Chapter 01

Will the IRS Audit the ERC Credit?

Although employee retention tax credits (ERTC) were designed to encourage businesses to retain their employees during COVID-19 pandemic and were a much-needed intervention, many businesses are now facing the IRS and potential audits.

So, do you really understand the ERTC well enough to handle an audit?

And what do you do when faced with an ERC audit?

That’s where we come in.

Firstly, will the ERC trigger an audit?

Yes, the ERC could trigger an audit. The IRS may conduct an ERC audit to verify that an employer has accurately calculated and claimed the credit in accordance with the provisions of the CARES Act and subsequent legislation.

However, claiming the ERTC does not automatically trigger an audit.

Instead, the IRS may audit a business's ERTC claim if they suspect that the business has made errors or misrepresentations in their claim, including if they're suspected of fraud or noncompliance.

An ERTC audit may also be triggered by: 

  • Incorrect or incomplete information reported on your tax returns, such as the Form 941 or Form 8974. 
  • Inconsistencies or discrepancies between your claimed ERTC amount and other financial or tax-related information—payroll records, financial statements, and tax filings.
  • Excessive or unreasonable ERTC claims that aren't supported by the eligible wages, number of employees, and other qualifying criteria states in the CARES Act.
  • Prior non-compliance with tax laws or regulations, which may increase the likelihood of an ERTC audit.

Employers should maintain accurate and detailed records to support their ERTC claims and be prepared to provide documentation and respond to any inquiries from the IRS during an audit.

Businesses should take care to ensure that they are accurately calculating the credit and meeting the eligibility requirements. Any errors or discrepancies in their ERTC claim may increase the risk of an audit.

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Interaction between the ERTC and the IRS

Employers must report the ERTC on Form 941, the quarterly payroll tax return. These forms are reviewed by the IRS to ensure businesses are claiming the credit accurately and meeting the eligibility requirements. 

The IRS has also provided guidance on the ERTC and updates the guidelines regularly. Businesses are responsible for understanding and following these guidelines to ensure they are eligible for the credit.

In addition, the IRS may request additional documentation to verify eligibility:

  • Financial statements
  • Payroll records 
  • Invoices
  • Receipts

These documents are used to verify that you've experienced a significant decline in gross receipts or that you were subject to a government shutdown order. 

You should also be aware of “qualified wages”, which are wages paid to employees during the applicable period. The applicable period is the period from March 13, 2023, to December 31, 2023, with the definition of qualified wages varying depending on the business size: 

  • 500 or less employees: All wages paid during the applicable period qualify. 
  • More than 500 employees: Only wages paid to employees who aren't providing services qualify.

Additionally, the ERTC can be used in conjunction with other relief programs, such as the Paycheck Protection Program (PPP) and the Shuttered Venue Operators Grant (SVOG). 

However, there are certain restrictions on how the ERTC can be used in combination with these programs. For example, a business cannot claim the ERTC for wages that were paid using PPP loan proceeds that were forgiven.

(See our guide on the employee retention credit and PPP for more help on this).

To claim the ERTC, a business must maintain documentation to support the credit, including records of the number of employees and their wages.

Keep these documents for at least 4 years after the date the tax becomes due or is paid, whichever is later.

How to prevent an ERTC audit

Unfortunately, there’s no full-proof method of avoiding an ERC audit.

However, we recommend you do these things to lower the chances of an ERC audit kicking in:

1. Review the IRS guidelines

While this might sound the most obvious thing to do, you’ll be surprised at how many people don’t check the most recent IRS guidelines.

They’re updated regularly, but I totally understand that you either don’t have the time to check them or need more clarification on what exactly the guidelines mean.

Nevertheless, just a glance through them might trigger you to question whether you’re compliant or not.

2. Use a reputable tax professional

Working with a reputable tax professional, like the team here at Brotman Law, ensures you’re accurately claiming the credit and meeting the eligibility requirements, which are two big factors for being flagged for an ERC audit.

In addition, we can also help businesses navigate any potential audits or IRS requests for documentation.

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3. Document ERTC calculations

Having all documentation to hand may just prevent them from needing to complete a full audit. 

And, even if an audit still occurs, the documentation will help clarify any inconsistencies and ensure the process is less painful than it needs to be.

4. Double-check ERTC calculations

As a responsible person in your business, you should double-check ERTC calculations to ensure their accuracy. Any errors or discrepancies in their claim may increase the risk of an audit.

5. Respond to any IRS requests promptly

If the IRS requests additional documentation to verify your ERTC claim, respond promptly and provide the requested documentation. Delaying or ignoring an IRS request could significantly increase the risk of an audit.

The Statute of Limitations for an ERC Audit

The statute of limitations is 3 years from the date the tax return was filed or the due date of the return, whichever is later.

However, if you've filed an amended return, the statute of limitations starts from the amended return file date.

On top of that, the statute of limitations for auditing the ERC depends on various factors:

  • Type of tax return filed
  • Whether you’ve filed an amended return
  • Audit circumstances

If fraud or intentional misrepresentation is suspected, the IRS can audit the business at any time, regardless of any statute of limitations.

What to do if subjected to an ERC Audit?

If you're at the wrong end of an IRS letter, the best thing to do is:

1. Review the notification letter

The IRS will typically send a notification letter to inform you that your business will be audited.

The letter will provide details on the scope of the audit, the IRS contact person, and the timeframe.

Review the letter carefully and take note of any deadlines or requirements.

2. Gather all relevant documents

Ensure all relevant documents related to the ERC are in order, such as payroll records, tax returns, and other supporting documentation.

You'll need these to respond to the IRS's requests and to demonstrate that the business is eligible for the credit.

Here are some tips on how to maintain your documents in case of an IRS audit:

  • Organized records: Keep your tax-related documents organized and easily accessible. Consider using a spreadsheet or software program to help organize your records. 
  • Proof of deductions: If you claim deductions on your tax return, make sure you have the proper supporting documentation. This includes receipts for charitable donations, medical expenses, and business expenses. 
  • Employment records: Keep detailed records of your employees' wages, taxes withheld, and benefits provided. This includes payroll records, W-2 forms, and other employment-related documents. 
  • Communication records: Retain any communication with the IRS, including letters, emails, and phone calls. This will help you keep track of any requests for information or other correspondence related to the audit. 

Remember that the burden of proof is on you, the taxpayer, to provide documentation to support your tax return filings.

By maintaining organized and accurate records, you can help make the audit process go more smoothly and increase your chances of a favorable outcome.

3. Cooperate with the IRS

It’s really essential that you fully cooperate with the IRS and provide all requested information promptly.

Failure to cooperate with the IRS can result in penalties and additional scrutiny.

4. Appeal the decision, if necessary

You may have the right to appeal the decision through the IRS's appeals process or through litigation in court.

However, this can be lengthy and may require additional time, cost and effort on your part. Naturally, this can be worth it.

Key takeaways on an IRS ERC audit

There are undoubtedly certain things you can do to mitigate the chance of the IRS auditing your ERC claims.

However, this doesn’t guarantee that you’ll totally avoid the audit from occurring. And, even if you do get audited, all isn’t lost.

Keeping all calculations and documentation updated and to hand will greatly help you. And, if you’re still stuck, you can always get in touch with the team here at Brotman Law so we can see how we can help.

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