Throughout the past three years, there has been a sudden increase in temporary consulting firms or Employee Retention Credit (ERC) Mills, encouraging businesses to apply for the ERC and, in many cases, without conducting thorough due diligence required under the Coronavirus Aid, Relief and Economic Security (CARES) Act and Internal Revenue Service (IRS) Notices. While the IRS mandates the submission of Form 941-X as the primary means of applying for the credit, it is widely understood that businesses must also maintain:
- Accurate documentation pertaining to a partial suspension of operations due to COVID-19.
- Corresponding governmental mandates relating to COVID-19 that caused this partial suspension.
Unfortunately, a notable oversight has been observed among these consultants, where they have neglected to adequately document any supporting evidence pertaining to government mandates. Even in the situation where cases of partial suspension were documented, these consultants often used broad Occupational Safety and Health Administration (OSHA) and Centers for Disease Control and Prevention (CDC) guidelines to qualify businesses. The IRS does not consider these government mandates for purposes of determining ERC. Consequently, businesses that engaged with these consultants are exposed to significant risk.
Understanding ERC Audits
What is an ERC Audit?
An ERC audit is a formal review conducted by the Internal Revenue Service (IRS) to ensure businesses have accurately claimed the ERC. The IRS may select businesses for audit based on various criteria, such as potential discrepancies or higher-risk factors. Understanding the audit process is crucial to be adequately prepared.
What Triggers an Employee Retention Credit Audit?
Several factors may trigger an Employee Retention Credit audit, including:
- Discrepancies in claimed ERC amounts compared to industry averages.
- Suspiciously high credit claims that warrant further investigation.
- Errors in documentation provided during the ERC claim process.
Businesses that claim the ERC need to be prepared for potential audits, and proactive measures can significantly reduce the likelihood of being audited.
How to Prepare for an ERC Audit?
To ensure a smooth Employee Retention Credit audit experience, businesses must be proactive in their preparations. Here are some essential steps to take:
- Maintain Accurate Records: Keep detailed records of all ERC-related transactions, including employee information, wages, and qualified expenses.
- Compliance Check: Conduct an internal compliance check to identify any potential issues or errors in your ERC calculations and claims.
- Seek Professional Guidance: Engage a qualified tax professional or ERC specialist to review your documentation and calculations for accuracy.
- Documentation Organization: Organize all supporting documents in a systematic manner, making it easier for auditors to review.
- Employee Eligibility Verification: Confirm that your employees meet the eligibility criteria for ERC.
- Stay Informed: Keep up-to-date with Employee Retention Credit guidelines and regulations to ensure compliance with any changes.
By implementing these preparatory measures, businesses can significantly reduce the likelihood of facing penalties during an Employee Retention Credit audit.
What to Expect During an ERC Audit?
When selected for an ERC audit, businesses should be aware of what to expect during the process. The IRS will initiate the audit by sending a notification letter detailing the issues they plan to examine. Typically, auditors will request various documents, including payroll records, financial statements, tax returns, and Employee Retention Credit calculations.
During the audit, businesses will have the opportunity to provide explanations and additional documentation to support their ERC claims. It is essential to remain cooperative and transparent throughout the audit, addressing any queries or concerns raised by the auditors.
The audit duration may vary depending on the complexity of the case, but businesses should be prepared for the possibility of a prolonged review process. Once the audit is complete, the IRS will issue a written report with their findings, which could result in either an approval of the ERC claim or a notice of adjustments or penalties.
What Documents Do You Need for an ERC Audit?
To streamline the Employee Retention Credit audit process and demonstrate compliance, businesses must gather and maintain a comprehensive set of documents. Some crucial documents to prepare include:
- Payroll Records: Detailed records of wages paid to employees, including relevant tax forms (e.g., Form 941).
- ERC Calculation Records: Documentation supporting the calculation of the Employee Retention Credit claim, including gross receipts, eligible expenses, and qualified wages.
- Financial Statements: Income statements, balance sheets, and cash flow statements.
- Employee Information: Employment records, job descriptions, and evidence of employee eligibility.
- Business Documentation: Articles of incorporation, business licenses, and relevant contracts.
- Government Orders and Shutdown Notices: Documentation of government-mandated shutdowns or significant decline in business operations.
- Supporting Evidence: Any additional documentation that validates ERC eligibility and credit calculations.
By maintaining well-organized records and documents, businesses can present a strong case during an ERC audit, minimizing the likelihood of penalties or adjustments.
ERC Audit Penalties
Failure to comply with ERC regulations and reporting requirements can result in severe penalties. The IRS may impose penalties for various reasons, including:
- Inaccurate ERC Claims: If the IRS determines that the Employee Retention Credit claim is substantially inaccurate or unsupported, the business may face penalties based on the percentage of the underreported credit.
- Late or Incomplete Documentation: Failure to submit requested documents or providing incomplete information during the audit can lead to penalties.
- Negligence: Penalties may be imposed if the IRS finds that the business has been negligent in complying with ERC guidelines.
- Fraudulent Claims: Intentional misrepresentation of ERC-related information can lead to substantial penalties and potential criminal charges.
To avoid these penalties, businesses should maintain accurate records, conduct internal audits to catch errors and work with experienced tax professionals to ensure compliance with Employee Retention Credit regulations.
How to Prevent IRS ERC Audits: Reducing ERC Audit Risk
While it is impossible to eliminate the possibility of an IRS ERC audit entirely, businesses can take proactive steps to reduce the audit risk significantly. Here are some strategies to consider:
- Professional ERC Claim Assistance: Seek guidance from experienced tax professionals or ERC specialists when preparing and filing your Employee Retention Credit claim. They can help ensure accuracy and compliance.
- Comprehensive Recordkeeping: Maintain meticulous records of all ERC-related transactions, including payroll, expenses, and eligibility details.
- Regular Internal Audits: Conduct periodic internal audits to identify potential ERC calculation errors or compliance issues.
- Follow ERC Guidelines: Stay informed about the latest ERC guidelines and changes to ensure compliance with all requirements.
- Proactive Communication: Engage in open and transparent communication with the IRS if you have any questions or concerns regarding ERC compliance.
By adopting these preventative measures, businesses can demonstrate their commitment to ERC compliance, thus reducing the likelihood of an IRS audit.
What Is the ERC Audit Period?
The ERC audit period refers to the timeframe during which the IRS may audit a business’s ERC claims. The audit period typically aligns with the statute of limitations for tax audits, which is generally three years from the date of filing the tax return or two years from the date of tax payment, whichever is later.
It’s essential to retain all relevant ERC-related documentation for the audit period as the IRS may request supporting documents from any year within this timeframe.
How Cherry Bekaert Can Help
At Cherry Bekaert we leverage our experience in effectively addressing IRS inquiries and defending our client’s positions in qualifying their clients for ERC. If you are having second thoughts about the ERC Mill claims, Cherry Bekaert’s dedicated ERC team can help document the status of an eligible employer and ensure that the credit claimed complies with all regulations. If the IRS does open an examination, we can help with responding to IRS inquiries and resolving issues raised by the IRS quickly and efficiently.
Related Insights
- Article: IRS May Credit ERC Refunds Against Unpaid PEO Federal Tax Liability
- Article: ERC Update: Tax Professional Responsibilities and IRS Examinations
- Article: 2023 Most Frequently Asked Questions about the Employee Retention Credit (ERC)
- Article: IRS Warns of Employee Retention Credit (ERC) Scams
