With the hype surrounding the Employee Retention Credit (ERC), many would-be advisors focus on the positive aspects of the ERC while failing to advise clients of the potentially negative aspects. “Find out in fifteen minutes if you qualify,” they say, “and get $26,000 per employee of free money!”
But the ERC is not “free money.” Yes, it’s a tax credit available to businesses and nonprofits who kept employees on payroll during the Covid-19 pandemic — but you have to have a legitimate basis for your claim. Yes, it can generate $26,000 per employee — but only if you qualify for every full quarter in which the ERC is available and don’t have any PPP setoffs. These are some of the reasons that clients choose to work with an ERC specialist… and why prospective clients should be wary of those who promise them the moon.
Smart, responsible business-owners and nonprofit directors considering any financial transaction want to know about the risks, not just the rewards. And in dealing with the IRS, one of the biggest risks people ask about is the risk of getting audited.
And in fact, the IRS reviewing your claim — not quite an “audit” in the usual sense, as we’ll explain in a moment — is indeed a strong possibility. The IRS has stated that it intends to review all claims over $250,000. They’ve warned companies not to make unsubstantiated claims. And, in the last several months, they have indeed been reviewing ERC filings and asking claimants for more information. So, can you get audited? Yes.
This doesn’t mean you shouldn’t get the credit you deserve. It means you should get the credit the right way.
First, let’s back up a bit. To obtain the ERC, all you actually file with the IRS is Form 941-X, which amends your Form 941, the quarterly employee tax return that all businesses with W2 employees must file. All the IRS gets is the bottom line: how much credit you’re claiming, and how much qualified wages and health expenses form the basis of that claim.
That’s very little information, which is why the IRS is routinely asking for more. Not because businesses did anything wrong, but because in the basic filing there’s almost no way the IRS can detect fraud or catch mistakes. We tell our clients to expect a review by the IRS, and to prepare for it. And of course, we help them do that by furnishing a complete report of all income, taxes, wages and health expenses that were factored into the claim, the legal and statutory bases for the claim, the governmental orders that affected the business, a full analysis of PPP setoffs, and all the calculations involved.
If you’re considering hiring an ERC advisor, ask them this question: what information do you provide so that I can provide it to the IRS?
In addition, there are often complicating factors. If one person owns multiple businesses, they need to be aggregated in a particular way. If a business is large, they have to calculate their 2019 employee numbers in a particular way to ensure eligibility. There are particular rules about consecutive quarters of revenue loss, elective alternate quarters, and other ways in which a claim may be established. You can’t “wing it.”
Now, what does an “audit” look like? This is very important.
According to firsthand accounts, the IRS generally requests information in the form of Information Document Requests (IDRs). You’re not going to go to a tax office with your business receipts like the family in Everything Everywhere All At Once. You’re going to receive a list of questions from the IRS in a form, and reply by providing documentary evidence. In one case, the IRS asked about eligibility and various aspects of the calculation. It sought documentation in the form of payroll journals, tax forms that were already filed, health plan expenses, lists of employees and owners (and related parties), information supporting the partial suspension of operations test or the gross receipts test, and information relating to PPP loan forgiveness and the allocation of wages between the PPP and ERC.
We already provide all of this information to every client we assist, regardless of claim size.
In sum, rather than worry about whether you’re going to have your claim reviewed, we suggest that you expect it. You should feel comfortable with everything you file with the IRS, and feel sure that you’re acting in good faith. Then, if the IRS does ask questions, you won’t be surprised. And even if they don’t, you’ll probably sleep better at night anyway.