What is the Process of an ERC Audit?

An ERC audit can be a scary thing. The IRS sending you a letter about an audit makes your stomach drop. But don't freak out just yet. An ERC audit doesn't have to be the end of the world. Lots of businesses go through ERC audits and make it through just fine. This article will walk you through what to expect during an ERC audit so you can be prepared.

What is an ERC Audit?

ERC stands for Employee Retention Credit. This was a tax credit passed by Congress in 2020 to help businesses during COVID. It lets you get money back from the government based on wages paid to employees during COVID shutdowns and slowdowns. Lots of businesses claimed this credit. Now the IRS is auditing companies that claimed the ERC. They want to make sure you qualified for the credit and calculated it correctly. An ERC audit means the IRS is going to look at your records to verify your ERC claim.

Why Are ERC Audits Happening?

The ERC was brand new in 2020. There was a lot of confusion about who qualified and how much credit you could claim. Many businesses claimed the ERC without really understanding the rules. Others pushed the limits on what they claimed. The IRS knows there were likely mistakes and abuse with ERC claims. So they are auditing to correct improper claims. The stakes are high, with billions in tax dollars at play. Don't take an ERC audit personally. For the IRS, it's just about making sure the rules were followed.

What Triggers an ERC Audit?

There are a few red flags that may have caused the IRS to select your business for an ERC audit:

Claiming a very large ERC amount compared to your payroll
Claiming the ERC even though your revenue did not decline in 2020
Claiming the ERC for employees who were not actually retained
Claiming the ERC for non-W-2 employees like contractors
Claiming the ERC retroactively on amended payroll tax returns

Of course, just because you claimed a large ERC does not necessarily mean you did anything wrong. But it does make the IRS more likely to check your records.

What Will the IRS Look at During an ERC Audit?

In an ERC audit, the IRS will ask to see your records to document your credit claim. This includes things like:

Payroll records showing wages paid to employees
Documentation of any COVID shutdowns or slowdowns
Records showing year-over-year decline in gross receipts
Proof that employees were retained even if not working

You need to be able to show the IRS documentation for the big facts supporting your ERC claim. For example, if you claimed the ERC because of a COVID slowdown, you need records to prove that slowdown was real.

What is the ERC Audit Process?

An ERC audit typically follows these steps:

Notice. You receive a letter from the IRS saying your ERC claim will be audited.
Information request. The IRS sends a detailed list of records they need you to provide.
Gather documents. You collect all the records requested by the IRS.
Submit records. You send copies of the requested records to the IRS.
Review. The IRS examines the records you provided.
Questions. The IRS may request clarification or additional documents.
Audit findings. The IRS sends their audit results, either confirming or adjusting the ERC claim.
Appeal. If you disagree with the audit findings, you can appeal.

This process can take many months depending on how complex your business is. Be prepared for this to drag out. Stay organized and respond promptly to all IRS requests. The faster you can provide what they ask for, the quicker the audit will be done.

How to Prepare for an ERC Audit

Getting ready for an ERC audit takes work but is totally doable. Follow these tips:

Gather all your documentation now so it's ready when the IRS asks.
Make copies of key records in case any originals get lost.
Talk to your accountant and attorney about the best audit strategy.
Designate one person in your company to handle the audit.
Be responsive and provide the IRS whatever they request.
Stay calm and don't get emotional with IRS agents.

Having your paperwork organized will make the audit go much smoother. And staying cool under pressure is key. The IRS agents are just doing their jobs. Getting upset will not help at all.

What Happens if the ERC Audit Goes Badly?

The worst case scenario is the IRS determines you did not qualify for the ERC you claimed. Here's what happens then:

You have to pay back the ERC money, plus interest and penalties.
The IRS can ban you from claiming certain tax credits in the future.
You may have to pay extra fines for reckless or fraudulent claims.

Getting hit with taxes, interest, and penalties is no fun. That's why it's so important to get your documentation in order before an ERC audit starts. Having organized records and a clear understanding of the rules will help avoid problems. Still, even with great records, the IRS may disagree with your interpretation of the complex ERC rules. This does not necessarily mean you did anything intentionally wrong. The rules were murky and confusing. Two reasonable people can look at the same facts and come to different conclusions. If you end up in a dispute with the IRS auditor, stay calm. Make your case politely but firmly. Explain your position and point to documentation supporting your view. If the auditor won't budge, you can appeal their decision within the IRS. Just don't let it get heated or personal.

Can You Get Help During an ERC Audit?

You don't have to handle an ERC audit alone. In fact, getting help from a tax pro is highly recommended. Here are people who can help:

Your CPA or tax preparer who filed your returns
An enrolled agent (federally licensed tax expert)
A business tax attorney
An ERC specialist

Having an experienced tax pro in your corner makes a huge difference. They know the ERC rules inside out. And they've handled IRS audits before, so they can guide you through the process. Yes, their fees cost money. But it's worth it to have someone fighting for your business every step of the way.

Tips for Surviving an ERC Audit

Getting through an ERC audit starts with the right mindset. Stay positive, be cooperative, and take it one step at a time. Here are some more tips:

Respond promptly to all IRS letters and requests.
Treat IRS agents with respect even if you disagree.
Clearly explain your qualifications for the ERC.
Highlight facts and records supporting your claim.
If errors are found, work constructively to resolve them.
Consider a settlement if you can't fully substantiate your claim.