The Employee Retention Credit (ERC) was intended to provide financial relief to struggling businesses during the pandemic. Offering a maximum benefit up to $26,000 per employee, it’s helped thousands of businesses to keep the lights on and employees on the payroll.

Many businesses had strong, well-documented claims to ERC funds based on genuine pandemic impacts. Others, unfortunately, were drawn in by ERC mills, unscrupulous marketers who promised easy money without proper eligibility or substantiation.

The Internal Revenue Service (IRS) began to issue warnings, advising taxpayers to be wary of third-party providers promising tax savings that sounded too good to be true.

Those warnings escalated until September 2023 when the IRS put a temporary moratorium on new claims. Its focus, the IRS said, was on protecting business owners from what had become an egregious multi-billion dollar scam.

In October 2023, the IRS offered employers an option to withdraw ERC claims. And in December, they launched a Voluntary Disclosure Program, an amnesty of sorts, for those employers who’d already received an erroneous credit, available through March 22, 2024.

Now it’s on to stage three: ERC audits. Read on to learn what ERC auditors are looking for and see a redacted ERC audit letter.

Employee Retention Credit Auditors Are on the Move

The IRS has hired hundreds of additional examiners who will focus exclusively on ERC investigations, and they already have thousands of audits in the pipeline. What’s more, Congress has extended the statute of limitations, giving auditors two additional years to assess penalties or bring civil action.

As of December 31, 2023, the IRS had initiated 352 criminal investigations involving more than $2.9 billion in potentially fraudulent ERCs. To date, 18 investigations have resulted in federal charges, with 11 convictions. Sentenced parties average 21 months.

Are You at Higher Risk for an Employee Retention Tax Credit Audit?

Certain red flags could target your claim for audit risk. Businesses with credits of more than $200,000 as well as those in IT and manufacturing are at greater risk of scrutiny.

Still others will be selected at random. The reality is that many businesses that truly qualified for, and deserved, the ERC credit will go through the difficult scrutiny of an IRS audit process.

IDRs = Spill the Tea

Right now, employers across the country are getting letters known as “IDRs” or Information Document Requests about their ERC claims.

An IDR is a formal notice from the IRS requesting additional information to verify the validity of your claim. It’s essentially a precursor to a potential audit, though not every IDR form leads to an official audit.

An IDR will specify the exact documents and information the IRS needs from you to assess your ERC claim.

That could include:

• Payroll records
• Financial statements
• Evidence of pandemic impacts on revenue and wages paid
• Documentation of specific governmental orders affecting your operations
• PPP loan forgiveness application and forgiveness letter (if applicable)
• Copies of any engagement agreement with an outside tax preparer

Auditors are requesting copies of government-issued suspension orders, showing restrictions and the length of time the orders were in effect.

Taxpayers should be prepared to explain precisely how each order impacted their specific business operations. The burden of proof is on the taxpayer to show they were affected.

ERC Audits: Complicated Questions for a Complex Credit

Those pop-up ERC promotors probably claimed that qualifying was easy. But many of those template submissions resembled a game of Mad Libs — more random facts than a customized, documented, show of eligibility.

Now IRS agents are scrutinizing every aspect of ERC claims, including:

• Eligibility: Did your business actually experience a significant decline in gross receipts? Were there limits on capacity or operations due to governmental orders?
• Number of FTEs: If you aggregated headcounts across multiple business entities, how did you determine aggregation, and how did you allocate the ERC among the aggregated group?
• Qualifying Wages: Were limits properly applied? Was there improper double dipping with wages used for PPP, FFCRA, or other credits? Did you properly exclude all owners and owner wages?
• Calculations: Did the business correctly determine and apply gross receipt reductions, without shifting funds from quarter to quarter to suggest the appearance of a loss?
• Taxation: Did the business amend their subsequent tax return to pay tax on the ERC? Did you reduce wage/health plan expenses accordingly (See IRS Notice 2021-20, Q&A #60-61)?
• Supply Chain disruption: This is a very narrow ERC qualification. A business must prove that a governmental order affected their supplier, the supplier could not deliver critical goods, and acceptable alternate supply sources were unavailable (See IRS GLAM memo from June 30, 2023).

As explained above, an IDR will likely request copies of any engagement agreement with an outside preparer. Taxpayers claiming “good faith” reliance on a professional may be asked to demonstrate some level of due diligence indicating why they believed their provider had expertise in complex ERC rules.

Employers who ignored the advice of their regular tax professional and used a pop-up shop to prepare their ERC claim may have trouble establishing reasonable good faith reliance (Ask yourself: Is there an email trail out there from a CPA who said you didn’t qualify?).

Get Ready for a Possible ERC Audit

Don’t wait for an audit notice to review your ERC claim. Here are three good reasons to start now:

1. Voluntary Disclosure: If you haven’t received an audit notice yet, the ERC Voluntary Disclosure Program remains an option until March 22, 2024. This program allows businesses that received but were not entitled to any ERC to proactively come forward and repay 80% of the credit, without further penalty or fee. It’s important to note that this applies only to unintentional errors, not willfully fraudulent claims.
2. Corrections: Double check eligibility criteria and credit calculations. If you’re concerned, it may be a good idea to have a tax attorney proactively review your claim. Consider amending claims preemptively, even past the March 22 deadline, if substantial problems are found.
3. Record Keeping: It’s critical to organize these records logically and keep your own copies. Recognize that you may experience employee/vendor/system changes over the next several years that could make it difficult to go back and reconstruct these records. Having solid evidence available now could save considerable time and headaches down the road.

The IRS may deny requests for additional time to respond to inquiries. So, it is wise to thoroughly prepare ERC documentation in advance rather than trying to construct a case mid-audit.

Navigating An ERC Audit: Not a Solo Mission

If your business is selected for an ERC audit, expect an interview and site visit. We generally do not advise taxpayers to attend these meetings but to send legal representation instead.

Engage an experienced tax attorney to field inquiries on your behalf. They can provide a professional buffer between you and the IRS and can defer responses if needed to formulate full, accurate answers.

Relying on counsel also helps avoid inadvertent admissions, confusion, or misremembering details that could weaken your audit defense.

When It Comes to IRS Audits, Hope Is Not a Strategy

The IRS has ERC claims in its crosshairs.

If your business received an Employee Retention Credit, make sure your claim is solid. Having to pay back a credit would be difficult, but that pales in comparison to the interest and penalties that could be levied for improper filing.

At The Law Offices of Alyssa Whatley, we are available to review your claim now. With organization in advance and professional counsel, businesses can place themselves in the best position to defend their credits.

With thousands of dollars at stake, it pays to prepare now rather than cross your fingers and hope the IRS never comes knocking.

Speak with a tax attorney now.