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Responding to ERC Audit Requests: Best Practices

You’ve Been Selected for an ERC Audit, Now What?

What is the ERC and Why is it Being Audited?

The Employee Retention Credit was a lifeline for businesses impacted by COVID-19, allowing them to claim a refundable tax credit for keeping employees on payroll. But, with over $120 billion in credits claimed, the IRS is cracking down on potential abuse and errors. Common ERC audit triggers include:

  • Large credit amounts
  • Using a third-party firm to claim the credit
  • Inconsistencies in documentation
  • Random selection for compliance review

Don’t panic if you’re audited, many businesses are facing the same scrutiny. The key is having a solid strategy and legal expertise on your side.

First Step: Understand the Audit Process

When that ominous letter arrives, read it carefully. It outlines the specific information the IRS needs and deadlines for providing it. Missing these can result in your claim being denied or penalties. The IRS may request:

  • Payroll records
  • Tax filings (941s, W-2s, etc.)
  • Documentation of COVID-19 impacts
  • Calculations supporting your credit amount

Don’t go it alone, consult an experienced tax professional or ERC attorney immediately. They’ll ensure you provide exactly what’s needed, in the proper format.

Gather Your Documentation, But Do it Right

Key documents include:

  • Payroll reports showing wages paid
  • Accounting records reflecting declines in gross receipts
  • Government orders restricting your operations
  • Health mandates or guidance impacting your workplace safety practices

But, it’s not just about having the paperwork. Your legal team must carefully review and prepare a supporting narrative explaining how each document relates to your eligibility. Presentation is critical.

Crafting Your Legal Response and Calculations

This is where the real work begins. Your attorneys will analyze your situation, documents, and the auditor’s specific inquiries to build a robust legal argument substantiating your claim. Calculations are paramount – the IRS will scrutinize every number. Expect to provide detailed breakdowns of:

Christine Twomey
Christine Twomey
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Guerline Menard
Guerline Menard
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Taïko Beauty
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Anthony Williams
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  • Qualified wages by employee and period
  • Gross receipts reductions quarter-over-quarter
  • Allocation of health plan expenses
  • Any other inputs factoring into your credit amount

Don’t make mistakes here. Inaccurate calculations can invalidate your entire claim and lead to penalties or interest charges. Lean on your legal team’s expertise.

Presenting Your Case and Potential Outcomes

With documentation organized and legal arguments prepared, it’s time to formally respond to the IRS audit. This may involve:

  • Submitting written responses and evidence
  • Participating in in-person or virtual meetings with auditors
  • Negotiating settlements if the IRS disputes part of your claim

Stay calm, but firm. Your attorneys are there to zealously advocate for you and ensure you retain maximum ERC benefits. Potential outcomes range from full acceptance of your claim, to partial adjustments, to complete disallowance. The key is having professionals who can effectively make your case and fight for what you deserve.

When to Consider an Appeal or Litigation

If the auditors’ final determination is unfavorable, you may have grounds to appeal or potentially litigate. An experienced ERC lawyer can advise if challenging the decision is worthwhile based on:

  • Errors in the IRS’s application of law or interpretation of facts
  • New evidence or calculations supporting your position
  • Potential precedents from other ERC cases or legal rulings

The appeals process is complex, with strict deadlines and procedures. Don’t attempt it alone – qualified tax controversy representation is crucial.

Why Proper Legal Guidance is Essential

From day one of receiving an audit notice, retaining a reputable ERC law firm is vital. They’ll ensure you:

  • Meet all deadlines and requirements
  • Provide well-organized, comprehensive documentation
  • Craft a strong legal argument supporting your eligibility
  • Accurately calculate the credit amount you’re owed
  • Effectively communicate and negotiate with the IRS
  • Explore all options for appealing unfair determinations

The potential ERC dollars at stake are too significant to risk going it alone. With the right legal strategy, you can successfully defend your claim.

Real-Life Examples: When Audits Go Right (and Wrong)

To illustrate best practices in action, let’s look at two hypothetical examples – one where a business properly handled an ERC audit, and one where critical missteps jeopardized their claim.

Example 1: A Successful ERC Audit Defense

Jackson’s Diner, a family restaurant in Ohio, claimed the ERC for 2020 and 2021 after experiencing significant COVID-related disruptions. In late 2022, they received an IRS audit notice. Recognizing the stakes, Jackson’s immediately retained a qualified ERC attorney to manage their audit response. The lawyer:

  1. Gathered and organized all documentation, including:
    • Payroll records showing wages paid to full-time and part-time staff
    • Quarterly sales reports reflecting drastic gross receipts declines
    • Copies of state and local orders restricting indoor dining
    • Health department guidance on enhanced sanitation protocols
  2. Prepared detailed calculations of the credit amount, such as:
    • Qualified wages of $425,000 in 2020 and $315,000 in 2021
    • Gross receipts reductions of 72% in Q2 2020 and 55% in Q3 2020 compared to 2019
    • Allocation of $85,000 in health plan expenses across eligible quarters
  3. Crafted a comprehensive written response, including:
    • Overview of how COVID-19 impacted Jackson’s operations and workforce
    • Analysis of how they met the gross receipts decline and government order tests
    • Detailed calculations cross-referenced to supporting documentation
  4. Participated in virtual meetings with auditors, allowing the lawyer to:
    • Directly address any concerns or questions from the IRS
    • Highlight key evidence supporting Jackson’s eligibility
    • Reiterate the thoroughness of their processes and good faith

Result: After a multi-month review, the IRS auditors accepted Jackson’s ERC claim in full based on the strong documentation and legal arguments presented.

