The rising popularity of the employee retention credit (ERC) has reached boy band status. You’ve heard of it on the radio, seen it on TV, and likely even discussed it with your friends. But as with any popular tax credit or deduction, the IRS is sure to be close behind. We’ve written about IRS audits rolling out last July, and the IRS followed up our article with a warning to taxpayers regarding third-party promotion of improper ERC claims.
An IRS audit can be scary, but this is especially true with ERC audits. With thousands, and sometimes millions, of dollars on the line, it is important to get your ducks in a row before speaking with or responding to the IRS. This article will lift the veil on the IRS audit process and give insight into the best way to get through a potential ERC audit.
How Do I Know I’m Being Audited?
If you’re one of the lucky taxpayers to be selected for an ERC audit, then you’ll most likely receive a letter from an IRS agent informing you that you’ve been selected for an audit, and it may even contain an Information Document Request (IDR). An IDR is exactly what it sounds like: a list of documents and information the IRS requests that you provide to substantiate your ERC claim. The IDR will include the ERC year(s) and quarter(s) under examination as well as relevant information regarding the expected timing of your response.
Important Note: The IRS may call you to set up an appointment or to discuss an ongoing audit, but it will not do so without first attempting to notify you by mail. Be careful with potential scammers who may try to contact you purporting to be an IRS agent requesting re-payment of ERC funds or other personal information.
What Supporting Documents Will I Need?
An IRS examination of an ERC claim will be far more extensive than you might think. The IRS will request more documentation than your CPA or ERC provider did when they prepared the claim. At a minimum, the IRS requires employers to maintain records to substantiate the ERC, including the following:
- Documentation supporting eligibility, including:
- Any governmental orders that suspended the employer’s business operations;
- Any records the employer relied upon to determine whether a more than nominal portion of its operations were suspended due to the governmental orders;
- Any records the employer used to determine if it had experienced a significant decline in gross receipts;
- Any records of which employees received qualified wages and in what amounts; and
- In the case of a large eligible employer, work records and documentation showing that wages were paid for time an employee was not providing services.
- Documentation supporting the amount of allocable qualified health plan expenses.
- Documentation supporting any conclusions regarding the aggregation rules.
- Copies of any completed Forms 7200 that the employer submitted to the IRS.
- Copies of applicable federal employment tax returns, including Forms 941, 941-X, and W-2.
Can an ERC Audit Open My Business up To Additional Scrutiny?
Yes. An ERC examination may or may not lead to additional scrutiny into other aspects of your business. An IRS agent may limit the scope of the examination to just the ERC, to a full-blown payroll tax audit, to a review of your federal income tax returns, or some combination of all three. However, generally speaking, ERC audits are limited to your ERC claims.
Should I Go It Alone or Hire Professional Help?
Given the additional scrutiny the IRS will apply to an ERC audit, it is extremely important that you hire a tax professional (i.e., lawyer or accountant) that is well-versed in the statute and all the IRS Notices, Revenue Procedures and FAQs relating to the ERC. That person is not your local CPA and not even the tax lawyer that assisted your cousin’s uncle a few years back with an income tax audit. You want a qualified tax professional with intimate knowledge of the ERC, and preferably someone who has calculated and processed hundreds of ERC claims, so they know the ins and outs of the ERC. Many ERC tax credit providers (especially the contingent fee ones) do not practice before the IRS and cannot represent you in an IRS examination.
Final word of advice – do not go it alone and hope for the best. Even though an ERC audit starts out as a civil examination, everything you say can and will be used against you. Preparation matters and getting your responses right the first time definitely matters and prevents unnecessary suspicion and intrusion by the IRS.
Withum has a dedicated team of ERC specialists that can assist you with your IRS audit. We have prepared more than one thousand ERC claims and have assisted more than 10 taxpayers in IRS audits in the last few months alone.