Understanding the Chances of IRS Audits for the Employee Retention Credit

Introduction

The Employee Retention Credit (ERC) has been a crucial lifeline for businesses during the COVID-19 pandemic. This tax incentive program, introduced as part of the CARES Act in 2020, has provided financial relief to employers who retained their employees despite economic hardships. However, as with any tax credit, there are questions and concerns about the likelihood of getting audited by the IRS when claiming the ERC. In this article, we will explore the factors that may affect your chances of an ERC audit and how to prepare to minimize the risks.

What is the Employee Retention Credit?

The Employee Retention Credit is a refundable tax credit designed to help businesses keep employees on their payroll during the economic downturn caused by the COVID-19 pandemic. Eligible employers can claim a tax credit against their payroll taxes, with the potential to receive substantial financial assistance. To qualify for the ERC, businesses must meet specific criteria, including experiencing a significant decline in gross receipts OR being subject to government-ordered partial suspension of operations.

Factors That May Trigger an ERC Audit

While claiming the ERC is entirely legitimate for eligible businesses, the IRS may choose to audit certain tax returns to ensure compliance with the program’s requirements. Several factors may increase the likelihood of an ERC audit:

1. Large ERC Claims: Larger credit claims may attract more attention from the IRS, as they represent a higher potential for revenue loss. If your business is claiming a substantial ERC, be prepared for closer scrutiny.
2. Complex Calculations: Calculating the ERC can be intricate, especially if your business had fluctuations in employee counts and wages during the qualifying periods. Errors or inconsistencies in your calculations could trigger an audit.
3. Frequent Changes in Tax Law: Tax laws and regulations related to COVID-19 relief programs evolved rapidly, leading to potential confusion and mistakes when claiming the ERC. Keeping up with the latest guidance and ensuring compliance with updated rules is crucial.
4. Comparative Analysis: The IRS may also conduct a comparative analysis of your business’s financial data and tax returns. Discrepancies between your ERC claim and your financial records may raise red flags.
5. High-Risk Industries: Certain industries, such as healthcare, restaurants, and hospitality, were disproportionately affected by the pandemic. Businesses in sectors not clearly impacted by the pandemic may face higher chances of audits.

Minimizing the Risk of an ERC Audit

While there is no foolproof way to guarantee you won’t be audited when claiming the ERC, there are steps you can take to minimize the risk:

1. Accurate Recordkeeping: Maintain detailed records of your financial transactions, employee headcount, and wages. Ensure that all documentation supports your ERC claim.
2. Consult a Tax Attorney: Seek guidance from a qualified tax attorney experienced in ERC matters. They can help you navigate the complex rules, perform accurate calculations and properly advise you about the benefits and risk of claiming (or not claiming) the credit.
3. Stay Informed: Keep abreast of IRS guidance and updates related to the ERC. Compliance with the latest rules is essential to avoid discrepancies.
4. Documentation: Retain all relevant documents, such as financial statements, payroll records, and tax filings, for at least four years. Proper documentation can help substantiate your ERC claim in case of an audit.
5. Review and Double-Check: Before submitting your ERC claim, review it meticulously for errors or inconsistencies. A careful review can catch potential issues before the IRS does.

The Employee Retention Credit has been a vital source of financial support for businesses struggling during the pandemic. While claiming the ERC is legitimate and essential for eligible employers, it’s essential to be aware of the factors that may increase your chances of an IRS audit. By taking proactive measures, maintaining accurate records, and seeking professional guidance when necessary, you can navigate the ERC program confidently and minimize the risk of an audit. Remember that thorough compliance with the program’s requirements and closely following your attorney’s guidance is key to a smooth ERC claim process.