The IRS is Preparing to Audit ERC Claims – Are You Ready?

September 14, 2023

At a glance

  • Many businesses applied for and received ERC through a relatively simple amended return process. ERC included strict eligibility requirements in order to receive the full refund, and many businesses and their providers performed in-depth analyses of their COVID impact to determine eligibility. However, many employers fell prey to deceptive practices of third-party firms promising easy money prompting several IRS warnings.
  • The IRS has initiated audits of ERC refund claims processed for 2020 and 2021, likely targeting large refund amounts, organizations utilizing-less-than professional providers and potentially focusing on businesses in specific industries, such as technology and manufacturing.
  • Any IRS inquiry or audit notification with respect to ERC or Forms 941-X for 2020/2021 should be responded to promptly. Engaging expert assistance and cooperating professionally with the IRS are key steps to navigate an audit effectively and showcase the legitimacy of your ERC claim.

Aprio’s experienced ERC team is prepared to help you respond to an IRS audit and defend your ERC claim. Connect with us today to begin preparing your response.

The full story

In March of 2020, Congress enacted the Coronavirus Aid, Relief and Economic Security (Cares) Act, which, among many relief provisions, created the Employee Retention Credit (ERC). Subsequent legislation added additional years and benefits to ERC.

With a maximum benefit up to $26,000 per employee, many businesses applied for and received ERC through a relatively simple amended return process. Even now ERC is still available to employers impacted during the years of the pandemic, and ERC refund claims are filed daily.

While many businesses had well-substantiated ERC claims documenting significant business and/or economic impact,  others were unfortunately taken advantage of by unscrupulous providers, sometimes referred to as “credit mills.”

Credit mills routinely approached businesses with an easy money proposal for refund recovery, often without analyzing and documenting ERC eligibility requirements. These claims, and the billions of dollars paid out, have been identified by the IRS and are the subject of a significant audit effort. 

Unfortunately, many employers that truly were impacted during the pandemic and met the eligibility requirements may be drawn into the IRS audit web and have to defend their positions.

IRS warns businesses of ERC scams

Recognizing the depth of the issue, the IRS included the filing of unsubstantiated ERC refund claims in its 2023 Dirty Dozen tax scams warning list. Whether or not you may have used an unscrupulous actor to process your ERC refund, the fact that so many scammers exist means that the IRS is on heightened alert to root out abuse of the ERC program.

IRS Commissioner Danny Werfel signaled a new phase of ERC response, saying additional procedures will be put in place to deal with the growing fraud risk. Speaking at the IRS Nationwide Tax Forum in Atlanta, Werfel plainly stated his concern, saying, “[t]he further we get from the pandemic, we believe the percentage of legitimate claims coming in is declining. Instead we continue to see more and more questionable claims coming in following the onslaught of misleading marketing from promoters pushing businesses to apply. To address this, the IRS continues to intensify our compliance work in this area.”

Should you be concerned about an IRS audit of your ERC claim?

The IRS has begun to conduct audits on ERC refund claims filed for 2020 and 2021. While the audit process is just getting underway, it is expected to increase over time as the IRS has indicated it is interested in auditing ERC claims.

It is anticipated that the audits will not be limited to specific industries or company sizes; any business that has filed for the ERC could come under IRS scrutiny. We know from conversations with IRS agents that companies with claims exceeding $200,000 in a quarter may be more likely to face a review of their claim. While this review might not always lead to an audit, it signals a heightened level of interest by the IRS with respect to higher value ERC claims.

Knowing whether or not you should be concerned begins with identifying any red flags that may exist with your ERC claim. You may even want to get ahead of the issue and review your eligibility position now, so as to be prepared should the IRS choose to audit your claim.

Why prepare for an audit now? 

The audit cycle may extend for up to five years after the Form 941-X is filed. Personnel may change, documents may be lost and proof may be needed in defense. That proof could include copies of state or local orders that might be deleted from websites. 

Gathering that information now might help make your case later.

Certain industries may be at a higher risk for an audit

The IRS could initially turn its attention for audits to industries such as manufacturing and technology.

Tech companies filing ERC claims may be scrutinized more closely due to the fact that many of them continued business operations remotely and were likely less affected by government orders impacting their work locations. 

