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The U.S. Congress passed multiple bills during the COVID-19 pandemic that provided various forms of relief for businesses and individuals. The Employee Retention Credit (ERC) benefited both by giving businesses an incentive to keep workers on their payrolls during government-mandated shutdowns or significant business slowdowns caused by the pandemic. Unfortunately, many scammers see the ERC as a great way to con businesses out of their money. The IRS placed ERC scams at the top of its “Dirty Dozen” list of tax scams for 2023. It is also placing a priority on scrutinizing ERC claims. This article offers an overview of the ERC and how your business can prepare for an IRS audit into your ERC claim.
What Is the Employee Retention Credit?
The ERC is a refundable tax credit that Congress created in § 2301 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020. Several subsequent laws amended or modified the credit. It was available to businesses that suffered losses during the period from March 13, 2020 to December 31, 2021.
To qualify for the ERC, a business must have continued paying employees during any of the following periods of time:
- A full or partial suspension of business operations “due to orders from an appropriate governmental authority” between March 13 and December 31, 2020;
- A “significant decline in gross receipts” between March 13, 2020 and September 30, 2021; or
- Qualification as a “recovery startup business” during the third or fourth quarters of 2021.
The ERC is not available to state or local governments, including any political subdivisions. Small businesses that received loan forgiveness through the Paycheck Protection Program (PPP) and not exempt from applying for the ERC but the same payroll costs cannot be used for both programs.
What Kinds of Scams Take Advantage of the Employee Retention Credit?
In its “Dirty Dozen” warning about ERC scams, the IRS describes schemes in which promoters make “too good to be true” offers regarding ERC claims. They claim to be able to obtain tax credits for businesses in exchange for a fee (many 15% or more of the ERC credit). They may pocket the fee and leave businesses to the consequences of filing an inaccurate or fraudulent claim.
Check out our summary of the 2023 Dirty Dozen list here!
The last time period for which the credit was available was the fourth quarter of 2021. The number of businesses that remain eligible for the credit can only decrease from this point on. Businesses should approach any offer related to the ERC with great caution.
How Can My Business Prepare for an Audit of Its Employee Retention Credit Claim?
Any ERC audit carried out by the IRS at this point will be retrospective. The last period of eligibility for the credit was more than one year ago. This can be both a benefit and a burden for businesses facing audits. Since all of the information you need is now historical, you do not have to worry as much about your ongoing operations affecting the information you must provide to the IRS. At the same time, you might need to dig into the archives to gather all of the required information.
The following strategies can help you prepare for an IRS audit of your ERC claims:
Know the ERC Eligibility Requirements
The eligibility requirements for the ERC are complex. Certain events have precise definitions. You may have to justify your eligibility if it appears like your situation does not meet the ERC’s standard. The CARES Act defines some important terms, and the IRS has issued guidance providing further details. The following are two of the most important defined terms related to the ERC:
- What is an “order” from an “appropriate governmental authority”? While the CARES Act does not define this term, the IRS has stated that it includes “orders, proclamations, or decrees from the Federal government or any State or local government” that restrict “commerce, travel, or group meetings” because of COVID-19, and that “relate to the suspension of an employer’s operation of its trade or business.” If the order comes from a state or local government, that governmental agency or entity must “have jurisdiction over the employer’s operations.” Statements by government officials that do not have the force of law, such as remarks at a news conference, do not count as “orders.” Supply chain disruption does not qualify your business.
- What is a “significant decline in gross receipts”? Section 2301(c)(2)(B) defines this as the period of time that begins in a calendar quarter in 2020 when a business’ gross receipts were less than 50% (80% for calendar quarters in 2021) of its gross receipts for the corresponding quarter in 2019. The business remains eligible for the ERC until the end of the calendar quarter when its gross receipts are greater than 80% of the gross receipts in the same 2019 quarter. This Gross receipts test is calculated based on the total business receipts, not just a business line.
Keep Organized Payroll Records
You will need complete and accurate records of your payroll from before and during the period for which you claimed the ERC. This includes a list of all full- and part-time employees during those time periods, along with the dates during which the business employed them.
Provide Documentation of Business Closures or Slowdowns
You will need records showing how your qualified for the ERC. This may include:
- Gross receipts during the relevant time periods; and/or
- Notices or orders relating to government-mandated shutdowns.
Learn More About ERC Audit Preparation
The ERC was an immense help to countless businesses in 2020 and 2021. The time to qualify for the credit has now passed, though, so businesses need to be wary of anyone claiming they can help them make a claim. The IRS is keeping a close eye on this issue.
Have questions? We would love to help!
Still need an audit even after the change in participant-counting methodology? We’re here for you! Contact us today to speak with a qualified employee benefit plan professional.
