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How to Prepare for an ERC Audit?

The Employee Retention Credit (ERC) has provided welcome relief to many businesses impacted by the COVID-19 pandemic. However, with billions in credits claimed, the IRS will be closely scrutinizing ERC filings. Indeed, the IRS has warned employers to be wary of companies promoting improper Employee Retention Credit claims. If your business has claimed the credit, you should prepare for a possible IRS tax audit in the next few years. Proper documentation is key to surviving the tax audit process. Here's what you need to know to prepare.

Maintain Organized Documentation

The IRS provided a checklist of documentation to substantiate ERC eligibility in Notice 2021-20. Gather these records and keep them in an organized file or digital folder that's easily accessible. Include documentation on:

  • Government orders suspending operations or limiting capacity
  • Revenue/gross receipts records showing significant decline
  • Which employees received qualified wages and amounts paid
  • Qualified health plan expenses allocated to wages
  • Aggregated group determinations affecting the credit
  • Completed Form 7200 Advance Payment applications
  • Completed employment tax returns claiming the credit

In addition, keep records of your analysis and calculations used to determine credit amounts. Document any surveys, interviews, and data used in your determinations. Contemporaneous documentation created at the time of filing is ideal.

Thorough documentation allows anyone in your organization to reconstruct how you calculated the credit if the person who originally determined it is no longer available. Organized records also facilitate efficient responses to IRS requests.

Retain Records for at Least 6 Years

The statute of limitations for the IRS to review your ERC claim is either three years, or five years depending upon which quarter is being audited. If the tax audit is for any quarter during 2020, or the first two quarters of 2021 the statute of limitations is 3 years. However, if the tax audit relates to the second two quarters of 2021 the statute of limitations is 5 years. In calculating the 3 or 5 year period it is calculated from (1) the date on which the original return that includes the calendar quarter with respect to which the ERC is determined is filed, or (2) the April 15 date of the following year on which the original return is treated as filed. To be safe, retain ERC documentation for at least 6 years from the filing date. Keep digital copies indefinitely since storage space is generally not a constraint. Proper documentation provides proof if your credit determination is questioned down the road.

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