Brotman Law May 4, 2024 15 min read

Employee Retention Tax Credit Audit Defense in Washington State - ERC Audits

How Washington Businesses Can Protect Themselves Against the IRS in an Employee Retention Tax Credit Audit 

Navigating the complexities of tax compliance can be daunting for any business.

When it comes to the Employee Retention Tax Credit (ERTC), the stakes are even higher.

This federal incentive, designed to help businesses retain employees during challenging economic times, has specific eligibility criteria. Missteps in claiming the ERTC can trigger an audit by the Internal Revenue Service (IRS).

In Washington State, businesses must be particularly vigilant. They need to understand the nuances of state-specific tax laws in addition to federal regulations.

This article aims to guide Washington State businesses through the intricacies of an ERTC audit. It will provide insights into audit defense strategies, documentation requirements, and best practices for tax compliance.

Whether you're a business owner, a financial officer, or an HR professional, this guide will equip you with the knowledge to confidently navigate an ERTC audit.

Understanding the Employee Retention Tax Credit (ERTC)

The Employee Retention Tax Credit (ERTC) is a federal initiative. It was introduced as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act in 2020.

The ERTC aims to provide financial relief to businesses affected by the COVID-19 pandemic. It does this by offering a tax credit for keeping employees on the payroll during periods of business disruption.

Understanding the ERTC is crucial for businesses. It not only helps in claiming the credit accurately but also ensures compliance with tax laws.

The ERTC is not a one-size-fits-all solution. It has specific eligibility criteria that businesses must meet to qualify for the credit.

Here are some key aspects of the ERTC:

  • It is available to businesses of all sizes.
  • The credit applies to wages paid during certain periods of business disruption due to COVID-19.
  • The amount of the credit varies based on the number of employees and the extent of wage payments.
  • Businesses must demonstrate a significant decline in gross receipts or a full or partial suspension of operations due to government orders.
  • The ERTC can be claimed on quarterly employment tax returns.

Eligibility Criteria for ERTC in Washington State

In Washington State, the eligibility criteria for the ERTC are the same as the federal guidelines. Businesses must demonstrate a significant decline in gross receipts or a full or partial suspension of operations due to government orders.

The decline in gross receipts must be more than 50% in any quarter of 2020 compared to the same quarter in 2019. For 2021, the decline must be more than 20% in any quarter compared to the same quarter in 2019.

It's important to note that the ERTC is not available to businesses that received a Paycheck Protection Program (PPP) loan.

A Summary of Washington State COVID-19 Orders Impacting ERTC

Although not an exhaustive list, here are some significant COVID-19 orders in Washington State during 2020 and 2021 that impacted businesses:

  • Stay Home, Stay Healthy (March 23, 2020) - Governor Jay Inslee issued a statewide order requiring all residents to stay home unless involved in essential activities. Non-essential businesses were required to close physical locations.
  • Phased Reopening Plan (May 2020) - Washington introduced a four-phase reopening plan for businesses, varying by county based on local infection rates. Restrictions included capacity limits and operational modifications across various sectors.
  • Statewide Mask Mandate (June 26, 2020) - A mandate required face coverings in all public spaces, both indoor and outdoor, impacting business operations, especially in customer-facing environments.
  • Pause on County Advancements (July 2020)- Due to rising case numbers, the state paused any further advancements in the reopening plan, affecting businesses anticipating fewer restrictions in the higher phases of reopening.
  • New COVID-19 Business and Employee Guidelines (November 2020) - New guidelines were introduced, including improved safety measures and protocols in the workplace to reduce the spread of the virus.
  • Temporary Ban on Indoor Dining (November 2020) - Indoor dining was banned, and restaurants and bars were restricted to takeout service and limited outdoor seating to curb the spread of COVID-19.
  • Expansion of Vaccine Eligibility (March 2021) - As vaccines became more available, eligibility expanded, directly impacting businesses by potentially reducing the number of infected individuals and allowing more employees to return to work safely.
  • Revised Outdoor and Indoor Gathering Limits (March 2021) - Washington state updated gathering limits for various events, influencing venues and event planners, along with businesses that host large groups.
  • Statewide Reopening (June 30, 2021) - Washington fully reopened, lifting most COVID-19 restrictions, including capacity and distancing requirements for all businesses, although mask mandates remained in place based on CDC guidelines.

These orders shaped how businesses operated during the pandemic, necessitating adaptations in operations, safety protocols, and customer interactions.

