Mar 21, 2024

What can I expect from an ERC audit?

What to Expect From an ERC Audit

The IRS is Coming For Your Employee Retention Credit

So, you claimed the Employee Retention Credit (ERC) on your payroll tax returns – and now, the IRS wants to take a closer look. Don’t panic, but also – don‘t take this lightly. The IRS has trained 300 auditors specifically to examine ERC claims, and they’re coming for businesses like yours. Why? Because they suspect many ERC claims were improper, or even fraudulent.But, take a deep breath. Getting audited doesn‘t automatically mean you did something wrong. The IRS just wants to verify that you qualified for the credit you claimed. Still, an ERC audit can be a lengthy, stressful process – with your money on the line. You could face repayments, penalties, and hefty fees for professional representation.Here’s the deal: the ERC was valuable relief for businesses impacted by COVID-19. But the rules around qualifying were pretty complex. Lots of businesses made honest mistakes in calculating their credit. Others, unfortunately, were misled by shady “ERC mills” into claiming credits they didn’t deserve.So, what do you do, if you get hit – with one of these things? Knowledge is power. Understanding the ERC audit process, and how to prepare, could make all the difference. We‘ll walk through what to expect every step of the way – so you can protect your business, and your wallet.

The Opening Salvo: The IRS Notification

It starts with a letter, folks. The IRS will send you an official notification that your business has been selected for an ERC audit. This letter is crucial – it outlines the specific issues the IRS wants to examine regarding your credit claim.The notification kicks off the whole audit process. So pay close attention to the details, like:

• The tax periods under review (which quarters did you claim the ERC?)
• The initial request for documents and information (more on this later)
• Deadlines for providing the requested materials
• Contact information for the IRS auditor assigned to your case

Don’t ignore this letter, and don’t miss those deadlines. Responding promptly, and providing what the IRS wants upfront, could make your audit smoother from the start.

Three Flavors of ERC Audit: Strap In

There are three main ways the IRS may conduct your ERC audit:

1. Correspondence Audit: This is the simplest version – a mail-based back-and-forth. The IRS requests documents by mail, you provide them, and most of the audit happens on paper.
2. Desk Audit: Here, you’ll have to arrange phone or video meetings with the IRS auditor. You’ll go through your documents together, and they’ll ask questions about your calculations and eligibility.
3. Field Audit: The full monty. With a field audit, the IRS sends an auditor to your place of business to examine your records and operations in person. These tend to be reserved for larger ERC claims or more complex cases.

No matter which audit approach they take, you can expect the IRS to request boatloads of documentation to back up your claims. We’re talking:

• Payroll records
• Financial statements
• Tax returns
• Employee information
• Calculations showing how you determined your ERC amount
• And anything else proving you were truly eligible for the credit

The IRS auditor’s job is to verify that you checked all the boxes for the Employee Retention Credit. So be prepared to prove, document-by-document, that you qualified.

The ERC Audit Document Drill: Brace Yourself

Speaking of documentation, let’s get specific on what kinds of records the IRS will want to see:Payroll Records: Things like quarterly payroll tax returns (Forms 941), W-2s, and actual payroll registers/wage listings. The auditor needs to verify the wages you paid, and which employees you paid them to.Financial Statements: Profit and loss statements, balance sheets, books of account – anything showing your business‘s financial situation during the periods you claimed the ERC.Tax Returns and Forms: The auditor will review your income tax returns, Forms 941, and any amended payroll tax returns where you originally claimed the ERC (Forms 941-X, for example).Employee Data: Expect to provide a lot of nitty-gritty employee details – hire/term dates, duties, locations, schedules, and more. The IRS needs to see which workers qualified for the ERC.Eligibility Records: This is the heart of your claim. The auditor will scrutinize any evidence proving you actually met the ERC requirements, like:

• Governmental orders that impacted your operations
• Records showing significant gross receipts decline
• Calculations of credits claimed per quarter
• PPP loan documentation (if applicable)

The list goes on. But the key is – you must have organized, comprehensive documentation justifying every aspect of your ERC claim. Missing or incomplete records could tank your audit defense.

