Brotman Law June 27, 2024 18 min read

ERTC Audit Defense in California: What You Need to Know

ERTC Audit Defense in California: What You Need to Know

Navigating the complex world of tax credits can be daunting for any business. For California businesses, the Employee Retention Tax Credit (ERTC) offers significant benefits. However, it also brings the risk of audits. Understanding how to protect your business from these audits is crucial, as it can save you from costly penalties and unnecessary stress.

In this article, we'll provide actionable advice on ERTC audit protection. We'll cover compliance strategies, the role of a tax attorney, and more. Stay tuned to learn how to safeguard your California business from ERTC audits.

Understanding the Employee Retention Tax Credit (ERTC)

The Employee Retention Tax Credit (ERTC) is a relief measure for businesses introduced to mitigate the financial impact of the COVID-19 pandemic. The ERTC provides a refundable tax credit against certain employment taxes and is available to businesses that retained their employees despite facing economic hardship due to COVID-19.

To be eligible for the ERTC, businesses must meet specific criteria, including:

  • Experiencing a significant decline in gross receipts during a calendar quarter.
  • Having operations fully or partially suspended due to government orders related to COVID-19.

Understanding the eligibility criteria is crucial. It helps businesses claim the ERTC correctly and avoid potential audit triggers. In the next section, we'll delve into why ERTC audits occur and how your California business can prepare for them.

COVID-19 Orders That Impacted ERTC Eligibility in California

California issued numerous COVID-19 orders that significantly impacted businesses during 2020 and 2021. These measures influenced ERTC eligibility and compliance:

  • Statewide Stay-at-Home Order (March 19, 2020) - Governor Gavin Newsom issued a stay-at-home order requiring non-essential businesses to close or modify operations, directly affecting many businesses' operations.
  • Small Business Relief Grants (April 2020) - California introduced relief grants to support small businesses and nonprofits struggling due to the pandemic, providing financial assistance to help them survive economic disruptions.
  • Temporary Ban on Commercial Evictions (March 27, 2020) The state imposed a moratorium on commercial evictions for businesses unable to pay rent due to COVID-19-related financial hardships.
  • Expanded Unemployment Benefits (April 2020)- California expanded unemployment benefits, which indirectly impacted businesses' payroll management and ERTC calculations.
  • Industry-Specific Guidelines (May 2020) - As businesses began to reopen, California issued specific guidelines to ensure safe operations, including social distancing, sanitation, and health protocols.
  • Regional Stay-at-Home Orders (December 2020) - California introduced regional stay-at-home orders based on ICU capacity, affecting businesses in severely impacted regions.
  • Blueprint for a Safer Economy (August 2020) - The state developed a tiered framework guiding reopening strategies, impacting business operations and eligibility for relief programs like the ERTC.
  • Paid Sick Leave Expansion (September 2020) - Legislation was passed to expand paid sick leave for employees affected by COVID-19, influencing payroll practices and ERTC claims.

These measures were designed to mitigate the economic impact on California's diverse business community, ensuring that both the health and economic well-being of the state were addressed. Many businesses were impacted by these orders, and citing these orders is very important during an ERTC audit. 

Why ERTC Audits Occur and How to Prepare

The Internal Revenue Service (IRS) conducts audits to ensure compliance with tax laws, and ERTC audits are no exception. They aim to verify that businesses claiming the credit meet all eligibility requirements. Audits can be triggered by various factors, including inconsistencies in tax filings, large ERTC claims, or random selection. Therefore, it's essential for businesses to maintain accurate records and ensure their ERTC claims are valid.

Preparation is key to surviving an ERTC audit. This involves understanding the audit process, maintaining proper documentation, and seeking professional help when necessary. In the following sections, we'll discuss these aspects in detail.

Remember, an audit is not necessarily a cause for panic. With the right preparation and response, your California business can navigate an ERTC audit successfully.

Proactive strategies:

  • Routine Record Audits: Conduct regular reviews of all ERTC-related documentation for completeness and accuracy.
  • Continuous Legal and Financial Advisory: Engage with tax professionals to stay informed about the latest ERTC guidelines and tax law changes.
  • Mock Audit Drills: Implement practice audits to identify any potential weaknesses in the audit trail that could be flagged by the IRS.

Common ERTC Claim Mistakes to Avoid

Many businesses make errors when claiming the ERTC. These mistakes can increase the risk of an audit. One common error is misunderstanding the eligibility criteria, such as misinterpreting the rules around full or partial suspension of operations or significant decline in gross receipts.

Another common mistake is poor record-keeping. Businesses must keep detailed records of qualified wages and health plan expenses. Failure to do so can lead to complications during an audit. Additionally, businesses often fail to calculate the credit correctly due to misunderstanding the rules or making mathematical errors. It's crucial to double-check all calculations before submitting your claim.

