How to Prepare for an Audit of Your Employee Retention Credit (ERC)

While the Employee Retention Credit (ERC) has been around for a few years, we are just now starting to see IRS audits of these credits begin in earnest. As Douglas O’Donnell, IRS deputy commissioner for services and enforcement was recently quoted in a WSJ article, “Just because a refund has been paid, it doesn’t mean you’re free and clear”. With more ERC Mills popping up and more aggressive approaches being taken, it’s a good time for a brief overview of what the IRS may request if your claim is audited. At this point, the IRS is issuing a new warning almost weekly, the most recent of which was released on May 25^th, 2023, which can be seen here. The information below is based on Information Document Requests (IDR) that the IRS has sent in relation to ERC filings selected for audit.

Whether filing under a partial suspension approach or a gross receipts decline, the IRS is looking for proof of the following:

• Documentation that the business was eligible for the ERC as filed.
  • Under the gross receipts approach, this would be quarterly gross receipts showing the proper declines to merit qualification. Partial suspension qualification will be covered in more detail below.
• Worksheets that support the calculation of the ERC as reported on the various 941-X’s.
  • This will need to be by employee to ensure that the proper limitations for the credit were applied on a per-employee basis.
• Documentation related to any PPP or PPP2 loans, including forgiveness applications in order to prove that there is no overlap in wages used for ERC and PPP/PPP2.
  • Note that the only real rule in ERC vs PPP as that you cannot “double dip” and use the same wages to qualify for both.
• If a Large Employer (over 100 employees for 2020 and 500 for 2021), documentation on how the employer determined wages paid to not provide services.
• General documents including but not limited to:
  • 2020 and 2021 business income tax filings
  • Form W-2 summaries/W-3’s for the periods in question
  • Copies of individual tax returns for all shareholders for the periods in question
  • Copies of state unemployment tax returns for the periods in question

When taking the partial suspension approach, the level of scrutiny on qualification is at a much higher threshold. In addition to the items above, the IRS will also request:

• Documentation with dates supporting that operations were either fully or partially suspended due to orders from a governmental entity that relate directly to COVID-19.
• Explain the specifics of said government order and how this related to a partial or full suspension of the business.
  • Recommendations from governmental entities (vs orders) do not qualify.

While these audits are very early in the process, the IRS continues to put out warnings regarding increasingly aggressive approaches that are unlikely to stand up under audit. It is prudent if you are filing for ERC or have filed in the past that either you or your advisor has the information above in case of an IRS audit in the future. If you have any questions on ERC filings you have made in the past, are planning to make in the future, or on if your business qualifies, please contact us.