15 Sep 23

Will the IRS audit the ERC credit?

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Last Updated on: 15th September 2023, 05:35 pm

Person worried about IRS audit

The Employee Retention Credit (ERC) has been a valuable lifeline for many small businesses during the pandemic, but some questionable claims have led the IRS to crack down. This has many business owners worried about the risk of an audit. So what are the chances your ERC claim could get flagged? Here’s what we know so far.

The ERC lets eligible employers get up to $26,000 back per employee in 2020 and 2021 for keeping workers on payroll and continuing health care benefits. But the IRS says billions have been claimed improperly, including by ineligible companies.

To get the facts straight, the credit applies to businesses that saw gross receipts drop by at least 20% compared to the same quarter in 2019. The Small Business Administration has a whole page explaining what counts as gross receipts. But some businesses used different calculations to make themselves look eligible when they weren’t.
Others claimed the ERC for bonuses or wages that had nothing to do with retaining employees during COVID-19. One big no-no was claiming the credit for federal government employees, since their wages came from taxpayer funds.

According to IRS Commissioner Charles Rettig, the agency is now wrapping up a huge backlog of 2020 claims. With that out of the way, the IRS is moving to a “new phase” of tackling ERC fraud. Rettig said the agency has trained auditors to examine high-risk claims and will implement new procedures to detect questionable filings.
The IRS also added ERC scams to its 2022 “Dirty Dozen” list of top tax scams. And its criminal investigations division is actively pursuing potential cheats. In March, the IRS issued a renewed warning about false ERC claims generating “compliance risk” for filers.

So what are the consequences if the IRS decides to audit your ERC claim? According to experts, it depends on whether the issues are minor inaccuracies or deliberate fraud.

For honest mistakes, the IRS may just make adjustments to reduce the credit amount. But penalties can range from 20% for negligence to 75% for fraud. The agency can also ban dishonest preparers from filing claims.
Criminal prosecution is possible too if the IRS thinks you willfully tried to bilk the government. The maximum penalty is a $250,000 fine and 5 years prison time.

The bottom line is legitimate businesses that did their best to comply have little to fear. But those who pushed the envelope should brace for IRS scrutiny. For now, the best move is being upfront if you discover any errors before the IRS does.

The ERC has thrown many complex rules at small employers already struggling with the pandemic’s challenges. So mistakes can happen, especially with so much murky guidance early on. The key is showing the IRS you acted in good faith to follow the laws.

With proper documentation, most businesses can justify their claims. But waiting for an audit notice before getting your facts straight makes it much harder to avoid penalties. Connecting with a tax pro now can help get ahead of any issues.

The ERC remains a valuable program for shoring up workforces in tough times. Despite the crackdown, experts believe most employers who received credits used them properly. As always, honest taxpayers have nothing to fear from the IRS. But those who misused the program may soon get a knock on the door.