IRS Can Offset COVID-19 Tax Credits Against Liabilities of Third-Party Payors

(Parker Tax Publishing June 2023)

In an email, the Chief Counsel's Office advised that the IRS may offset certain COVID-19 employment tax credits (for example, the employee retention credit (ERC)) to any existing tax liabilities of a Professional Employer Organization (PEO) that pays wages to individuals as part of the services provided to a client employer under a service agreement, even though the credits are attributable to wages paid to a client employer's employees. According to the Chief Counsel's Office, the IRS made the decision to offset excess refundable COVID-19 employment tax credits to any existing tax liabilities on the employer's account, and this decision applies to all types of refundable COVID-19 employment tax credits including the ERC, the credits for paid sick and family leave wages, and the COBRA credit. CCA 202319015.

In response to the COVID-19 pandemic, Congress enacted several temporary employment tax credits. These credits included the employee retention credit (ERC) for employers that kept employees on the payroll despite experiencing economic hardship due to the pandemic, as well as credits for providing paid sick and family leave for employees affected by COVID-19. In addition, credits were provided to employers that provided COBRA continuation health insurance coverage to employees who experienced a reduction in hours or involuntary termination of employment.

In CCA 202319015, the Office of Chief Counsel was asked to advise whether the IRS is authorized to offset these COVID-19 employment tax credits to any existing tax liabilities of a Professional Employer Organization (PEO) that pays wages to individuals as part of the services being provided to a client employer under a service agreement, even though the credits being claimed are attributable to wages paid to a client employer's employees.

The Chief Counsel's Office advised that under Code Sec. 6402(a), the IRS has 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." According to the Chief Counsel's Office, the IRS made the business decision to offset excess refundable COVID-19 employment tax credits to any existing tax liabilities on the employer's account. This decision applies to all types of refundable COVID-19 employment tax credits including the ERC, the credit for paid sick and family leave wages, and the COBRA credit.

The Chief Counsel's Office noted that for taxpayers who use third-party payors (TPPs), the process for claiming credits against employment tax liabilities and liability for erroneously claimed credits differs depending on the type of TPP used (e.g., a Code Sec. 3504 agent, Certified Professional Employer Organization (CPEO) or PEO). Although the credits being claimed on the Schedule R (Form 941), Allocation Schedule for Aggregate Form 941 Filers, are attributable to wages paid to a client's employees, the Chief Counsel's Office said that the Code Sec. 3504 agent, CPEO or PEO is the taxpayer who is actually claiming the employment tax in an aggregate amount on a single line on a Form 941 filed under its own employer identification number. According to the Chief Counsel's Office, if a refund is ultimately issued to the TPP aggregate filer, it is then between the TPP aggregate filer and the client to ensure that the TPP remits any portion of the refund it received to the client in the appropriate amount.

The Chief Counsel's Office explained that the IRS is not a party to the service agreements and has no legal obligation to refund any portion of the TPP filer's refund to a client identified on Schedule R. In addition, when the IRS conducts an audit of a Form 941 filed by these types of TPPs, the IRS is examining the aggregate total amount of the line item credit claimed by the TPP on the Form 941, using the client-by-client allocation information provided on Schedule R as part of the examination. The IRS does not issue refunds or make credit adjustments to the client entities themselves, but rather any credits/refunds are paid to the TPP.

The Chief Counsel's Office noted that any credits claimed against the employment taxes reported on the Form 941 reduce the reported liability of the TPP. Moreover, any adjustment to a credit claimed by a TPP on the Form 941 will affect the total employment tax liability on the TPP aggregate filer's employment tax return. According to the Chief Counsel's Office, the Schedule R only provides a portion of the information (the allocable share of wages and credits on a client-by-client basis) which was used by the TPP, in part, to determine its own total tax liability on the return. Since the Schedule R information is not itself determinative of the TPP's ultimate tax liability, the Chief Counsel's Office said that the IRS would not be able to determine the appropriate refund to issue to the TPP based solely on the Schedule R information on a client-by-client basis for any particular employment tax credit. Rather, until the IRS determines entitlement to the entire line item amount claimed on the Form 941, no refunds or credits are paid out to the TPP. The Chief Counsel's Office noted that offsetting a TPP's outstanding tax liability is, in fact, providing the credit to the TPP by way of a reduction in the TPP's liability.

Although employers who utilize TPPs may encounter difficulties receiving payment of the refundable tax credits they may be entitled to if the TPP they have chosen has outstanding federal tax liabilities, the Chief Counsel's Office said that this is a civil matter strictly between the TPP/PEO and the client employer.

For a discussion of the employee retention credit, see Parker Tax ¶106,460. For a discussion of the payroll credit for paid sick leave, see Parker Tax 106,410. For a discussion of the payroll credit for paid family leave, see Parker Tax 106,430. For a discussion of the credit for employers covering COBRA premiums, see Parker Tax ¶160,480. For a discussion of third party payors of employment taxes, see Parker Tax ¶210,105.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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