How to Prepare for an ERC Audit
Contents
- 1 Understanding ERC Audits
- 2 Why ERC Audits Happen
- 3 Types of ERC Audits
- 4 Correspondence Audit
- 5 Desk Audit
- 6 Field Audit
- 7 Preparing for an ERC Audit
- 8 Maintain Accurate Records
- 9 Conduct Compliance Checks
- 10 Seek Professional Guidance
- 11 Organize Documentation
- 12 Verify Employee Eligibility
- 13 Stay Updated
- 14 During the Audit
- 15 Potential Penalties
Understanding ERC Audits
The Employee Retention Credit (ERC) was a valuable tax incentive, designed to help businesses retain employees during the COVID-19 pandemic, but it also opened the door for potential abuse and errors, so the IRS is now auditing ERC claims extensively. An ERC audit is a formal review by the IRS to verify a company’s eligibility and compliance with ERC rules.
Why ERC Audits Happen
The IRS has several reasons for increasing ERC audit activity:
- Ensure the substantial funds involved in the ERC program aren’t misused or exploited.
- Identify errors or fraudulent claims in ERC filings.
- Promote compliance with tax laws and prevent improper use of government funds.
- Close the tax gap and collect revenue owed to the government.
The IRS may select businesses for audit based on factors like:
- Discrepancies between claimed ERC amounts and industry averages.
- Suspiciously high credit claims warranting investigation.
- Errors in documentation provided during the ERC claim process.
Types of ERC Audits
If selected for an ERC audit, you’ll receive a notification letter detailing the issues under examination and next steps. There are three main types of ERC audits:
Correspondence Audit
This is conducted primarily through mail, where the IRS requests specific documents related to your ERC claim, which you must provide to substantiate your eligibility and credit calculations.
Desk Audit
In a desk audit, you’ll arrange phone/video meetings with IRS auditors to discuss the documents provided and address any questions or concerns. This allows direct communication with the auditor.
Field Audit
The most extensive type, a field audit involves an IRS auditor physically visiting your business premises to examine financial records, documentation, and overall operations. Field audits for ERC claims are rare and typically reserved for complex cases.
Preparing for an ERC Audit
Preparation is crucial to navigate an ERC audit smoothly. Here are some essential steps:
Maintain Accurate Records
Keep detailed records of all ERC-related transactions, including employee information, wages, qualified expenses, and supporting evidence. Well-organized records can substantiate your claims during an audit.
Conduct Compliance Checks
Review your ERC calculations, eligibility criteria, and documentation to identify and address any potential issues or errors before an audit.
Seek Professional Guidance
Engage qualified tax professionals or ERC specialists to review your documentation, calculations, and provide guidance throughout the audit process. Their expertise can be invaluable.
Organize Documentation
Systematically organize all supporting documents, such as payroll records, financial statements, tax returns, and ERC calculations, making it easier for auditors to review.
Verify Employee Eligibility
Confirm that your employees met the eligibility criteria for the ERC during the claimed periods.
Stay Updated
Keep up-to-date with the latest ERC guidelines and regulations to ensure compliance with any changes.
During the Audit
During an ERC audit, be cooperative and transparent. Provide explanations and additional documentation as requested by the auditors. Address any queries or concerns raised promptly and professionally.The audit duration may vary depending on the complexity of the case, but be prepared for a potentially prolonged review process.
Potential Penalties
Failure to comply with ERC regulations and reporting requirements can result in severe penalties from the IRS, including:
- Disallowance of the claimed ERC credit.
- Assessment of additional taxes, interest, and penalties.
- Potential criminal charges in cases of fraud or intentional misrepresentation.