ERC Audit Penalties: Understanding the Risks

Understanding ERC Audit Penalties

The Employee Retention Credit (ERC) was a valuable lifeline for businesses during the COVID-19 pandemic, but now, the IRS is cracking down on potential abuse through increased audits. If your business claimed the ERC, you may wonder – what are the penalties if you get audited and the IRS reduces or denies the credit? The stakes, can be high.

Common Penalties

The most common penalty is a 20% accuracy-related penalty. So, if your ERC is reduced by $10,000, you’ll owe $2,000 on top of repaying the excess credit.3 But, things escalate quickly, if the IRS asserts you committed civil fraud.

Civil Fraud Penalty

The penalty skyrockets to a whopping 75% of the disallowed amount. Using our example, your penalty would be $7,500 instead of $2,000.3 The IRS has a high bar for civil fraud – they must show you intentionally evaded taxes you knew you owed. Red flags include:

• Claiming the ERC despite clearly not meeting eligibility
• Using sham companies or false employees to multiply the credit
• Fabricating documentation to support a larger credit3

Criminal Penalties

In extreme cases of deliberate fraud, the IRS may pursue criminal prosecution, which is very rare but devastating:

• Up to $100,000 in fines for individuals ($500,000 for corporations)
• Up to 5 years in prison3

Accurately claiming only what you’re entitled to is critical to avoid such severe consequences.

Failure-to-Deposit Penalty

Another risk is the failure-to-deposit penalty. If you initially claimed the refundable ERC but are later denied, the disallowed portion becomes an underpayment of payroll taxes. The penalty is 2-15% of the underpaid amount, depending on lateness.3 However, the IRS may waive this if you show reasonable cause.

Statute of Limitations

The IRS typically has 3 years from your filing to assess accuracy and civil fraud penalties. But, there’s no statute of limitations on criminal prosecution for tax fraud – they can pursue charges at any time if deliberate evasion is suspected.2

Mitigating Penalties

The best defense is thorough documentation proving your ERC eligibility:

• Evidence of the required revenue decline in 2020/2021
• Proof employees were retained but not working
• Records of wages paid during eligible periods3

Promptly responding to IRS inquiries about your claims is crucial. If you get an audit notice, contact a tax professional immediately. They can help make the strongest case to avoid penalties.3 If the audit does reduce your eligible ERC, consider amending your return before the IRS formally asserts penalties. This may help avoid accuracy penalties, though not fraud penalties.3

Red Flags and Schemes

The IRS has identified numerous schemes wrongly obtaining ERC credits. Signs a so-called “expert” may be selling you an improper strategy:

• Claiming eligibility for credits far exceeding payroll
• Using sham companies or false employees
• Advising you to fabricate documentation
• Charging exorbitant contingency fees based on the credit3

Stick to reputable tax professionals with legitimate strategies for maximizing credits legally. If it seems too good to be true, it likely is.

Getting Help

Are you stressed about ERC penalties? Want to disclose mistakes or fraud? Facing an audit? Need penalty abatement help? Reach out to a tax professional through TaxCure for guidance based on your situation.5 At Spodek Law Group, our tax attorneys deeply understand ERC complexities. We can review returns, guide you through audits, and fight for penalty relief. Don’t go it alone – contact us for the strongest defense against crippling ERC audit penalties. Call us today at 212-210-1851 or schedule a free consultation online.