The Five Burning Questions: Be Ready

As the audit progresses, the IRS will dig deeper into the specifics of your situation and ERC claim. Prepare to face detailed questions around five core areas:

1. Eligibility Criteria: How, exactly, did your business qualify for the ERC? Were operations fully or partially suspended by a governmental order? Did you experience a significant gross receipts decline?
2. Qualified Wages: Which employee wages, specifically, were used to calculate your credit amount? Do those wages meet the strict “qualified wages” criteria for the ERC?
3. Credit Calculations: Show your work. The auditor will scrutinize the calculations you used to determine your ERC amount for each qualifying period.
4. PPP Loan Interaction: If you received a Paycheck Protection Program (PPP) loan, the auditor must verify you properly accounted for those funds when claiming ERC credits.
5. Third-Party Advisors: Uh-oh, did you use one of those sketchy “ERC mills” for your claim? Be ready to explain that relationship, and defend the advice you received.

Nailing the details in these five areas is critical for passing your ERC audit. Contradictions, missing info, or unexplained calculations could spell disaster – and a whole lot of extra fees and penalties.

When the Auditor Comes Knocking: Know Your Rights

Throughout the ERC audit process, it’s important to understand your rights as a taxpayer. The auditor may sometimes seem like they‘re grilling you – but you’re not required to take a beating.

• You have the right to professional representation. Hire a qualified tax pro to advise you and advocate for your position.
• You can request more time to provide records and information, if the auditor’s deadlines are unreasonable.
• If you disagree with the auditor’s findings, you have rights to appeal and protest the results through official IRS channels.
• The IRS cannot simply seize funds from you without proper notice and your ability to dispute the action.
• You are protected from unfair treatment or harassment from IRS personnel during an audit.

Knowing these rights lets you approach the audit confidently and professionally. Don’t let an auditor bully you into a corner. But also, don‘t be uncooperative – that could seriously damage your case.

Audit Aftermath: The Results Are In

After all the document sharing, meetings, and questioning – the auditor will finally render their verdict. They’ll issue a written report outlining their findings and conclusions about your ERC claim.There are three main potential outcomes here:

1. No Change: Congratulations! The auditor agrees with the ERC amount you originally claimed. Your credit is safe, no further action required.
2. Adjustments Proposed: Uh-oh. The auditor believes you overclaimed the ERC, or didn’t qualify for the full amount. They’ll issue a proposal to reduce your credit – and you may have to repay funds, plus potential penalties and interest.
3. Full Disallowance: The worst case scenario. The auditor determines you didn’t qualify for the ERC at all. You’ll have to repay the entire credit amount, with penalties and interest likely coming your way too.

If the auditor proposes adjustments or disallows your ERC claim entirely, you have options to dispute those findings through the IRS appeals process. But you’ll be on the clock, with strict deadlines to file appeals or pay up.

When to Call In the Pros: Lawyers > Auditors

Look, we get it – dealing with the IRS is the last thing you want for your business. ERC audits are stressful, document-heavy slogs that can drag on for months. Handling one alone is like wrestling an auditor with one hand tied behind your back.That’s why, when you get that ominous IRS notification letter, your first call should be to an experienced tax lawyer or ERC audit professional. Having the right representation is half the battle.A qualified tax pro knows the ERC rules and regulations inside-out. They‘ll ensure you provide the exact documentation required, calculate your credit correctly, and respond to the auditor’s inquiries with precision.More importantly, a skilled audit representative knows how to advocate for your position persuasively. They can negotiate with the IRS on your behalf, dispute adverse findings through official channels, and fight to protect your business from excessive penalties.Don’t try to play auditor yourselves, folks. The risks of going it alone – repayments, fines, legal headaches – just aren’t worth it when professional audit defense is an option.

What can I expect from an ERC audit?