The New Wave of IRS Audits You Need To Know About: ERC Audits

The latest wave of IRS audits – known as ERC or Employee Retention Credit Audits – are in full swing and business taxpayers need to be prepared.

The IRS is cracking down and auditing companies that applied for and received Employee Retention Credits, arguing that some used the opportunity for financial assistance from the government to fraudulently claim credits for which they were not actually eligible.

If your business is audited and your credits are reduced, the ERC audit penalties and interest could be substantial. The amount you have to pay back to the IRS will depend on whether the IRS believes your application was inaccurate or that you intentionally committed fraud.

In addition to repaying the credit along with civil penalties, the IRS could bring criminal fraud charges against you, which could possibly result in imprisonment.

A successful defense to an ERC audit requires attention to detail, an enormous amount of paperwork and detailed knowledge of how to negotiate with the IRS for the best possible outcome. If your business has been hit with an ERC audit from the IRS, don’t manage it alone.

Contact an experienced tax attorney who understands the ins and outs of ERC audits now.

How The ERC Audit Problems Began

The ERC was created in early 2020 as part of the federal CARES Act, to incentivize companies that continued to pay employees during the pandemic shutdown or had a significant reduction in gross receipts (less than 50% in the same calendar quarter).

This refundable federal payroll tax credit was intended to make it easier for eligible businesses to stay afloat. The ERC covers businesses that kept people employed between March 13, 2020, and December 31, 2021.

When the ERC was initially created, the maximum credit was $5,000 per worker. But when Congress extended the credit availability into 2021 under the American Rescue Plan Act (ARPA), it also increased the maximum credit per worker to $28,000 and opened the door to start-up companies claiming the ERC if they started after February 15, 2020, and had average gross receipts of less than $1 million.

Big tax problems arose because businesses that were not eligible for the credit — or not eligible for as large a credit as they requested — applied and quickly received payment or got credits for the payroll tax liabilities. Now, the IRS is going back to review ERC credit applications that seem fishy, leading to a big surge in complicated IRS audits.

To make matters worse, companies known as ERC mills have been scamming businesses, convincing them that they qualify for the credit without determining whether they meet the criteria, or submitting applications for credits that are much bigger than what a business is due.

Why You Might Land With An ERC Audit

Some of the red flags that could lead to an ERC audit include:

• Claiming the maximum credit allowed for a large number of employees in a business — meaning a high dollar amount — that was opened in early February 2020 or that added a new line of business in response to the pandemic.
• Your business claimed that it qualified for the ERC during every quarter that it was available. The IRS might assume that is unlikely to be true.
• You calculated your ERC and applied for it based on the total payroll expenses for your employee(s) and used the same payroll expenses to qualify for PPP loan forgiveness. Under the law, any part of wages used to qualify for ERC can’t generally be used to qualify for PPP loan forgiveness and vice-versa.

What Happens If Your Business Is Tapped for An ERC Audit

An ERC audit is a type of employment tax audit conducted by the IRS. During an ERC audit, the IRS will review the same base documents as other employment tax audits, such as Form 941 and corporate tax returns, in addition to whether the business met the qualifications for the ERC.

If the IRS is questioning your Employee Retention Credits, you can expect they will send you a letter indicating that they believe there was an error. The letter will ask if you have any additional information to provide that clarifies the error they have flagged.

If you don’t respond to the letter, it may be elevated to a formal Information Document Request (IDR). That means you have been selected for an audit.

An IDR will state the revenue agent assigned to your case and there will be a deadline to respond, at which time the IRS requires you to provide an extensive list of information.

That will include such things as payroll data for relevant years, gross receipts, your detailed calculations of the ERC for each employee, records that prove government mandate ordering your business to shut down during certain dates, and much more.

You might also receive a summons for an in-person interview of the business owner at the IRS building.

As part of their investigation, the IRS might also request to speak to current or former employees. If the revenue agent feel like they are being ignored, they have a power to issue an administrative summons for the employees to appear in person for an interview. Whatever you do, you do NOT want to speak to a federal employee alone.

How A Skilled Tax Attorney Can Represent Businesses In An ERC Audit

The most important thing to do is to respond to the IRS in a timely manner from the very beginning of the case. Do not panic and ignore calls or notices from IRS revenue agents.

Read the IDR carefully and gather all requested documentation. An experienced IRS audit attorney can help you put together the requested information, ensure you meet all deadlines and handle your audit on your behalf, including all responses and interactions with the IRS revenue agent.

The goal of an attorney representing you is to contain the case as a civil matter — avoiding it escalating to a criminal fraud case whenever possible — and then minimize your tax liability.

In short, an IRS audit attorney can help you reduce how much you have to pay back in your ERC audit, through gathering substantiation that were scattered in clients’ file, organizing requested documents in a meaningful manner, and advocating clients’ eligibility and criteria for the credit. Any missing or inadvertent errors must be explained to close the case. Once the audit is closed, there are various ways to settle your IRS tax debt, such as negotiating an offer in compromise or installment agreement, reducing penalties and interest, as well as other options.

ERC Audits Are Going On Now — Get Help From A Tax Attorney

ERC audits are ongoing, and generally they are expected to continue through 2025. The IRS is targeting businesses that appear to set up shop specifically for the government credits during the pandemic while their documentation to prove their eligibility for the credit may be less than perfect.

The IRS might also seek to extend the time limit to conduct an ERC audit for both parties’ benefit, giving the IRS more time to review records and the business more time to appeal. The IRS has no time limit for auditing what they expect to be intentionally fraudulent or false ERC claims.

If you need representation in an ERC Audit or want to reduce the amount you owe back to the IRS, speak to Attorney Sammy Kim now.