Large erroneous ERC refund by the IRS

Technical topics regarding tax preparation.
#1
Riki_EA  
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We helped one of our business clients file (via 941-X) for the ERC for two quarters in 2021, after we determined that they qualified. This was nearly a year ago. We were working this week on the 2022 accounting, and turned out that for one of the checks, the IRS made some sort of data entry error, and misplaced a decimal point by two spaces. Instead of a $793 Non-refundable portion of the ERC, they showed $79,300, added it to the refundable portion and issued the business a check for close to $100k.

The business owner did not contact us, but just deposited it into his business bank account in June 2022. It was misidentified by the bookkeeper as business income, and it was only when I asked the business owner for the letters from the IRS (since I couldn't locate the ERC deposits) that the mistake came to light. The business owner claimed he did not realize that the check wasn't correct at the time.

Needless to say, the business owner no longer has the $79k to pay back the IRS. He closed the business late in 2022 after selling the assets of the company. The LLC's checking account has a minimal balance.

Just wondering whether anyone out there has any experience with (large) erroneous refunds with any of their clients, particularly one in which the taxpayer cashed the check? I have looked through https://www.irs.gov/pub/irs-wd/0014033.pdf and IRM 21.4.5. In this case, the IRS is unaware of the erroneous refund, and the business owner does not have the means to repay. The business has closed, so there will be no future tax refunds that the IRS could offset.

Any advice or experiences to share? We did advise returning the $79k to the IRS (esp. because of the possibility of an ERC audit), but he let us know he doesn't have the means to repay. Not sure what to advise the client to do at this point. Thanks in advance.
 

#2
novacpa  
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Are you asking - what could happen to us (you and the CPA you work with)?
1.) Nothing, the IRS may never realize their mistake - but I don't think so.
2.) The IRS could be really upset with you and initiate an action through
the Office of Professional Regulation and debar you from further Practice
before the IRS and seek a consent order by a Federal District Court
ordering you never to prepare tax returns for payment.
3.) Advise the client (who effectively stole the Gov't's money)
to file a Petition in Bankruptcy Court, naming the IRS as a creditor
and serve the IRS with with that Notice.
4.) File Form 211 with the IRS Whistleblower's Office alerting them
to the crime. Detail your efforts to recover all of the Gov't's money.
5.) Advise the client to make an appointment with the local IRS Office,
the most senior Agent on duty and turn himself in and beg for mercy.
Bring a very good explanation of why he knowingly and wrongfully spent the
Gov't's money (taxpayer's money) and offer to make an installment plan
to recover all of the erroneous proceeds with interest.
6.) The worst course of action is to stand by - seemingly
hapless and helpless and do nothing.
 

#3
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Riki, I had a client receive over $20,000 erroneously, however, the client did not cash the check. I searched and could not determine exactly what it was for; it just referenced a 941. Since I prepared the 941, I knew it was a mistake. I had the client send the check back with a letter that I drafted, explaining we thought it was in error. Several months later, they sent them another check for the same amount. I again advised against cashing the check. Finally was able to get through to the IRS; they were showing a large credit on the 941. I advised I was looking at the 941 and there was no credit shown on it. We sent in another letter with a copy of the originally filed 941 telling them the refund was a mistake. Client said if they received another check they were keeping it! It was finally reversed, but honestly, I do not think IRS would have ever caught their mistake. They had simply made a keying error, and instead of putting the amounts as deposits, they put them in as a credit. All of this took about a year to straighten out. It's tough when the client has already cashed - and spent - the money though!
 

#4
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The money went somewhere, presumably.

I would probably consider disengaging from the client.

Also, if you do plan to continue working with the client, I would strongly suggest working on a retainer basis.
 

#5
Riki_EA  
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Thanks, Recked & Seaside. We may end up disengaging with the client, but we will have to see how they respond once they have had time to react. (We told them about the issue just a few days ago, and they will get back to us.) Yes, the money went somewhere, so hopefully the business owner can find a source to repay.

