The Internal Revenue Service (IRS) is ramping up efforts to investigate possible abuse of the federal Employee Retention Credit (ERC), which was an important monetary lifeline for many businesses that struggled financially during the COVID-19 pandemic.
Is your business in the cross hairs for an IRS review? The answer is: possibly. Now is the time to review your ERC program participation and to prepare for a possible IRS inquiry.
By way of background, the ERC allowed qualified businesses to seek a refund for payroll taxes paid during the 2020 and 2021 tax years based on qualified wages that the business paid to its employees.
Currently, a typical ERC claim does not require supporting documentation from the business when making the claim for the IRS to process a refund. Provided that the business was not claiming more wages than it had on its original Form 941 return, the IRS would simply issue the claimed refund.
Recently, however, the IRS has begun to reexamine the refund claims made during this pandemic-era program. Because of the absence of any documentation requirements when the refund claims were made and paid, the IRS has begun looking to see if there was abuse in the form of third parties improperly claiming large ERC credits for businesses that did not qualify.
The IRS is gearing up for the remainder of 2023 to address this potential abuse. While it is currently unknown to what extent the IRS will audit past ERC claims, one can expect the IRS to be very active. Indeed, as the IRS readies itself for the review of prior years, it initiated an administrative pause on the issuance of any new refunds through at least the remainder of 2023 (see IR-2023-169).
If your business filed a claim through the ERC and received a refund, you should assemble and maintain any records that support the qualifying dates and wages used to claim the credit. At a minimum, businesses should gather the following documents:
- Executive order(s) issued by the state, municipality or federal agency that fully or partially suspended the operations of the business. This will generally come from the governmental website in the state that the business resides. This documentation should include the specific government order that suspended any business operations as well as the order that fully lifted the suspension.
- Documentation to support that the business experienced the required decline in gross receipts for 2020 or 2021. Ideally, this will be in the form of a quarterly profit and loss statements for 2019, 2020, and 2021.
- Documentation that supports the qualified wages paid to employees that were allocated to the ERC. This will likely come from a payroll provider and should include tips where applicable. This documentation should be broken out for each employee to show their wages by pay period.
- Any claimed health plan expenses paid by the employer for each employee. This also will come from a payroll provider. This should only be collected if these expenses were used for ERC qualification which may not be applicable for some businesses.
- Evidence to show that wages were appropriately allocated between the Paycheck Protection Program (PPP) and the ERC. Qualified wages that were allocated to PPP loan forgiveness are not eligible to be used to generate an ERC. Businesses should be prepared to show how these allocations were made when the ERC was initially calculated.
- Any relationships to businesses where common ownership is present. The ERC program requires that businesses aggregate related businesses that share a common ownership group. Businesses must be able to demonstrate that common ownership was analyzed during ERC qualification.
- The ERC program uses full or partial shutdown and a decline in gross receipts as the primary two tests for ERC qualification. If a third-party provider used another test such as supply chain, material modification or social distancing to qualify the business for the ERC, the business should request the following in writing:
- Primary source(s) that demonstrate that the test used for qualification is supported by the CARES Act and any subsequent IRS notices; and
- A narrative issued by the third party that supports the applicability of the test to the business’s unique facts.
By proactively gathering the documentation needed to support your ERC claim now, you can set yourself up to be able to respond to an IRS audit in the future.
- Senior Attorney
Joseph A. Peterson is a member of Plunkett Cooney's Business Transactions & Planning Practice Group and serves as leader of the firm's Tax Law Practice Group. He has extensive experience with tax law, risk management and litigation.
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