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So, You’re Being Audited by the IRS for Having Claimed the Employee Retention Credit –
Now What?

Firstly, you probably feeling a little hot and tight around the collar, well you received a notification letter from the IRS – that makes anyone nervous. When the IRS selects you for an Employee Retention Credit (ERC) audit, they send a letter detailing the issues to be examined and informing you that an agent has been assigned to your case. It's crucial to respond by the deadline noted on the letter or contact the auditor to request a 30-day extension.

The IRS initiates a compliance check of your initial claim by sending an Information Document Request (IDR) inquiry into the ERC claim. This request may not explicitly mention ‘ERC’ since an amended payroll tax return Form 941-X was used to claim the credit, and this can be audited during regular business examinations.

The IDR will require the employer to provide evidence to support one or more of the eligibility 'tests' from the initial application process. Required documentation includes:

  • Profit and loss statements
  • Tax returns
  • Calculations showing significant decline in gross receipts
  • Wage records or payroll register
  • Allocable health plan expenses
  • Paycheck Protection Program (PPP) loan documentation
  • Proof of COVID-19 government shut-down orders

Additionally, the IRS conducts a thorough review of Form 940, as many audits lead to increases in the amount reported on this form, regardless of any adjustments made to the ERC claimed on Form 941.

It is important to note that the likelihood of an ERC audit is higher if you claimed the credit or filed for a tax refund for 2020 and 2021.

How Do I Prepare for an ERC Audit?

Preparing for a potential Employee Retention Credit (ERC) audit is crucial even before you receive any notification from the IRS. The audit process begins with the IRS sending an Information Document Request letter, Form 4564, notifying you of your selection for an audit and outlining the issues that will be examined.

It is advisable to seek the guidance of a tax attorney who is well-versed in ERC matters to conduct a thorough ERC risk assessment. The IRS can conduct an audit either by mail or through in-person interviews. Audits by mail, also known as Correspondence Audits, are conducted through written correspondence or telephone and are typically reserved for straightforward matters. As long as all required documents are properly prepared, reviewed, and submitted within the IRS-stipulated deadlines, these audits can be streamlined. The audit may be conducted in an IRS area office, a field office, or even in the offices of your tax representative.

During the audit, the IRS will request documents needed to verify elements of your ERC claim. You will be responsible for providing any and all required documents by the deadline provided unless you request and receive an extension. It is expected that most audits will focus on more complex issues related to the ERC that cannot be resolved through correspondence alone.

It is important to remember that the burden of proof lies with the taxpayer. Ensure that you are prepared with all necessary documentation and professional support to navigate the audit process effectively.

In preparing for an ERC audit, legal prudence dictates that one should personally undertake the eligibility analysis and ERC calculations if they were not initially prepared, as inaccuracies are prevalent. Should amendments to the claim be necessary, it is advisable to address these in your initial response to the IRS. Submissions to the IRS should be meticulously verified and only include information with which you are entirely comfortable. It is essential to acknowledge that most IRS agents are performing their duties in good faith, striving for accurate determinations; thus, compliance and readiness of records are imperative for an expedited audit process. Given that requests for extensions to provide Information Document Request (IDR) responses may not always be accommodated, it is critical to document ERC claims comprehensively and ensure preparedness well in advance of the audit.

Don’t be fooled, facing an ERC audit is a complex and challenging endeavor. It is imperative to consult with a knowledgeable tax attorney who is well versed on ERC claims. At Brager Tax Law Group, our seasoned tax litigation attorneys provide expert guidance through the intricate ERC audit process, offering comprehensive support and advice at every stage.

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