IRS May Credit ERC Refunds Against Unpaid PEO Federal Tax Liability

calendar iconMay 24, 2023

In a situation where a Professional Employer Organization (PEO) has an outstanding Internal Revenue Service (IRS) liability, employers who utilize PEOs may encounter difficulties when receiving payment of the refundable Employee Retention Credits (ERCs) to which they may be entitled.

On May 12, 2023, the IRS made CCA_2023031609200704 available, which contains internal email correspondence from March 2023 specific to the ability for the IRS to offset ERCs against existing tax liabilities of a PEO. PEOs generally provide services such as acting as a paymaster and W-2 filer, or providing human resource services for its clients.

For businesses that qualify as an Eligible Employer under the ERC regime and use a PEO, the PEO files the ERC refund claim on behalf of its client. The PEO reports the client’s ERC claim on Schedule R of the PEO’s Form 941. When the IRS refunds the credits to the PEO, the contractual relationship between the PEO and its client, the Eligible Employer, governs how those credits are paid to the client.

For more information about qualifying as an Eligible Employer or filing ERC refund claims: Read Our ERC Resource Guide

IRS Announcement Propositions

In the internal email correspondence, the IRS indicated that it has the discretion to credit any overpayment (such as an ERC refund) against any unpaid tax liability of the PEO. In the analysis, the IRS recited the following propositions:

  • Section 6402(a)grants the IRS discretion to credit any overpayment against “any liability in respect of an internal revenue tax on the part of the person who made the overpayment.”
  • With respect to the COVID-19 employment tax credits, the IRS makes the business decision to offset excess refundable COVID-19 employment tax credits to any existing tax liabilities on the employer’s account.
  • For taxpayers using a PEO that pays wages to individuals as a service provided to a client pursuant to a service agreement, the credits claimed on the Form 941 Schedule R are attributable to wages paid to a client’s employees. In this case, the PEO is the taxpayer that claims the employment tax in an aggregate amount on a single line on a Form 941, filed under its own employer identification number.
  • If a refund is ultimately issued to the PEO, the PEO and the client must ensure the PEO remits any portion of the refund to the client in the appropriate amount.
  • The IRS is not a party to those agreements and has no legal obligation to refund any portion of the PEO’s refund to a client identified on Schedule R.
  • When the IRS conducts an audit of a Form 941 filed by a PEO, the IRS examines the aggregate total amount of the line-item credit claimed by the PEO on the Form 941, using the client-by-client allocation information provided on Schedule R.

The IRS email suggests that payment of an ERC refund to a client of a PEO is a civil matter, strictly between the PEO and the client employer. IRS internal emails are not authoritative guidance, but they do give insight into the current IRS thinking on issues. A business that uses a PEO and is eligible for the employee retention credit should be alert to this IRS position and review its working arrangement with its PEO.

How Cherry Bekaert Can Help

Cherry Bekaert has an experienced team of ERC professionals who are able to assist with determining your ERC eligibility and reviewing your ERC claims.

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