What is the penalty for an ERC audit?

The Truth About ERC Audit Penalties – And How to Avoid Them

You Claimed the Employee Retention Credit, Now What?

So, you claimed the Employee Retention Credit (ERC) on your payroll tax returns – smart move, that credit was a lifeline for many businesses during the pandemic. But, now you’re worried – what if the IRS comes knocking with an audit? What kind of penalties could you face if they determine you weren’t actually eligible or made mistakes in your calculations?Take a deep breath, we’re going to walk through this together. As a top criminal defense law firm, we’ve seen all kinds of tax troubles, and we know how to guide you through even the trickiest IRS audits. Let’s start with the basics.

What is the Employee Retention Credit?

The ERC was a refundable tax credit designed to encourage employers to keep workers on payroll during the COVID-19 pandemic. Eligible employers could claim a credit for qualified wages paid between March 13, 2020 and September 30, 2021.The rules around eligibility were complex, with factors like:

• Full or partial suspension of operations due to government orders
• Significant decline in gross receipts
• Status as a recovery startup business

And the credit amounts varied by year and employer size. It was a lot to keep track of, which is why many businesses hired professional tax preparers or third-party firms to handle their ERC claims.

Why the IRS is Cracking Down on ERC Claims

With such a valuable credit on the line, it’s no surprise the IRS is being vigilant about potential abuse or mistakes. They’ve stated outright that auditing ERC claims is a top priority, and they’ve extended the statute of limitations to give themselves more time to review these credits.The IRS is particularly concerned about:

• Fraudulent claims from businesses that were never eligible
• Inflated or miscalculated credit amounts
• Lack of proper documentation to substantiate eligibility

They’ve even gone so far as to temporarily pause processing new ERC claims while they get a handle on the audits already in progress.So if you claimed the ERC, yes, you could very well face an audit down the line. But an audit doesn’t automatically mean you’re in trouble – it just means the IRS wants to take a closer look at your claim and make sure everything was on the up-and-up.The real danger lies in being unprepared if the IRS does come calling. That’s where those penalties come into play.

ERC Audit Penalties Explained

If the IRS determines you weren’t actually eligible for the ERC or miscalculated the credit amount, they can “disallow” your claim and make you repay any refund or credit you received, plus interest.But that’s just the start. Depending on the specifics of your situation, you could also face:

Accuracy-Related Penalties

This is a 20% penalty on the amount of any excessive ERC claim. So if you claimed $100,000 in credits but the IRS says you were only entitled to $60,000, you’d owe a $8,000 accuracy penalty (20% of the $40,000 overpayment).The IRS can assess this penalty if they determine you were negligent or disregarded the rules when claiming the ERC. Using a third-party firm that steered you wrong is not a valid excuse here.

Fraud Penalties

Now we’re in the big leagues – a 75% civil fraud penalty on any excessive ERC claim amount. This applies if the IRS finds you knowingly made false statements or omissions to claim credits you didn’t qualify for.Using our example from above, a $40,000 overclaim could mean a $30,000 fraud penalty. Ouch.The IRS might also pursue criminal fraud charges in extreme cases, which could mean fines or even jail time on top of having to repay the credits.

Failure to Pay Penalties

If you can’t immediately repay any disallowed ERC amounts after an audit, additional penalties start accruing right away. The “failure to pay” penalty is 0.5% of the unpaid balance per month, up to a maximum of 25%.On a $100,000 disallowed credit, that’s a $500 per month penalty until you can settle up with the IRS.

Underpayment Interest

To add insult to injury, you’ll also owe interest on any ERC amounts the IRS says you underpaid. The interest rate is determined quarterly and compounds daily on the unpaid balance.As of early 2024, the interest rate was around 7% – nothing to sneeze at when compounded over years while an audit drags on.