Manufacturing companies and businesses dependent on a flow of products from outside sources could be analyzed more closely, particularly if their claims relied on general economic conditions and an inability to procure goods. Simply providing supply chain breakdowns, trucker shortages and clogged ports as the sole reason for eligibility may not constitute the impact position that the IRS is looking for as the foundation of an ERC claim. 

The IRS Chief Counsel recently released a Generic Legal Advice Memorandum (GLAM) specifically addressing the position of supply chain disruption in the case of ERC claims, and detailed an extremely limited basis for eligibility utilizing that as a driver.

Handling an IRS Audit Notice

While there is no way of knowing whether or not your company will be audited, there are certain things you can expect to occur as a result of the IRS audit process.

1. Notification and Initial Response

First, it is important to know that the IRS will NOT contact you by phone or in person. They will not knock at your door or call or text you to tell you they are auditing you.

Instead, the IRS will send you an Information Document Request (IDR) by mail informing you that an agent has been assigned to your case. This request might not explicitly mention ERC, as the mechanism for claiming the credit is an amended payroll tax return (Form 941-X), which can be audited during regular business reviews. 

Although not every IDR signifies an ERC audit, the likelihood is higher if you have claimed the credit or filed for a refund for tax years 2020 and 2021.

It is critical to engage your legal counsel or tax department immediately upon receiving an IDR, and devise a strategy to respond. If you use an outsourced payroll firm, you can certainly pass the notice to them, but they likely will not be able to provide you with the expert guidance and support you need as you formulate your initial course of action.

Pay attention to the response deadline on the IRS notice and take appropriate action on a timely basis. Failing to meet the response deadline could carry additional penalties.

2. Engage Professional Assistance

After consulting your in-house legal and tax team, you may find that outside assistance is needed.

Aprio’s experienced team is skilled in this area and has helped clients prepare thousands of ERC claims and specializes in IRS audit defense. Collaborate with our experts who comprehend the eligibility criteria for ERC as well as the nuances of the IRS audit process. This step is crucial to navigating the audit effectively.

3. Gathering Documentation

Work closely with your chosen advisor to gather all documentation supporting your ERC claim. This includes payroll records, bank statements, tax returns, and evidence illustrating pandemic-related revenue losses and employee payments. Organize these documents logically and keep copies for your records.

As noted previously, a crucial step may also be identifying and producing specific state and local COVID-related orders that impacted your business. Through our thousands of eligibility reviews we have accumulated an extensive library of orders that your business will need to defend your position. 

4. Timely and professional response

Again, it’s critical to respond to the audit notice promptly and professionally. Avoid ignoring or delaying your response, which could lead to penalties or claim denial. Always be polite and respectful in your communication. Allow your advisors to handle any disagreements or complaints while ensuring accuracy and honesty in your responses.

5. Cooperate with the IRS

As the audit progresses, cooperate fully with the IRS auditor. They might request additional documents, seek answers to questions, or schedule meetings. Always involve your trusted advisors in discussions and rely on their guidance for the right responses. Maintain a professional yet assertive demeanor when interacting with the IRS.

A final word

Receiving an IRS audit notice with respect to any tax matter naturally creates anxiety.  For those businesses that have filed for and received refunds as a result of ERC claims, it is important to step back and consider your organization’s COVID journey and how best to present that to an IRS agent.  

The audit process is a means for the IRS to verify your eligibility for the Employee Retention Credit, ensuring that the financial relief you received was rightfully claimed. By engaging experienced representation, providing accurate documentation, and maintaining a professional attitude throughout the audit process, you can skillfully navigate an IRS audit.

Related Resources/Assets/ articles/pages

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An audit is not an indictment. It’s an opportunity to showcase the legitimacy of your claim and secure the financial support your business needs. For help responding to an IRS audit of your ERC claim, connect with Aprio’s ERC team today.

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About the Author

Scott Schapiro

As ERC and Employment Tax Leader and Tax Partner for Aprio, Scott applies more than 37 years of payroll tax expertise to his leadership of our ERC team. He is particularly skilled in helping clients determine eligibility for and defend the legitimacy of ERC claims in the event of IRS audits.