We all knew this day was coming, and it has finally arrived. Multiple businesses notified us recently that their claims for the employee retention credit (ERC) are being audited by the IRS. This does not mean that these businesses did anything wrong, or that they will end up owing money to the IRS; it just means that the IRS selected their ERC claims for review. It is not known whether they were randomly selected for audit or whether they were targeted for some reason.
We have written previously about the topics the IRS is likely to inquire about on audit. Most likely, the IRS will focus on eligibility, the ERC calculation, and whether the taxpayer amended its income tax returns to pay tax on the ERC. Within these broad categories, however, there are many areas where businesses can trip up. For example, did the business apply the aggregation rules properly? These rules are very complex and applying them correctly is no easy task. Did the business calculate its average number of 2019 full-time employees (FTEs) correctly, remembering that the FTE concept for the ERC is different than the FTE concept for the PPP? For the ERC, businesses need to add up the number of employees that worked 30 hours/week or 130 hours/month during each calendar month in 2019, and then take an average of the 12 monthly figures. See Notice 2021-20, Q&A #31.
As we’ve said many times, now is the time to double check your analysis if you claimed an ERC, particularly if you think you or your advisor may have taken aggressive positions. Claiming the ERC is no different than claiming a deduction on an income tax return – both are done under penalties of perjury.
Do not wait until the IRS contacts you to start buttoning down the facts and the analysis of your ERC claim. Document your gross receipts or governmental orders now, and remember that one of the requirements of the ERC program is that you must maintain adequate documentation for at least 4 years after the date the tax becomes due or is paid, whichever comes later. See Notice 2021-20, Q&As 70 &71.
We are also starting to see the initial data requests coming from the IRS in the form of Information Document Requests (IDRs). In the first IDR we have seen, the IRS asked detailed questions about eligibility and various aspects of the calculation. It also sought documentation in the form of payroll journals, tax forms that were already filed, health plan expenses, lists of employees and owners (and related parties), information supporting the partial suspension of operations test or the gross receipts test, and information relating to PPP loan forgiveness and the allocation of wages between the PPP and ERC. In the case of the gross receipts test, it also sought spreadsheets showing the breakdown of gross receipts and a reconciliation of such breakdown to yearly gross receipts for tax years 2019, 2020, 2021 on either a monthly or quarterly basis.
Withum has assisted countless businesses in determining eligibility for the ERC and in calculating the amount of the ERC. We have worked through the difficult issues around aggregation and the partial-suspension-of-operations test, and we have developed algorithms to allocate wages between the ERC and PPP to ensure the maximum amount of ERC is obtained without violating the rule against double dipping. In short, we have spent a lot of time parsing the CARES Act (which created the ERC), the ERC statute (§3134), and the various notices published by the IRS regarding the ERC, and we are knowledgeable about all aspects of the ERC.
We are available to assist any business that is selected for audit by the IRS, even if its ERC was calculated by another firm. We have a deep bench of specialists in the ERC and we have significant experience representing clients before the IRS.
Please reach out to a member of the ERC team at Withum if you need effective representation before the IRS.