Tax Controversy Archives - MGO CPA | Tax, Audit, and Consulting Services

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.

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.