The OBBB and ERC Audit Risk: Three Steps to Defending Your Claim

Summary: The OBBB Act significantly impacts the Employee Retention Credit (ERC) program, retroactively invalidating certain ERC claims and extending the IRS ERC audit statute of limitations. These changes increase the likelihood of ERC audits, penalties, and disallowed claims.

Outlining the Changes to ERC

The OBBB shifted the risk landscape for ERC investigations and disallowed claims. Here’s a breakdown of what’s changed:

• Refund claims for Q3 2021 and Q4 2021 filed after January 31, 2024, are retroactively invalidated. Claims filed via Form 941-X for these quarters that were filed after the specified date and have not been processed are now disallowed.
• The statute of limitations for audits is extended. Claims for Q3 2021 and Q4 2021 now carry a statute of limitations of 6 years, extended from the previous 5 years. This means that the IRS can review and audit these claims 6 years from either the original return filing date or the ERC claim filing date – whichever comes later.

Understanding the Impact

OBBBA retroactively suspends the processing and payment of ERC claims submitted after January 31, 2024, but only for wages paid during the third quarter of 2021, and for the fourth quarter of 2021 in the case of recovery startup businesses.  It is important to note that the invalidation date is based upon when the claim was submitted, not when it was received or posted by the IRS. Even claims that were sent timely but posted after January 31, 2024, may be in danger of incorrect treatment and invalidation.

Notably, the law does not claw back refunds already issued, even if they were paid on claims filed after the January 31 cut-off. This creates a potential fairness issue: two similarly situated taxpayers may receive different outcomes based solely on whether the IRS processed their claims before or after the enactment date. With the IRS having paused ERC processing for a prolonged period in 2023 and 2024, many valid claims may fall into this suspended window—despite having been timely filed under existing rules.

The Act further extends the statute of limitations for ERC claims—but only for Q3 and Q4 of 2021. Under prior law, claims for those quarters were already subject to an extended assessment window, expiring April 15, 2027. OBBBA adds another year, pushing the expiration to April 15, 2028—or later, depending on when the claim was filed.

In addition, Taxpayers who filed ERC claims that have not already been issued may be at a higher likelihood of audits and incorrectly disallowed claims. If you have unprocessed ERC claims, especially if those claims are for Q3 or Q4 of 2021 and were filed before January 31, 2024, make sure you have a game plan in place to defend your claim.

Three Steps to Defend Your Claim

These changes mean many businesses with open ERC claims could be at increased ERC audit risk – and that audit cycle may extend for several more years. In that span of time, personnel may leave (if they haven’t already), taking critical knowledge of the claim and circumstances with them, and documents may be lost to internal retention policies. To prevent future headaches, organizations should proactively plan for what to expect and how to respond to a potential future audit.

Step 1: Build a documented ERC audit defense case with payroll records, tax filings, and COVID-19 orders.

The best way to protect your claim and survive an audit is to prepare a strong ERC audit defense. The IRS is going to want documented proof of how your business met the ERC qualification requirements for each quarter included in the claim. Proactively make sure you’ve compiled every piece of documentation you can, including:

• Evidence illustrating pandemic-related revenue losses and/or business changes mandated by government orders
• Payroll records
• Bank statements
• Employment tax and corporate tax returns
• Employee payments
• Forms W-2

All of these will tell a convincing story of how your claim is uniquely qualified. It will also be crucial to present these facts within the context of any applicable state and local COVID-related orders that impacted your business.

Step 2: Respond promptly to IRS Information Document Requests (IDRs) to avoid penalties.

If the IRS decides to investigate your ERC claim, they will do so by issuing an IDR or Audit notice by mail. The IDR may identify a tax examiner assigned to the case, list the specific documents they wish to review, and establish a deadline for your response. Note that 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. Also remember that the IRS will never initially contact you by phone, email, text, or in person, so be vigilant against potential scams.

Responding timely and thoroughly is important, as failing to do so could negatively impact your organization’s ability to defend its claim. Proactively compiling thorough documentation before you’re audited will make this easier. As the audit progresses, plan to be cooperative and responsive, but also only provide what is explicitly requested. The auditor may issue additional document requests, ask follow-up questions, or even request an in-person or virtual meeting to discuss the investigation.

Step 3: Engage professional advisors experienced in tax controversy services and ERC audit defense.

The most important step your business can take in the event of an ERC audit is to involve an advisor that’s experienced with ERC claims and audits. Successfully sustaining an ERC claim during an audit is all about the strategy: you need to be able to tell the story of exactly how COVID impacted your business within the context of the credit’s eligibility requirements and without inadvertently providing details the IRS might view as disqualifying. Telling such a carefully curated story requires deep knowledge of ERC eligibility criteria and the nuances of the audit process beyond what your in-house legal and tax teams may be able to provide.

Aprio has a team of advisors specifically dedicated to ERC audit and controversy services that can streamline the audit preparation, response, and defense process. Through the many audits we’ve already helped clients navigate, we’ve built an extensive library of relevant documentation, like state and local COVID-related orders, so that our clients don’t have to waste time digging for them. We also know exactly what the IRS does and does not want to see, so we can help you build the most effective case using fewer of your own resources.

Aprio’s ERC Audit Defense Advantage

The IRS is only continuing to ramp up scrutiny of ERC claims, now with the support of Congress and provisions from the OBBB. 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. Make sure you’re prepared to defend your claim by building a curated and well-documented case for your eligibility.

Aprio’s team of ERC audit and controversy advisors provide IRS ERC audit help, defend against penalties, and protect your employee retention credit claims.