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What triggers a ERC audit?
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What Triggers an ERC Audit?
The Employee Retention Credit (ERC) has been a lifeline for many businesses during the pandemic. This tax credit helps companies keep employees on payroll by providing a credit for wages paid. However, with any tax program, there is always a risk of audit if the IRS suspects potential errors or fraud. So what might trigger the IRS to take a closer look at your ERC claims?
Dramatic Changes in Payroll
One red flag is if your payroll spending changed significantly from year to year. For example, if your payroll in 2020 was $500,000 but in 2021 it jumped to $2 million. That big increase could indicate you improperly claimed the ERC for wages that were not really paid. The IRS computers may flag rapid changes in payroll as suspicious.
High Dollar Claims
Another trigger is very large ERC refunds. Just like with individual tax returns, big dollar claims get more scrutiny. If you have a small business but claimed hundreds of thousands in ERC, expect a higher chance of audit. The IRS will want to verify those large payroll numbers are accurate.
Multiple Amended Returns
Filing amended returns can also catch the IRS’s attention. Let’s say you claimed a small ERC credit initially but then filed two or three amended returns to increase the credit. That pattern looks fishy and makes the IRS suspect you are trying to improperly inflate the credit. Stick to one accurate return.
Claiming Both PPP and ERC
While technically allowed, claiming both Paycheck Protection Program (PPP) loans and the ERC for the same wages can increase audit risk. The IRS will want to verify the amounts do not overlap. Keep meticulous wage records to prove no “double-dipping.”
Math Errors
Like with individual returns, simple math errors on business returns can lead to increased audits. Be sure your ERC calculations are done carefully and double-check for accuracy. Sloppy math is an easy trigger for the IRS computers.
Prior Audit History
If you have been audited before, chances are higher the IRS will audit you again. Previous issues with your returns make them want to monitor you more closely. Expect more frequent audits if you have a history of problems.
Inconsistent Employee Count
The IRS may look closely at companies whose employee headcount seems inconsistent with ERC claims. For example, claiming the ERC for 100 employees when past returns only showed 10 employees on payroll. Large unexplained jumps in employee count are a red flag.
Using Multiple Companies
Having different companies claim the ERC for the same employees can trigger an audit. The IRS checks for situations where a person’s wages are illegally claimed for the credit by more than one business. Make sure no double-dipping happens.
Industry-Specific Issues
Some industries have seen more fraud related to the ERC. Construction companies and staffing agencies, for example, may see more audits to verify claims. Your industry could impact audit selection if the IRS sees patterns.
No Detailed Documentation
Meticulous wage and hour records are crucial for supporting your ERC claim and avoiding audit issues. Lack of detailed documentation on eligible wages paid will almost guarantee an IRS audit. Keep excellent payroll records.
While the examples above may increase chances of an ERC audit, the most important thing is filing an accurate return. Document your eligibility and wage support, double-check your math, and be consistent across years. With good recordkeeping, an IRS audit does not need to be feared. Maintaining proper documentation can give you peace of mind that your ERC claims are fully justified.
References
IRS Begins Correcting Errors on Some Forms 941, 941-X and 941-SS for the 2020 Tax Year