Nova, your response seems extreme. We have documented our advice to the client to pay back the erroneous refund. They definitely qualified for the ERC, our Form 941-X requested refund was correct, and it was solely an IRS error that resulted in the overpayment. Knowing this particular client, it is definitely believable that he had no clue that the payment was too large. Reading the IRM and the IRS memorandum, it does not appear that erroneous refunds due to IRS errors lead to criminal prosecution. It looks like the IRS can file suit to return the funds, or more often will offset other refunds, with a fairly tight statute of limitations. See https://www.irs.gov/pub/irs-wd/0014033.pdf.

The IRS is limited because a non-rebate erroneous refund is not a tax or a tax assessment, so they do not have the same power to collect as they would if it were an assessment of tax. I agree that the client has a moral obligation to return the funds, but we also want to advise the client on what the IRS might do if he doesn't have the means to repay the funds. That's why I was interested in finding out if anyone has had a similar situation.
 

#6
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ReckedCPAEA wrote:The money went somewhere, presumably.

I would probably consider disengaging from the client.

Also, if you do plan to continue working with the client, I would strongly suggest working on a retainer basis.



+1 on both counts
 

#7
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How are you going to classify this refund on the tax return if you end up preparing the Federal income tax return?
 

#8
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Riki_EA wrote:Nova, your response seems extreme.
That's a gracious way to describe it.
Dave

Taxation is the price we pay for failing to build a civilized society. ~ Mark Skousen
 

#9
Riki_EA  
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Keninmichigan, if the client needs time to get the funds together, we were considering keeping the LLC alive past the 2022 tax year, filing the 1065 showing the liability. (The original plan was to mark the Form 1065 final for 2022.) Reading about prior cases, if the business owner is not able to pay it back, the IRS may issue a 1099-C. It would then show up as income. If he is able to pay it back, we will then clear the liability in the year it is paid. (If we are still working with this client, that is.) So it would not immediately impact the 2022 tax return other than to show up as a liability.
 

#10
JAD  
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What a mess. I think a certain post was extreme, but still, you have to be careful how you handle this. You have to protect yourself from OPR if you get a nasty IRS agent, if the agent disagrees with how you ultimately report this. You also need to protect yourself from a future suit by your client, in case he starts looking for ways to recover the cash that he has to part with, if/when the IRS comes after him. If it were me, I'd send an email to my liability insurance co and ask what they suggest. They are always happy to hear from me because they like to mitigate any potential future risk.

It seems to me that the excess either has to be shown as a liability on the balance sheet or as income. Of course, as income your client will have to pay tax. Then, when required to repay, there will be complexities as to the treatment of the deduction. I don't find sec 1341 to be much fun.

On a larger scale, what does this say about safeguards in our system? I wonder how many times this happened and how much $$ in total were lost....
 

#11
CathysTaxes  
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Riki, I question the response from the client. $793 does not turn into $100,000. When it was deposited, what did they book it against? And what in the world did he do with all that money? Client needs to find the means pay it back. I personally don't buy his story. Definitely contact your insurance carrier.
Cathy
CathysTaxes
 

#12
CathysTaxes  
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May I suggest that this discussion gets moved to PFZ?
Cathy
CathysTaxes
 

#13
Riki_EA  
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UPDATE
We did not give our client enough credit. He contacted us yesterday. He had called the IRS directly to tell them about the erroneous refund and to get advice on what to do. The agent on the phone recommended that he file another Form 941-X, showing the erroneous refund, with the bottom line showing the amount due back to the IRS. He will file it, and then when the payment notice comes back to him, he will set up some type of installment agreement.

From my research, I don't think he will be charged penalties or interest, particularly since he came forward voluntarily. We'll see what happens when he receives correspondence back.

Answer to some previous questions. The owner had sold the (assets of the) business and the erroneous refund was booked as part of the sales price by the bookkeeper. The owner then took draws after paying back debts of the business. We believe he used the extra funds to pay down personal debt, including his mortgage, and that is why he did not have the funds sitting around available to pay back.

We will keep it on the books as a liability and the owner will need to keep the LLC alive until the IRS debt is paid back.

Thanks again for your input!
 

#14
CathysTaxes  
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Glad that the client is trying to do the right thing.
Cathy
CathysTaxes
 


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