminal Investigation division had initiated 252 investigations involving more than $2.8 billion in potentially fraudulent ERTC claims. Fifteen investigations have resulted in federal charges, with six of those resulting in convictions with an average sentence of 21 months.
Taxpayers who are not certain of their eligibility should consult with a trusted tax professional for a second review and may want to avail themselves of the IRS’s new settlement and/or withdrawal programs.

The IRS recently took a drastic step to impede a wave of ineligible ERTC claims by halting the processing of new refund requests through at least December 31, 2023.

Ineligible ERTC claims have plagued the IRS since Congress enacted the credit in 2020. In fact, the IRS opened its 2023 “Dirty Dozen” list with warnings about common ERTC scams that taxpayers should be wary of. This prominently placed notice — as well as subsequent announcements from the IRS — alerted taxpayers to unscrupulous actors who have been advising employers to claim credits in excess of what they could legitimately qualify for while charging those employers hefty upfront fees or fees contingent on ERTC refunds.

In the wake of a flurry of IRS investigations that identified more than $2.8 billion potentially fraudulent claims, the halt on processing ERTC claims will allow the IRS to further focus their efforts on investigating and ultimately prosecuting fraudulent claims. In the following we’ll detail the impact of the IRS moratorium and provide guidance if you suspect you’ve been exposed to inaccurate or fraudulent ERTC claims.

Background on the ERTC

First established in 2020 by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, the employee retention tax credit was critical — along with Paycheck Protection Program (PPP) — in giving businesses that struggled to navigate the pandemic’s challenges much needed resources to pay employees while the businesses were shut down or facing declining sales.

For most taxpayers, the ERTC was claimed on quarterly payroll tax returns encompassing the period March 13, 2020, through September 30, 2021 (i.e., first quarter of 2020 through the third quarter of 2021). For a small subset of businesses classified as “recovery startup businesses” (as defined below), the ERTC could also be claimed for the fourth quarter of 2021.

Despite the halt in processing by the IRS, eligible taxpayers are still able to claim the credit by filing amended quarterly payroll tax returns. Amended payroll tax returns for 2020 quarters are able to be processed by the IRS as long as they are filed on or before April 15, 2024, while amended payroll tax returns for 2021 quarters are able to be processed as long as they are filed on or before April 15, 2025.

The credit is calculated based on the “qualified wages” of employees. The maximum amount of payroll tax credit that an employer can claim per employee is $26,000.

Qualification Tests

To be eligible for the ERTC, businesses must generally satisfy one of the following criteria for each of the quarters for which they are claiming the credit:

Government Mandate Test — They experienced a full or partial suspension of operations that resulted from government orders that limited commerce, travel, or meetings.
Decline in Gross Receipts Test — They experienced a significant decline in gross receipts resulting in more than a 50% decline during each claimed 2020 quarter or more than a 20% decline during each claimed 2021 quarter.
Recovery Startup Business — They qualified as a “recovery startup business” — a business that began operations after February 15, 2020, and whose average annual gross receipts were $1 million or less. (Note that this last qualification only applies for the third and fourth quarters of 2021.)

The IRS Processing Moratorium

On September 14, 2023, the IRS announced that it would halt the processing of new ERTC claims through at least December 31, 2023. The IRS also stated that it plans to subject its queue of more than 600,000 existing ERTC claims to stricter compliance reviews, increasing the standard processing goal for those claims from 90 days to 180 days — with a potential for a much longer processing time for claims that require further review or audit.

This processing moratorium comes on the heels of a significant influx of claims – many of which the IRS believes are ineligible. The IRS stated that it has received more than 3.6 million ERTC claims over the life of the ERTC program, with about 15% of those claims being received in the 90-day period preceding the processing freeze. This amounts to roughly 50,000 claims still being received a week. To put this in perspective: the IRS has paid out about triple the amount that Congress had originally estimated for the program.

Additionally, as of July 31, 2023, the IRS Criminal Investigation division had initiated 252 investigations involving more than $2.8 billion in potentially fraudulent ERTC claims. Fifteen of the 252 investigations had resulted in federal charges, with six of those resulting in convictions. Four of the six convictions had reached the sentencing phase with an average sentence being 21 months.

The IRS intends on utilizing the moratorium to add more safeguards to the processing of ERTC claims, to protect businesses by decreasing the momentum of the pop-up ERTC mill industry, and to provide several solutions for taxpayers who submitted invalid claims. Those solutions include:

A claim withdrawal program will be rolled out in Fall 2023 allowing businesses to withdraw ERTC claims that have not been processed or paid, even if those claims are under audit or awaiting audit.
A claim settlement program rolling out in Fall 2023 that will allow businesses to repay ERTC claims, while also avoiding penalties and future compliance actions. (Note that fraudulent claims may still be subject to criminal referral.)

How to Respond to IRS Scrutiny of ERTC Claims

Given the expected extra scrutiny that businesses can expect to face on their claims, businesses should review ERTC claims that they have made and/or intend to make where there are any doubts regarding the eligibility of those claims:

If you have already submitted the ERTC claim and received a refund: If you have any doubts regarding your eligibility, we recommend reaching out to a trusted tax professional to obtain a fresh, objective assessment of your qualifications for the credit. If you determine that you were ineligible, you can participate in the IRS’s settlement program so that you can repay the claim, avoiding both penalties and audit-related fees.

If you have already submitted the ERTC claim, but the claim has not been processed or paid: The claim will take longer to process than during the summer — increasing from a three-month turnaround time to a likely six-month turnaround time. If you have any doubts regarding the claim during this period, we recommend reaching out to a trusted tax professional to have a second review of the claim. If you determine that you were ineligible, you can withdraw the claim under the IRS’s withdrawal program without penalties, even if an audit has commenced.
If you have not yet submitted the ERTC claim: Any claim submitted between September 14 and the date that the IRS lifts the moratorium – currently after December 31, 2023 – will not be processed. This should provide an opportunity for you to re-evaluate whether the claim has merits and to bolster the claim if needed. We recommend working with a trusted tax professional to have the best possible substantiation for your claim so that it is more likely that the claim will be sustained if challenged by the IRS.

How MGO Can Help

MGO’s ERTC Second Look program is geared towards the types of objective, trustworthy reviews that would benefit you during this time of heightened ERTC claim scrutiny. Our experienced Credits & Incentives team can identify audit red flags, areas that need more substantiation, miscalculations, and incomplete filings. In addition, our Tax Controversy team — in tandem with our Credits & Incentives team — can defend you if any of your ERTC claims are challenged by the IRS, with the ability to represent you during audit, appeals, and tax court. Contact us to learn more.