Example 2: A Flawed Audit Response Jeopardizes the Claim

Contrast Jackson’s positive outcome to a manufacturer who mishandled their ERC audit from the start:

  1. They failed to promptly engage professional representation after receiving the audit notice.
  2. When compiling documentation, they provided incomplete payroll records and no calculations.
  3. Their legal response lacked specifics on COVID-19 impacts and eligibility requirements.
  4. During meetings with auditors, they struggled to explain their methodologies.
  5. They missed key deadlines for submitting information due to disorganization.

Unsurprisingly, the IRS auditors denied their entire ERC claim, determining they failed to substantiate eligibility or accurately calculate the credit amount. The manufacturer is now weighing an appeal, but faces an uphill battle due to their flawed audit response. Proper handling from the outset could have avoided this predicament. As these examples demonstrate, your approach to an ERC audit can make or break your claim’s chances of survival. Comprehensive documentation, legal expertise, and attention to detail are paramount.

Overcoming Common ERC Audit Challenges

Even with professional guidance, ERC audits present some unique hurdles to overcome. Here are strategies for addressing frequent sticking points:

Proving the Significant Decline in Gross Receipts Test

For employers not subject to a full or partial government suspension, meeting the gross receipts decline test is key to ERC eligibility. But calculating these reductions properly can be tricky.When responding to an audit request, be prepared to:

  • Provide quarterly gross receipts figures from 2019 (baseline year) and 2020/2021
  • Calculate quarter-over-quarter declines compared to 2019
  • Explain reasons for any variances from your original calculations
  • Highlight periods with declines over 50% (for 2020) or 20% (for 2021)

Using accounting software reports and reconciling to tax filings bolsters your documentation. Auditors may require proof that your calculations align with tax return positions.

Substantiating the Impact of Government Orders

Even if you experienced gross receipts declines, you must also show how government orders partially suspended your operations. Auditors want specifics on:

  • What orders were in place and during what periods
  • How those mandates impacted your workforce and ability to operate
  • Changes made to comply (reduced hours, remote work, new safety protocols)

Provide copies of actual orders rather than just citing them. Explain with concrete examples how they constrained your business. Detailed timelines and employee communications can corroborate your claims.

Proving the Health Plan Expenses Allocation

For 2021, employers could claim the ERC based on paying health plan expenses for employees, even without a decline in gross receipts or government order. But proper allocation is critical. Auditors may scrutinize:

  • How you determined the qualified health plan costs
  • Which employees were included in the allocation
  • Periods and amounts allocated to each quarter

Having a clear, consistent methodology that ties to your actual health plan invoices and payroll data is essential. Auditors will want assurance you didn’t double-count these expenses elsewhere.

Managing Third-Party Firm Involvement

Many businesses utilized professional service firms to claim the ERC. While legal, this can raise red flags for auditors concerned about noncompliance or inflated claims. If you worked with a third party, be prepared to:

  • Explain their role and your oversight of their work
  • Produce the underlying documentation they relied upon
  • Reconcile any differences between their calculations and yours
  • Demonstrate your reasonable cause and good faith effort

Having an experienced ERC attorney involved can provide credibility and insulate you from accusations of improper conduct.

Addressing Potential Penalties and Strategies

In worst-case scenarios, the IRS could fully deny your ERC claim and even assess penalties – like the 20% negligence penalty or 75% fraud penalty.But you have recourse, especially if you:

  • Relied on professional tax advice
  • Made reasonable cause efforts to comply
  • Have a solid legal argument for your position

Your attorneys can negotiate to remove penalties during audit resolution. Or potentially file an appeal or pursue litigation to contest improper assessments. The key is carefully developing your legal strategy from the very start of an audit notice. With meticulous documentation and representation, you maximize your chances of avoiding costly penalties.

Why Partnering with an Elite ERC Law Firm Matters

The complexities and high-stakes nature of ERC audits underscore why partnering with a premier ERC law firm is critical. They provide:

  • In-depth knowledge of eligibility rules and calculations
  • Proven strategies for compiling thorough documentation
  • Skilled legal writing and audit response preparation
  • Effective IRS audit representation and negotiation
  • Options for appealing unfavorable determinations

At a firm like Spodek Law Group, you get tax attorneys who have successfully defended countless ERC audits across the nation. Their expertise could mean the difference between losing your entire claim or retaining maximum credits.Don’t risk your ERC dollars with inexperienced representation. An elite law firm is your biggest asset when facing IRS scrutiny.

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