Third Party Payers Are Liable for Improperly Claimed Employee Retention Credits

(Parker Tax Publishing March 2024)

The Chief Counsel's Office advised that a third party payer (TPP) that is a Code Sec. 3504 agent, professional employer organization (PEO) subject to Reg. Sec. 31.3504-2, or certified professional employer organization (CPEO) is liable for any underpayment resulting from an improperly claimed employment tax credit that the TPP claimed for a client on the TPP's employment tax return filed under the TPP's employer identification number, where the credit was claimed based on wages paid by the TPP to the client's employees. The Chief Counsel's Office stated that this rule applies to the employee retention credit as it would any other employment tax credit. AM-2024-001.

Background

The Office of Chief Counsel was asked to advise on the liability of certain third-party payers (TPPs) for an underpayment of certain employment taxes resulting from an improperly claimed credit that was claimed by the TPP for a common law employer client on an employment tax return filed by the TPP under its own employer identification number (EIN). Specifically, the Chief Counsel's Office was asked about the liability of TPPs for underpayments of employment tax where the employee retention credit (ERC) was improperly claimed.

A common law employer may choose to enter into an agreement with a TPP pursuant to which the TPP withholds, deposits, and pays employment taxes with respect to the employees of the employer. In certain arrangements, the TPP pays wages to the employees of its employer clients (clients) and files employment tax returns for these clients using its own EIN rather than the EIN of the clients. The three types of TPPs relevant to this memorandum are Section 3504 agents, non-certified professional employer organizations (PEOs), and certified professional employer organizations (CPEOs).

Code Sec. 3504 states that in situations where a TPP has the control, receipt, custody, or disposal of, or pays the wages of an employee or group of employees, employed by one or more employers, the TPP may be designated as an agent to perform such acts as are required of employers. Reg. Sec. 31.3504-1 provides that a TPP may be designated an agent by application. An employer uses Form 2678, Employer/Payer Appointment of Agent, to request the IRS to authorize a TPP to act as an agent of the employer.

Reg. Sec. 31.3504-1(a) provides that "all provisions of law (including penalties) and of the regulations applicable to an employer with respect to [the acts the agent is designated to perform] shall be applicable to the agent," but that "each employer for whom the agent acts shall remain subject to all provisions of law (including penalties) and of the regulations applicable to an employer with respect to such acts." This means that for an agent designated by its client to pay employment taxes on the wages the agent pays to the client's employees (Section 3504 agent), both the agent and the client are liable for underpayments of employment tax related to such wages.

Under Reg. Sec. 35-3504-2, if a TPP such as a non-certified PEO pays wages or compensation to individuals performing services for a client pursuant to a service agreement (as defined in Reg. Sec. 31.3504-2(b)(2)) between the TPP and the client, the TPP may be designated to perform acts of an employer, including filing employment tax returns and paying employment taxes, with respect to the wages or compensation paid by the TPP to those individuals.

The Stephen Beck, Jr., Achieving a Better Life Experience (ABLE) Act of 2014 (Pub. L. 113-295) required the establishment of a voluntary program for TPPs to apply to the IRS to become certified as a CPEO. The ABLE Act added new Code sections 3511 and 7705 relating to the federal employment tax consequences and certification requirements, respectively, of a CPEO. Under these provisions, a TPP who becomes certified as a CPEO will be treated as the employer of any employee performing services for any customer of the TPP, but only with respect to wages paid by the TPP to the employee. Under Code Sec. 3511(a)(1), a CPEO is treated as the only employer and the CPEO assumes all employment tax liability and responsibilities for the wages it pays to work site employees of its customers, including liabilities arising from underpayments of employment tax. Under Code Sec. 3511(c)(1), a CPEO is treated as the employer for all wages it pays to its customer's non-work site employees, but the customer may also be liable for any underpayments of employment tax on wages paid to non-work site employees.

Analysis

The Chief Counsel's Office advised that a TPP that is a Section 3504 agent, a PEO, or CPEO is liable for any underpayment resulting from an improperly claimed employment tax credit that the TPP claimed for the client on the TPP's employment tax return filed under the TPP's EIN, where the credit was claimed based on wages paid by the TPP to the client's employees. The Chief Counsel's Office stated that this rule applies to the ERC as it would to any other employment tax credit.

