By: Tim Watt | 11/20/23
The Employee Retention Credit (ERC) has served as a crucial support for numerous businesses, offering financial assistance in times of adversity. Nevertheless, along with the advantages of the ERC tax credit, arises the obligation to adhere to the ERC laws enacted by Congress. This includes navigating the myriad of Internal Revenue Service (IRS) guidance issued to implement the legislative mandates. In this comprehensive guide, we will explore what ERC audits entail, how to prepare for them, and the potential penalties companies may face.
An ERC audit is an examination carried out by the IRS to verify a company’s eligibility and compliance with the Employee Retention Credit program. The IRS ERC audit program is a result of the agency’s dedication to ensuring tax credit programs are not abused or exploited. This specialized program is designed to scrutinize companies’ claims for ERC tax credits, with a particular focus on accuracy and adherence to program rules. The program employs a mix of random and targeted audits to ensure that both a broad spectrum of businesses and those with higher ERC audit risk are thoroughly examined.
The IRS recently announced that it has trained 300 employees to handle ERC audits, signifying the increasing focus on this tax credit. Businesses that have claimed the ERC on their payroll tax returns are facing heightened scrutiny. If your business is chosen for an ERC audit, the IRS will send an audit notice to your last known address. To avoid missing these notices, it’s crucial to keep your address information up to date with the IRS. Failure to update your address may lead to missed audit notifications and the disallowance of the credit without your knowledge. The audit notice will specify the type of audit, the issues under examination, and the subsequent steps to be taken. There are three main types of ERC audits: correspondence, desk, and field audits.
Preparation is paramount when facing an ERC tax credit audit. Companies must be ready to provide documentation, back up their claims, and ensure compliance with IRS regulations. Here’s a breakdown of the key steps and considerations for effective preparation:
During an audit, you’ll need to substantiate your claim for the credit. The burden of proof for the ERC initially lies with the taxpayer. While solid record-keeping practices can make this process smoother, ERC audits may present unique challenges. Here are the kind of records you might need to provide:
1. Proof of Eligibility for the Credit: Depending on the basis for your ERC claim, you’ll need to provide specific documents:
2. Proof of Qualifying Wages: You may need to demonstrate that you’ve claimed the credit only on Qualified Wages, which may involve providing:
3. Additional Payroll Details: The audit may extend to examining general payroll records and wage-related information such as time sheets, payroll reports, and bank account statements.
Non-compliance with the ERC can lead to severe penalties for companies. These penalties can significantly impact a business’s financial stability and reputation. Here are some potential punishments to be aware of:
For companies not yet under an IRS exam process and are concerned about the eligibility of their ERC claim, or those who suspect an erroneous or overstated ERC claim, the IRS has provided 2 pathways to avoid penalty assessments and future compliance action. The first is a voluntarily withdraw option for unpaid ERC refund claims. The second, the IRS has announced that it will soon introduce a settlement program to repay ERC claims previously received. Advisory from a tax professional or legal expect, such as Bennett Thrasher, should be sought to navigate these programs effectively.
Facing an ERC audit can be a challenging experience for any company. However, with proper preparation and compliance, the risk of facing penalties can be significantly reduced. It is crucial for businesses to avoid prior assumptions of their ERC claim, understand the intricacies of the ERC tax credit audit process, gather supporting documentation, and seek expert guidance when necessary.
The key takeaways from this guide are that ERC audits are a vital part of IRS oversight to protect tax revenue and ensure businesses receive their due credits. If selected for an IRS exam, companies should prepare diligently, review eligibility criteria, and compare compliance with ERC legislation, IRS notices, revenue procedures and other guidance to assess potential credit disallowance and penalties that could harm their financial health and reputation. Always remember that thorough preparation is the best defense against the uncertainties of an ERC audit.
For more information on surviving an ERC audit, contact Tim Watt, partner of Tax, or James Pickett, Director of Tax Controversy at Bennett Thrasher.
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