With the introduction of the Employee Retention Credit (ERC), also known as Employee Retention Tax Credit (ERTC), the CARES Act created a lifeline for many businesses to weather the storm of the COVID-19 pandemic. Unfortunately, it also created confusion, an environment ripe for misuse, and a chance for businesses to find themselves deep in trouble due to incorrect, insufficiently supported, or downright fraudulent claims. On March 7, 2023, the IRS issued a renewed warning to businesses (IR-2023-40) to be wary of third parties advising organizations to claim the credit for which they may not qualify.

In October 2022, the IRS announced that the Small Business/Self-Employed division had recently trained IRS examiners to focus on ERC claims. Unsurprisingly, such a valuable credit is highly susceptible to improper claims resulting in examinations by the IRS. Each examiner has completed a 56-hour training course. The IRS Criminal Investigation Unit continues to focus on COVID-19 fraud, including improper Paycheck Protection Program (PPP) loans and ERC claims, and those that enabled or promoted them. Organizations that are found to have improperly claimed the credit will need to return the funds and may also be subject to interest, penalties, or criminal charges.

What Questions Will the IRS Ask in an ERC Audit?

In addition to informing the public that examiners had received specialized training, the IRS also released the Training Guide that those examiners will use as they investigate ERC claims. The linked training guide will provide some insight into the focus of the examiners.

It makes sense that the significant credit claims will incur substantial scrutiny. Businesses that have claimed the ERC should be on the lookout for audit notices or Information Document Requests (IDRs). In the initial IDR, the IRS will frequently ask specific questions related to eligibility, documentation of tax returns and forms filed, PPP loans and forgiveness, payroll details, and thorough records of government orders, if any, that were used as justification for the claim. The intricacies of eligibility and the calculations required to ensure qualification for the credit are complex, with many opportunities for error. The time to compile all documentation and support for any positions taken in claiming the credit is prior to receiving any communication from the IRS.

During an ERC audit, the IRS may ask various questions related to the business’s eligibility for the credit, how the credit amount was determined, and the documentation supporting the credit. Some questions that the IRS may ask include:

  1.  Were your operations fully or partially suspended due to a government order?
  2. Did your gross receipts decline by more than 50% in any quarter in 2020, or by more than 20% in the first three quarters of 2021 compared to the same quarter(s) in 2019?
  3. Was the credit properly calculated based on qualified wages paid to eligible employees?
  4. Provide documentation to support your eligibility for the credit and the calculation of the credit.
  5. Did your organization receive a Paycheck Protection Program loan and was it forgiven? Were the wages used to calculate your ERC credit also used for the PPP loan forgiveness?
  6. Are the owners of this business owners of other businesses?
How Should Organizations Prepare for an IRS ERC Audit?

Now that you are aware of some of the questions that could be asked by the IRS, organizations should contact those who assisted in their ERC claim to ensure that proper documentation is retained and preserved. Businesses under audit should be prepared to provide thorough documentation of any qualifications to support their ERC claim. If your provider is unwilling or unable to assist with this, Thompson Greenspon does provide ERC claim and ERC audit assistance. It is good practice to ensure errors are discovered and corrected before the IRS seeks correction in order to create a smooth audit process.

Businesses can take several steps to prepare for an ERC audit. Here are some tips to help organizations prepare:

  • Gather Documentation: Businesses should gather and organize all documentation related to their eligibility for the credit and the calculation of the credit. This may include copies of government orders resulting in full or partial suspension, payroll records showing qualified wages paid to eligible employees, and financial statements demonstrating the decline in gross receipts.
  • Review Eligibility Criteria: Businesses should review the eligibility criteria for the ERC to ensure that they meet all the requirements. The measures may include determining if they were fully or partially suspended due to a government order or if they experienced a decline in gross receipts.
  • Verify Qualified Wages: Businesses should verify that they properly calculated qualified wages for eligible employees during the covered period. This verification may include reviewing payroll records and ensuring that wages were paid during the correct time frame.
  • Consult with a Tax Professional: ERC audits can be complex. Businesses may benefit from consulting with a tax professional to help prepare for the audit and ensure compliance with all ERC requirements.
  • Be Responsive: If the business receives a notification of an ERC audit, they should respond promptly to any requests for information from the IRS. The notification may include a request to provide additional documentation or answer questions related to their eligibility for the credit and the calculation of the credit.

By taking these steps, businesses can help ensure that they are prepared for an ERC audit and demonstrate their eligibility for the credit and the credit calculation.

If a business made a wrongful ERC claim, it may be subject to penalties and interest, including potential criminal fraud penalties. If the business determines that it has made an incorrect claim, steps should be taken to correct this immediately, before an IRS audit, as it may reduce any penalties including criminal fraud.

How Long Does the IRS Have to Audit ERC Claims?

While taxpayers have until 4/15/24 to file 2020 ERC claims, and until 4/15/25 to file 2021 ERC claims, the IRS has an extended statute of limitations period to examine ERC claims, thanks to the American Rescue Plan Act. The IRS will likely examine ERC refund claims until at least April 2027.

The ERC is a valuable tax credit that can help businesses offset the pandemic’s financial impacts, providing a much-needed boost to their cash flow. However, it is vital to ensure that companies comply with all eligibility and documentation requirements to avoid potential IRS audits or penalties. Thompson Greenspon can help you navigate these requirements and ensure your ERC is appropriately executed. Contact us and speak with one of our ERC specialists to see if we are the right fit to assist you with any or all of the following related to the ERC: eligibility analysis, documentation, calculation, filing, or audit defense.

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Erin Kidd
Erin Kidd, MBA, EA, AFC

Erin Kidd is the Special Projects Manager at Thompson Greenspon and has nearly a decade of tax experience specializing in individual taxation. Throughout her career, she has focused on simplifying complex tax issues and educating clients to maximize their tax benefits and plan for future events. Erin holds a Bachelor’s and Master’s Degree in Business Administration from Morehead State University, is an Enrolled Agent, a federally licensed tax preparer who has unlimited rights to practice before the IRS, and an Accredited Financial Counselor ®. She has been recognized by the Garrison Commands of West Point, NY and Fort Leavenworth, KS for her contributions to the military community for her work with the installations’ Volunteer Income Tax Assistance Centers.