When the Taxman Cometh for (Potentially) Invalid ERC Claims

The IRS has repeatedly warned businesses of promoters presenting wildly misleading claims about the Employee Retention Credit (“ERC”), leading to “many invalid [ERC] claims . . . coming into the IRS.” Indeed, the ERC made the top of the list of the IRS’s “2023 Dirty Dozen” list of “12 scams and schemes that put taxpayers and the tax professional community at risk of losing money, personal information, data and more.” With the IRS’s concern about invalid ERC claims, it is not shocking we have started to see audits of ERC claims.

Substantiating an ERC in an Audit

Below is a non-exhaustive list of documents a taxpayer should obtain and keep in a central location BEFORE claiming the ERC.

• Worksheets used to compute the ERC and other amounts included on the Form 941-X to compute the ERC
• Supporting documents used to prepare the worksheets and Form 941-X.
• A list of employees who were paid wages for which the ERC was claimed, including as follows:
  • Employee name
  • Date of payment
  • Amount and allocated health costs, if applicable
  • Total gross wages
  • Wages paid with the PPP loans
  • Wages for the ERC
• Substantiation that you were eligible to claim the ERC and your basis for eligibility (whichever of following is applicable).[1] 
  • Documentation that operations were fully or partially suspended due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings due to COVID-19.  This can include written company policies and emails demonstrating suspension of operations.  Government orders are becoming increasingly difficult to find, so Taxpayers should also have copies of the government orders that required the suspension of operations.
  • Documentation that your business experienced a significant decline in gross receipts during the calendar quarter for which the ERC was claimed.
  • Documentation that your business qualifies as a recovery startup business during the calendar quarter for which the ERC was claimed for the 3^rd or 4^th quarter of 2021 only (if applicable).
  • Documentation that you were a severely financially distressed employer for 3^rd or 4^th quarter of 2021 only (if applicable).

This list is largely taken from Information Document Requests (“IDR”) received from the IRS during audits of taxpayers. This list contains only the basic documents requested by the IRS; some IDR’s contain much more detailed requests.

Conclusion

It goes without saying that employers who claimed the ERC should have all the above-mentioned documents in a single location BEFORE filing for the ERC.  However, many promoters and entities that were created solely for the purpose of filing ERC claims did not care to gather this documentation. And many employers failed to ask for them. Employers who have used a third party to claim the ERC should immediately obtain the above-mentioned documents from the third party. Employers who are in the process of claiming the ERC should gather the above-mentioned documents BEFORE claiming the ERC; if a third party cannot provide the above-listed documents, the taxpayer should seek another opinion from a trusted tax professional, as the IRS warned.

For more information about the ERC, see:

Red Flags to Consider when Using Third-Party ERC Advisors

Clarifying Misconception Surrounding the Employee Retention Credit

Employee Retention Tax Credit: Potential Applicability for Law Firms