Impact of COVID-19 on California's Top Cities

The COVID-19 pandemic has had profound effects on cities across the globe, and California's major urban centers are no exception. Each city, with its unique economic structure and industry focus, faced distinct challenges brought on by the pandemic. Understanding these city-specific impacts is crucial for businesses aiming to navigate the complex landscape of the Employee Retention Tax Credit (ERTC) and avoid potential audit triggers. Here’s a closer look at how Los Angeles, San Francisco, and San Diego have been impacted by the pandemic, highlighting the diverse hurdles businesses in these cities have encountered.

  • Los Angeles: As the largest city in California, Los Angeles experienced significant impacts from COVID-19. The tourism and entertainment industries, which are vital to the city's economy, faced major downturns due to travel restrictions and public health safety measures. Additionally, the closure of public offices and service providers disrupted local businesses, especially those reliant on government contracts and services.
  • San Francisco: With its strong focus on technology and finance, San Francisco encountered unique challenges during the pandemic. The shift to remote work disrupted the local economy, affecting businesses such as cafes, restaurants, and services that cater to office workers. Moreover, the decline in tourism and conferences significantly impacted the hospitality and event sectors.
  • San Diego: As a major tourism and military hub, San Diego felt the effects of COVID-19 profoundly. The drop in visitor arrivals led to a considerable downturn in the tourism sector, affecting hotels, restaurants, and retail establishments. Additionally, restrictions on gatherings and events impacted the hospitality industry, which heavily relies on conventions, weddings, and other large gatherings for revenue.

These city-specific impacts underscore the diverse challenges faced by businesses across California's urban centers. Understanding these dynamics is crucial for businesses to navigate ERTC eligibility criteria and potential audit triggers effectively.

Essential Documentation for ERTC Audit Defense

Proper documentation is key to surviving an ERTC audit. It's not enough to simply claim the credit; you must also be able to prove your eligibility. This requires maintaining accurate and thorough records. The IRS may request various documents during an audit, including payroll records, health plan expense records, and business financial statements. It's important to keep these documents organized and readily accessible.

Here are some key documents to keep on hand:

  • Payroll records showing the number of employees and their wages.
  • Records of health plan expenses.
  • Financial statements showing a significant decline in gross receipts.
  • Documentation of full or partial suspension of operations due to COVID-19.

Remember, the burden of proof lies with the business. It's your responsibility to provide the necessary documentation to support your ERTC claim.

Implementing Strong Compliance Practices

Compliance is not a one-time event; it's an ongoing process that requires diligence and attention to detail. Implementing strong compliance practices can help protect your business from ERTC audits. Start by understanding the eligibility criteria for the ERTC and ensuring you meet all the requirements before claiming the credit. Regularly review IRS guidance and updates to stay informed about any changes to the ERTC program.

Finally, consider designating a team or individual to handle ERTC compliance. This person or team can be responsible for maintaining records, tracking changes to the ERTC program, and ensuring that your business remains compliant.

The Role of a Tax Attorney in California ERTC Audit Defense

Navigating the complex world of tax laws and audit procedures can be challenging. This is where a tax attorney comes in. They can provide valuable guidance and support during an ERTC audit. A tax attorney can help you understand the nuances of the ERTC, assist in negotiating with the IRS, and resolve disputes. Their expertise can be invaluable in ensuring that your business is prepared for an audit.

In California, there are many tax attorneys who specialize in ERTC audit defense. They understand the specific tax laws and regulations that apply to businesses in the area and can provide tailored advice and strategies to help protect your business from audits. Remember, the potential financial impact of an ERTC audit can be significant, and investing in professional legal help can be a wise decision to safeguard your business.

Proactive Measures: Internal Reviews and Mock Audits

One of the best ways to prepare for an ERTC audit is to conduct an internal review or mock audit. This can help you identify any potential issues or discrepancies in your ERTC claims before the IRS does. An internal review involves thoroughly checking your documentation and compliance practices, ensuring that you're meeting all the ERTC requirements. A mock audit simulates the IRS audit process, giving you a clear idea of what to expect during a real audit.

By taking these proactive measures, you can significantly reduce your risk of facing an unfavorable audit outcome. It's all about being prepared and staying one step ahead.

Responding to an IRS Notice or Audit

If you receive an IRS notice regarding your ERTC claim, don't panic. It's crucial to respond promptly and professionally. Gather all relevant documentation and consult with your tax attorney before replying. During an audit, maintain a cooperative and calm demeanor. Remember, the IRS is just doing its job, and your goal is to provide clear, concise answers to their queries. Avoid volunteering extra information that isn't directly related to the audit.

In case of a dispute, your tax attorney can negotiate with the IRS on your behalf, helping resolve the issue and potentially minimizing any negative financial impact.

Conclusion: Creating a Comprehensive Audit Protection Plan

In conclusion, protecting your California business from an ERTC audit involves careful planning and diligent compliance. It's about understanding the ERTC, avoiding common mistakes, and maintaining thorough documentation. With the right strategies and professional guidance, you can leverage the ERTC benefits while minimizing audit risks. Remember, proactive measures are your best defense.

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Last updated: July 8, 2024

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