20 Sep 23

Will the IRS audit ERC claims?

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Last Updated on: 20th September 2023, 02:55 am

Will the IRS Audit ERC Claims?

The Employee Retention Credit (ERC) has been a lifeline for many businesses during the pandemic. But with billions in funds disbursed, the IRS is now taking a hard look at these claims. So should you be worried about an ERC audit? Let’s break it down.

The ERC Basics

First, a quick refresher. The ERC was created by the CARES Act in March 2020 to help businesses retain employees during COVID-19 shutdowns and slowdowns. Eligible employers can claim a tax credit for 50% of up to $10,000 in wages per employee for 2020. This was increased to 70% of $10,000 per quarter in 2021. To qualify, businesses had to experience a significant decline in gross receipts or operations due to the pandemic.

The ERC has been massively popular, with over $80 billion claimed so far. But not surprisingly, scammers have also taken advantage. The IRS estimates that over $95 billion in improper ERC claims have been made.

The Coming ERC Audit Wave

To combat fraud, the IRS stopped processing new ERC claims in September 2022. They also announced plans to audit every single ERC claim – that’s over 9 million businesses.

“The ERC is an inherently risky tax credit that will lead to a high volume of audits over the next five years,” warns Aprio, an accounting firm. The IRS has already trained auditors to examine high-risk ERC claims. And their criminal division is investigating potential fraud.

So expect a tidal wave of ERC audits in the coming years. The question is – will your business get swept up?

Red Flags That Increase Audit Risk

The IRS looks for certain red flags that suggest an improper or fraudulent ERC claim:

  • Claiming credits for employees who weren’t actually retained or paid
  • Claiming the credit without the required revenue loss
  • Claiming credits for related companies as if they were one employer
  • Claiming wages for employees who weren’t actually working
  • Claiming the credit retroactively for prior tax years

Basically, the IRS scrutinizes claims that seem too good to be true. So if you pushed the envelope on ERC eligibility, expect extra attention.

Document, Document, Document

“The best defense against a future ERC audit is to prepare thorough documentation now,” advises Aprio.

You should be able to clearly show:

  • How COVID impacted your revenues or operations
  • That claimed employees actually worked for you when claimed
  • Employee wages paid for the credit periods
  • Your eligibility based on business type and size

Having clean, well-organized paperwork makes a huge difference if audited. So take the time now to make sure your ERC house is in order.

Responding to an ERC Audit

If you do get that dreaded audit letter, stay calm. Just having an ERC audit does not mean you’ll automatically lose the credits.

“The IRS has a high burden of proof in court,” explains tax attorney Sam Brotman. “With the right documentation and legal arguments, many taxpayers could successfully defend their ERC claims.”

When responding to an audit:

  • Be polite and professional with the auditor
  • Clearly present your eligibility facts and documents
  • Consider hiring a tax pro to represent you
  • Don’t ignore deadlines for responding

If you do end up losing, you can also appeal IRS decisions or negotiate settlements. So don’t assume an audit means automatic ERC denial.

The Cost of ERC Noncompliance

If an audit does result in denial of your ERC, know that the IRS takes this very seriously.

You’ll have to repay all credits claimed, along with interest and penalties. For intentional fraud, penalties can reach 75% of the disallowed amount. The IRS may also pursue criminal prosecution in egregious cases.

“Taxpayers improperly claiming the ERC must pay it back, possibly with penalties and interest,” warns the IRS.

So if you knowingly claimed bogus ERC credits, speak with a tax attorney about making things right through the IRS voluntary disclosure program before they find you first.

The Outlook for ERC Audits

The bottom line is ERC audits are ramping up big time. If your business claimed this credit, expect extra IRS scrutiny in coming years.

The best defense is thorough documentation showing your eligibility and compliance. With the right preparation, most businesses can survive ERC audits intact. But improper claims could lead to stiff repayment and penalties.

Consult with your tax advisor about your ERC risks and documentation. With some precaution now, your business can be well prepared in case of an audit.

Here are some tips to get ready:

  • Gather and organize all documentation showing your revenue declines and employee retention during the pandemic. Having clear proof will be key to defending your ERC claims.
  • Review eligibility criteria again to ensure you fully qualified for the ERC. Document any unclear gray areas where interpretation was required.
  • Calculate your ERC claims carefully based on actual retained wages paid. Double check for any potential errors.
  • Consider having your documentation reviewed by an independent tax pro or law firm. Get an objective opinion on the strength of your audit position.
  • Make sure your record retention policies are in order. You need to keep ERC documentation for at least 6 years after claiming credits.
  • If any red flags or concerns surface during preparation, consider amending returns proactively to correct errors.
  • If your ERC claims seem questionable, consult with legal counsel about options like IRS voluntary disclosure.

With billions in ERC funds claimed, IRS audit scrutiny will be intense. But businesses that prioritize documentation and compliance can feel confident going into the process. By spending time now to get audit-ready, your company will be in a much better position if the IRS comes knocking.

The ERC offered a vital lifeline for employers during COVID-19. But the IRS is now aggressively guarding against misuse of the program. With the right precautions, businesses can survive the impending wave of ERC audits. Don’t wait – start preparing your documentation today.