Brotman Law May 13, 2024 18 min read

ERTC Audits: How Kentucky Businesses Can Protect Themselves

Employee Retention Tax Credit Audit Defense Tactics

In Kentucky, where the economy is anchored by industries such as bourbon distilling in Bardstown, automotive manufacturing in Louisville, and coal mining in the eastern regions, the Employee Retention Tax Credit (ERTC) has provided essential support during the economic downturn caused by the COVID-19 pandemic. This federal program helps businesses maintain their workforce despite significant operational and financial challenges. However, receiving the ERTC also subjects businesses to potential IRS audits. For Kentucky enterprises, comprehending the intricacies of ERTC compliance is essential to maximize the program's benefits and manage potential audits effectively.

This guide will offer strategies for ERTC audit defense tailored to the economic backdrop of Kentucky, emphasizing the importance of thorough preparation and the critical role of professional legal advice.

Understanding the ERTC in Kentucky’s Economic Context

The ERTC provides a refundable tax credit to employers who retained employees during periods of financial hardship, either due to significant declines in gross receipts or because of full or partial suspensions of their business operations mandated by governmental COVID-19 restrictions. For Kentucky businesses, particularly those impacted by disruptions in their specific sectors, documenting these impacts accurately is crucial for ERTC eligibility and audit preparedness.

Kentucky Statewide Orders That May Have Impacted Their Business

During the pandemic, Governor Andy Beshear issued several orders that impacted businesses across the state of Kentucky. Although not a complete list, these are some justifications businesses can use to defend themselves against IRS scrutiny in an Employee Retention Tax Credit Audit.

  • State of Emergency Declaration (March 2020) - Governor Andy Beshear declared a state of emergency as the pandemic began. This foundational order initiated statewide responses, setting the stage for financial and operational adjustments crucial for businesses assessing disruptions for ERTC eligibility.

  • Closure of Non-Essential Businesses (March 2020)- Non-essential businesses were mandated to close temporarily, significantly affecting retail, entertainment, and personal service sectors. This direct government-mandated suspension of operations supports businesses’ claims for the ERTC.

  • Healthy at Home Order (March 2020) - Residents were instructed to stay at home except for essential activities, reducing customer traffic and drastically affecting businesses’ ability to operate normally. This enforced reduction in operations is critical for ERTC claims.

  • Mandatory Mask Mandate (July 2020) - A statewide mandate required masks in public spaces, adding operational challenges and costs for businesses to enforce compliance, relevant for ERTC claims as it affected customer interactions and operations.

  • Phased Reopening (May 2020) - Kentucky introduced a phased approach to reopening, allowing businesses to resume operations under strict health guidelines and capacity limits. Despite reopening, the continued restrictions impacted business functionality and profitability, qualifying them for the ERTC due to partial suspensions of normal operations.

  • Ban on Large Gatherings (2020-2021) - With restrictions on the size of public gatherings, venues and businesses reliant on such events continued to face operational limitations, supporting their ERTC claims due to restricted operational capacity and direct revenue impacts.

  • Extension of Unemployment Benefits (2020) - Extended unemployment benefits affected businesses’ workforce decisions, particularly as some employees opted to remain on unemployment. This situation is relevant for ERTC claims, demonstrating challenges in maintaining staff levels amid financial and operational stress.

  • Healthy at Work Initiatives (Ongoing from 2020) - Guidelines and initiatives aimed at helping businesses operate safely during the pandemic necessitated investments in health and safety measures, impacting how businesses could operate and interact with customers.

  • Eviction Relief Measures (2020) - Temporary measures to prevent evictions provided some relief for business property rentals, indirectly supporting businesses by preserving cash flow during operational downturns.

  • Vaccination Incentives and Business Support (2021)- As vaccines became widely available, the state encouraged businesses to facilitate vaccinations, including offering incentives for vaccinated employees. This supported businesses in safely increasing operational capacity and managing workforce health, which is relevant to sustaining employment and ERTC eligibility.