The Chief Counsel's Office explained that, as noted above, for PEOs and Section 3504 agents, both the TPP and its client are liable for underpayments related to the wages paid by the TPP to its clients. When improperly claimed credits are claimed by a PEO for its client, and the credit claim is based on the wages paid by the PEO to the client's employees and reported on the PEO's employment tax return, both the PEO and its client are liable for any underpayment of tax resulting from the improperly claimed credits. Similarly, when improperly claimed credits are claimed by a Section 3504 agent for its client, and the credit claim is based on the wages paid by the Section 3504 agent to the client's employees and reported on the agent's employment tax return, both the Section 3504 agent and its client are liable for any underpayment of tax resulting from the improperly claimed credits.

As for CPEOs, the Chief Counsel's Office noted that Code Sec. 3511 does not address liability for improperly claimed credits. The Chief Counsel's Office reasoned that, unless a credit-specific statutory provision provides otherwise, the existing statutory and regulatory rules regarding CPEO liability apply to liabilities arising from improperly claimed employment tax credits claimed by a CPEO for its customers. Under Code Sec. 3511(a)(1), a CPEO is solely liable for employment tax liabilities on remuneration the CPEO pays to worksite employees of its customers, which means a CPEO is solely liable for underpayments resulting from improperly claimed credits that were based on wages paid by the CPEO to the worksite employees of its customers and reported on the CPEO's employment tax return (absent specific legislative authority that provides differently). Under Code Sec. 3511(c)(1), both the CPEO and its customer are liable for underpayments of tax related to the wages paid by the CPEO to the customer's non-work-site employees (assuming the customer is the common law employer of such employees, or otherwise liable). Therefore, the Chief Counsel's Office advised that both the CPEO and the customer are liable for underpayments resulting from improperly claimed credits that were based on wages paid by the CPEO to the non-worksite employees of its customer and reported on the CPEO's employment tax return.

TPP Liability for the Employee Retention Credit

Section 2302 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) (Pub. L. 116-136) enacted the employee retention credit (ERC) with respect to qualified wages paid after March 12, 2020, and before July 1, 2021. The CARES Act was later amended and extended by the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Relief Act). The American Rescue Plan Act of 2021 (ARP Act) (Pub. L. 117-2) provided a substantially similar ERC under Code Sec. 3134 for qualified wages paid after June 30, 2021, and before January 1, 2022.

After reviewing the statutory language of the CARES Act and the amendments made by the Relief Act, the Chief Counsel's Office concluded that these statutes did not change preexisting rules concerning TPP liability for improperly claimed credits that are based on wages paid by the TPP to its client's employees and reported on the TPP's employment tax return. The Chief Counsel's Office noted that in Notice 2021-20, the IRS addressed TPP client liability for improperly claimed credits. Specifically, Q&A #67 in Section M of Notice 2021-20 states that "[t]he client employer and the [TPP] will each be liable for employment taxes that are due as a result of any improper claim of [ERC] amounts that are improperly claimed in accordance with their liability under the Code and applicable regulations for the employment taxes reported on the federal employment tax return filed by the [TPP] on which the credit was claimed."

According to the Chief Counsel's Office, the IRS has consistently maintained this position in guidance and information issued subsequent to Notice 2021-20, including the regulations issued in T.D. 9978 under Code Secs. 3111, 3132, 3134, and Code Sec. 3221 that provided for the administrative recapture of erroneously refunded COVID-19 credits. For instance, Reg. Sec. 31.3134-1(c) generally provides that employers against whom an erroneous refund of the ERC can be assessed as an underpayment of taxes include both TPPs, consistent with their liability for the taxes against which the credit is applied, and common law employer clients that remain subject to all provisions of law applicable to employers with respect to the payment of wages or compensation, as applicable.

For a discussion of third party payers, see Parker Tax ¶210,105. For a discussion of CPEOs, see Parker Tax ¶218,101. For a discussion of the employee retention credit, see Parker Tax ¶106,460.

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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