The Role of the IRS in ERTC Audits

The Internal Revenue Service (IRS) is responsible for auditing ERTC claims. Their role is to ensure that businesses are compliant with the tax laws and have accurately claimed the credit.

During an audit, the IRS will review your business records and ERTC documentation. They will check for any discrepancies or errors in your claim.

If the IRS finds any issues, they may disallow your ERTC claim. This could result in penalties and interest on the disallowed amount. Therefore, it's crucial to be prepared for an audit and have all necessary documentation in order.

Common Triggers for an ERTC Audit

There are several factors that may trigger an ERTC audit. These include inconsistencies in your ERTC claim, large claim amounts, or a history of tax compliance issues.

The IRS may also select your business for an audit randomly. However, certain red flags can increase your chances of being audited.

Here are some common triggers for an ERTC audit:

  • Inconsistencies between your ERTC claim and other tax filings
  • Large ERTC claim amounts
  • A history of tax compliance issues
  • Errors in your ERTC calculations
  • Failure to maintain adequate documentation to support your ERTC claim

Immediate Steps Upon Receiving an Audit Notice

Receiving an audit notice can be daunting. However, it's crucial to respond promptly and appropriately. The first step is to review the notice carefully.

Understand what the IRS is questioning. It could be your ERTC claim, your payroll records, or your eligibility criteria. This will help you prepare your defense.

Next, gather all relevant documents. This includes payroll records, proof of eligibility, and any other documents related to your ERTC claim. Having these at hand will make the audit process smoother.

Essential Documentation for ERTC Audit Defense

When facing an ERTC audit, documentation is your best defense. The IRS will want to see proof of your eligibility and your claim.

You'll need to provide payroll records. These should clearly show the wages paid to each employee during the relevant periods.

Proof of your business's financial impact due to COVID-19 is also crucial. This could be in the form of financial statements or other relevant documents.

Here's a list of some key documents you might need:

  • Payroll records
  • Financial statements
  • Proof of full-time equivalent (FTE) calculations
  • Documentation of employee retention strategies
  • Records of any changes to your business due to COVID-19

Remember, the more thorough your documentation, the better your chances of a successful audit defense.

Best Practices for Record-Keeping and Compliance

Maintaining accurate and comprehensive records is key to ERTC compliance. This not only helps in substantiating your claim but also in identifying any discrepancies before an audit.

Use technology to your advantage. There are various software solutions available that can help manage your ERTC documentation. These tools can ensure that all necessary information is recorded and easily accessible.

Lastly, make sure to stay updated on any changes to ERTC regulations. This will help you ensure that your records meet the current requirements and avoid any potential issues during an audit.

Consequences of Failing an ERTC Audit and How to Avoid Them

Failing an ERTC audit can have serious consequences. These may include penalties and interest on disallowed ERTC amounts. In severe cases, it could even lead to legal action.

To avoid these outcomes, it's crucial to ensure your ERTC claims are accurate and well-documented. Regular internal audits can help identify and correct any discrepancies before an IRS audit occurs.

Remember, good-faith mistakes are different from intentional fraud. The IRS is more likely to be lenient with honest errors, especially if you take steps to correct them promptly.

Professional Assistance: When to Seek Help

Navigating an ERTC audit can be complex. It often requires a deep understanding of tax laws and regulations. If you're unsure about any aspect of the process, it may be wise to seek professional help.

Tax advisors or attorneys can provide valuable guidance. They can help you prepare for the audit, present your case effectively, and respond to any inquiries in a timely manner.

Remember, the goal is not just to survive the audit, but to do so in a way that minimizes stress and potential liability. A professional can be a valuable ally in achieving this goal.

Conclusion: Staying Prepared and Informed

In conclusion, the key to a successful ERTC audit defense lies in preparation and knowledge. Understanding the ERTC, its eligibility criteria, and the audit process can help you navigate the audit smoothly.

It's also crucial to stay informed about any changes in tax laws and regulations. This includes staying updated on IRS announcements and guidance, as well as understanding the impact of legislative changes on ERTC audits.

Remember, an audit is not a punishment, but a process to ensure tax compliance. With the right approach and resources, you can successfully defend your ERTC claim and continue to benefit from this valuable tax credit.

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-Aileen Dwight, Licensed Clinical Social Worker & Psychotherapist

Last updated: May 18, 2024

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