Throughout the pandemic, Governor Andy Beshear’s administration implemented a series of measures aimed at balancing public health with economic impacts. For Kentucky businesses preparing for an Employee Retention Tax Credit Audit, it is essential to document how each state order affected their operations, financial health, and employment practices. Detailed records should include timelines of government orders, descriptions of how these orders influenced operational capacities, financial impacts, and efforts to retain employees under challenging conditions. This comprehensive documentation will be key to demonstrating the necessity of the ERTC during periods of significant operational disruption and recovery.

Impact of COVID-19 on Kentucky's Economy

In Kentucky, the economic impacts of the COVID-19 pandemic were felt differently across various regions, reflecting the diverse industrial bases from Louisville’s manufacturing and shipping sectors to Bardstown’s bourbon industry and the coal mining operations in Eastern Kentucky. Each area faced unique challenges that necessitated significant adjustments and precise documentation to substantiate Employee Retention Tax Credit (ERTC) eligibility and prepare for potential IRS audits effectively.

  • Louisville: Manufacturing and Shipping Disruptions. Louisville, a critical hub for manufacturing and shipping, encountered significant disruptions due to the pandemic. As global supply chains were impacted by lockdowns and shipping delays, businesses in the area faced shortages of raw materials and components, which hampered production schedules and increased operational costs. Additionally, changes in consumer demand, particularly a shift towards online shopping, placed further pressure on the shipping and logistics sectors to adapt rapidly. These companies had to invest in expanding their e-commerce capabilities and enhancing their logistics operations to handle a higher volume of online orders. For businesses in Louisville, documenting these supply chain disruptions and shifts in consumer behavior is crucial. This includes detailing the extent of supply shortages, changes in production outputs, and investments made to adapt to new market realities, all of which are essential for justifying ERTC claims.
  • Bardstown: Bourbon Industry Setbacks. In Bardstown, known for its storied bourbon industry, the pandemic caused a twofold impact. The industry’s heavy reliance on tourism meant that public health restrictions, which curtailed travel and led to the cancellation of tours and tastings, severely affected revenue streams. Simultaneously, production was disrupted as distilleries had to implement strict health and safety measures, reduce workforce capacity, or even temporarily halt operations to comply with social distancing mandates. The bourbon industry’s challenges during this period need to be meticulously recorded, from the decline in tourist numbers and its financial implications to adjustments in production practices and how these factors compelled the retention of essential staff amidst operational cutbacks.
  • Eastern Kentucky: Coal Mining Difficulties. The coal mining sector in Eastern Kentucky, already under economic strain due to a long-term decline in demand, faced exacerbated challenges during the pandemic. Reduced workforce availability due to health concerns and further fluctuations in demand as industries slowed down globally impacted operations. Mines had to navigate how to maintain production with a limited workforce while ensuring safety against the backdrop of the pandemic. The documentation of these challenges is vital for coal operations aiming to claim the ERTC. It must include specific details on reduced workforce numbers, adjustments in mining operations, and the direct impact of demand fluctuations on the sector’s economic health.

For businesses across these Kentucky regions, the narrative of navigating through the pandemic involves a complex interplay of industry-specific challenges and adaptive measures. Accurately documenting the economic impacts and operational changes is not just crucial for historical accounting but essential for accessing vital financial support through mechanisms like the ERTC. This comprehensive documentation ensures that businesses can effectively demonstrate the extent of the pandemic’s impact and their ongoing efforts to sustain operations and retain critical staff, thereby providing a solid foundation for ERTC eligibility and readiness for IRS audits.

The Landscape of Kentucky ERTC Audit Defense

Kentucky businesses seeking the benefits of the Employee Retention Tax Credit (ERTC) often encounter various challenges during IRS audits. These audits assess compliance with the complex requirements of the ERTC program, designed to encourage businesses to retain employees during periods of financial hardship caused by the COVID-19 pandemic. Understanding these challenges and seeking the expertise of a tax attorney can significantly enhance a business's ability to navigate and defend against these audits successfully.

