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Tips if the IRS audits your business' ERC claim

Masked business woman holding open sign
Many businesses that stayed open during the height of the coronavirus pandemic were able to do so thanks to the Employee Retention Credit (ERC). Some companies, however, subsequently filed for the 2020-2021 tax benefit at the urging of unscrupulous ERC promoters, and now are finding the IRS is looking into their claims. 

The Internal Revenue Service earlier this summer warned businesses about Employee Retention Credit (ERC) promotions that could land the companies in tax trouble.

The ERC was created in 2020 as part of the $2 trillion Coronavirus Aid, Relief and Economic Security (CARES) Act to help businesses and their workers survive the virus-related economic slowdown. It was extended though 2021 by the American Rescue Plan Act (ARPA).

The ERC provided businesses thousands of dollars per employee as long as the company showed that the coronavirus was hurting their bottom lines and that they were continuing to pay workers.

When legitimately claimed, the fully refundable tax credit could get employers up to worth up to $5,000 per employee for 2020. For the 2021 tax year, it paid small businesses up to $7,000 per employee per quarter, or a maximum of $28,000 per employee.

False claim cons: ERC promoters have been urging companies to amend their tax returns to claim credits they overlooked in the prior tax years.

Employers have until April 15, 2024, to file Form 941-X, Adjusted Employer's QUARTERLY Federal Tax Return or Claim for Refund (excerpt below), to claim the ERC for any quarter in 2020 and until April 15, 2025, to file a claim for any quarter in 2021.

IRS Form 941-X adjusted employer quarterly federal tax return or claim for refund
See more tax forms and more about them at Tax Forms 2023.

But some of those promotions are sketchy, and often convince ineligible employers into claiming the credit based on inaccurate information and computations.

The IRS has received so many fraudulent claims that it added fraudulent ERC filings to its latest annual Dirty Dozen list of tax scams.

It's bad enough to be scammed. It's worse when the bad tax claim means you end up facing an IRS audit. But that is what's happening in many cases.

ERC claim audits: As of March 3, just more than 866,000 companies had claimed and received ERC amounts of around $152.6 billion, according to the latest IRS Data Book.

COVID-19 employer tax credit claims_IRS Data Book 2022

If that happens, your first step is to find a tax professional who is familiar with the ERC and can review the claim in question.

That tax adviser also will help you prepare for the IRS examination. If that happens, the Detroit-based law firm Dickinson Wright says that based on ERC audits so far, employers should expect the IRS to demand the following:

  • A list of employees who were paid wages for which the ERC was claimed.
  • Whether any of the employer's employees who received wages under the ERC are related to owners.
  • The amount of wages paid to each employee for which the ERC was claimed.
  • Documentation that operations were fully or partially suspended due to an appropriate governmental authority due to COVID, including copies of each governmental order.
  • Documentation demonstrating how the employer determined that either "more than a nominal" portion of the business was suspended, or that a required modification had a "more than nominal impact" on business.
  • Copies of income tax returns, employer tax returns, and Form W-2s for all related entities if the employer is part of an aggregated group of employers

Possible IRS ERC relief: "I do think people were duped," said National Taxpayer Advocate Erin Collins, speaking at the American Institute of Certified Public Accountants' annual conference this month. People claimed the credit and may have already received a refund, she added.

Collins also said the IRS is working on guidance for filers who may have wrongly claimed the credit.

Pending any official IRS recommendations, Dickinson Wright says the best thing a company that incorrectly claimed the ERC to do now is to voluntarily amend the wrong Form 941-X and repay any claim benefits before an audit.

The law firms says that by doing that, the employer may be able to avoid interest and penalties, as well as the expense of an audit.

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