How to Minimize Your ERC Audit Risk

Hopefully those penalty amounts have your full attention. The key takeaway: an ERC audit is not something to be cavalier about if you want to avoid potentially catastrophic financial consequences.The good news? There are proactive steps you can take to bulletproof your claim and minimize any audit risk:

1) Thoroughly Document Your Eligibility

The #1 mistake we see is businesses claiming the ERC without maintaining thorough documentation to prove they actually qualified. The burden is on you to have:

• Copies of any government orders that suspended your operations
• Calculations showing your decline in gross receipts quarter-by-quarter
• Payroll records tying wages to specific pay periods
• Health plan costs and other qualified expense documentation

Don’t rely on a third-party firm’s word that you were eligible. Get those source documents together now before an audit hits.

2) Double-Check Your Credit Calculations

Miscalculating the ERC credit amount is another huge audit risk. Make sure you:

• Separated wages paid with PPP loan proceeds (not eligible for ERC)
• Applied the correct credit rate for each period
• Properly aggregated affiliates and controlled groups
• Excluded any wages paid to majority owners

Having an experienced tax pro review your original calculations can catch errors before the IRS does.

3) Consider Making an ERC Disclosure

If you’ve identified potential eligibility issues or calculation errors in your original ERC claim, you may want to make a proactive disclosure to the IRS through programs like:

• Employee Retention Credit Compliance Resolution Program (temporary)
• Voluntary Disclosure Practice (permanent)

By self-disclosing and paying back overclaimed amounts, you can potentially avoid harsher ERC audit penalties down the road.

4) Hire Experienced ERC Audit Representation

Even if you’ve dotted every i and crossed every t on your original claim, having experienced legal representation for an ERC audit is absolutely essential. Tax litigation is extremely complex, and the IRS auditors are laser-focused on denying as many ERC claims as possible.At Spodek Law Group, our tax controversy team has extensive experience guiding businesses through all types of audits and appeals. We know how to:

• Compile and present documentation that satisfies the IRS
• Negotiate to minimize or avoid penalties
• Appeal audit findings through all available channels
• Represent you in U.S. Tax Court if needed

We take a strategic, aggressive approach to protect your business’s financial interests. An ERC audit doesn’t have to be a financial death sentence with the right legal team in your corner.

The Bottom Line on ERC Audit Penalties

Look, we get it – the Employee Retention Credit seemed like a great opportunity to get some financial relief during an incredibly difficult time. And for businesses that genuinely qualified and documented everything properly, it absolutely was.But the IRS isn’t messing around when it comes to enforcing ERC compliance. They’ve got auditors specifically trained to sniff out any eligibility issues or calculation errors. And the penalties for getting caught with an improper claim are no joke – from hefty accuracy penalties all the way up to potential criminal fraud charges.So if you claimed the ERC, the time to get your ducks in a row is NOW before those audit notices start hitting mailboxes. That means:

• Gathering comprehensive documentation proving your eligibility
• Double-checking all credit calculations for errors
• Considering a proactive disclosure if you suspect issues
• And most importantly, lining up experienced tax litigation support

At Spodek Law Group, we’ve got a whole team ready to guide you through ERC audits and appeals from start to finish. We know this process inside and out, and we’re not afraid to take the fight to the IRS if they’re being unreasonable.Because at the end of the day, you did what you had to do to survive one of the toughest economic periods in recent history. You shouldn’t have to pay a massive penalty on top of everything else just because the rules around the ERC were so complicated.But you do have to be prepared to back up your claim, period. Otherwise those penalties could be absolutely crippling for your business.So don’t wait until you get that dreaded audit notice in the mail. Get out ahead of this thing by calling Spodek Law Group today. We’ll make sure you’re audit-ready and give you the best possible chance of avoiding any ERC penalties whatsoever.Because that’s what it’s all about – protecting you and your business, no matter how complex the situation. It’s why we’re the firm businesses trust when the stakes are highest.

Key Takeaways:

• The IRS is aggressively auditing Employee Retention Credit claims
• Potential penalties include repayment, accuracy penalties up to 20%, fraud penalties up to 75%, failure to pay penalties, and compounding interest charges
• Thoroughly documenting eligibility, double-checking calculations, and making a proactive disclosure can minimize audit risk
• Having experienced tax litigation representation is crucial for negotiating with the IRS and avoiding harsh penalties
• Spodek Law Group has a dedicated team ready to guide businesses through every stage of an ERC audit