The ERTC offers a substantial benefit, but determining eligibility and correctly applying the rules can be daunting. Kentucky businesses must prove significant operational disruption due to government orders or a notable decline in quarterly revenue. The intricate details, such as defining gross receipts and identifying applicable government orders, often pose the first major hurdle.

How a Tax Attorney Helps

A tax attorney can provide clarity on the ERTC’s eligibility requirements and help businesses accurately interpret how these rules apply specifically to their circumstances. This professional guidance is crucial in preparing an initial claim that adheres strictly to IRS standards, potentially reducing the likelihood of an audit triggered by eligibility concerns.

Maintaining Adequate and Compliant ERTC Documentation 

Proper documentation is critical in defending an ERTC claim. Businesses must retain detailed records of payroll, employee counts, health and safety expenditures, and more. The challenge often lies not only in gathering this documentation but also in ensuring it meets the specific evidentiary requirements of the IRS.

How a Tax Attorney Helps

Tax attorneys assist businesses in understanding what documentation is essential and how to maintain records in a manner that aligns with IRS expectations. They can help organize and review documentation before an audit occurs, ensuring that all records are complete and readily accessible.

Handling Overlapping Relief Benefits

Many Kentucky businesses have taken advantage of multiple relief options available during the pandemic, such as PPP loans in addition to the ERTC. However, overlapping benefits must be carefully managed as double-dipping is not allowed—expenses used to claim one form of relief cannot be used for another.

How a Tax Attorney Helps 

 A tax attorney can help navigate the complexities of coordinating multiple relief programs. They ensure that claims are structured properly to maximize benefits without violating the rules against overlapping benefits, a common area of confusion that can lead to significant audit issues.

Dealing with IRS Employee Retention Tax Credit Audit Processes

The audit process itself can be intimidating and challenging for businesses unaccustomed to such scrutiny. The IRS may request additional detailed information, pose challenging questions, and in some cases, dispute the validity of the claim.

How a Tax Attorney Helps 

Tax attorneys can represent Kentucky businesses during the audit, acting as an intermediary to manage communication with the IRS. Their expertise in tax law enables them to argue effectively on behalf of the business, challenge erroneous findings, and negotiate resolutions that protect the business’s interests.

Ensuring Ongoing Compliance and Strategic Planning

Defending against an ERTC audit is not only about addressing current issues but also about strategizing for future compliance. The IRS continuously updates its guidelines and interpretations of the tax laws, requiring businesses to remain vigilant and adaptable.

How a Tax Attorney Helps

Tax attorneys keep abreast of changes in tax legislation and IRS policies that impact ERTC claims. They can provide ongoing advice to ensure that businesses not only remain compliant but are also positioned to respond proactively to future changes in the tax landscape.

Conclusion: Ensuring Continued Benefits from the ERTC in Kentucky

For businesses across Kentucky, effectively managing ERTC claims involves more than just meeting eligibility criteria; it requires strategic planning, meticulous documentation, proactive audit defense measures, and the utilization of specialized legal expertise. In conclusion, while Kentucky businesses may face significant challenges in claiming and defending the ERTC, the support of a knowledgeable tax attorney can alleviate these burdens. Through expert guidance on compliance, documentation, audit defense, and strategic planning, tax attorneys play an indispensable role in helping businesses navigate the complexities of ERTC audits.

"Sam is a wonderful, results-oriented and extremely knowledgeable and talented attorney, who really has 'heart' in working on behalf of his clients, and explains options in a straightforward, respectful manner. He has assisted us with great outcomes which have added to our quality of life. I would not hesitate to recommend Sam for his services as he is an ethical, personable and expert attorney in his field. You will likely not be disappointed with Sam's work ethic, approach and his efforts."

-Aileen Dwight, Licensed Clinical Social Worker & Psychotherapist

Last updated: May 18, 2024

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