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:
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.
What Happens if I Fail my ERC Audit? Navigating the Complexities of ERC Claim PenaltiesThe Employee Retention Credit (ERC) has provided significant financial relief for businesses during challenging times, but it comes with stringent compliance requirements. Failure to adhere to these requirements can result in severe penalties. Here's an overview of the potential penalties associated with ERC claims that legal professionals need to be aware of:
Civil Tax Fraud Penalty: Claiming fraudulent ERC benefits leads to the forfeiture of those claims and attracts a substantial penalty. The penalty is calculated at 75% of any understated tax amount, with a maximum cap of $100,000. This hefty penalty underscores the importance of ensuring the accuracy and legitimacy of claims.
Criminal Fraud Penalties: The ramifications for criminal fraud are even more severe. Individuals found guilty can face fines of up to $100,000 and imprisonment for up to five years. Corporations may encounter even harsher penalties, reflecting the serious nature of fraudulent activities.
Accuracy-Related Penalty: Errors in reporting can also lead to significant penalties. If an under-reported tax amount is identified, a penalty amounting to 20% of the under-reported tax will be imposed. This penalty emphasizes the necessity for meticulous tax reporting and verification.
Failure-to-Pay Penalty: In cases where the required taxes are not paid, a penalty of 0.5% of the tax liability is levied. The IRS retains the right to backdate this penalty to the original due date of the tax, adding to the financial burden of non-compliance.
Failure-to-Deposit Penalty: The failure to deposit taxes as required can result in penalties up to 10% of the unpaid tax amount. This penalty serves as a reminder of the critical nature of timely tax deposits.
Tax Preparer Penalties: Tax preparers are not immune to penalties. Depending on whether a mistake is deemed honest, due to negligence, or involves fraud, both tax preparers and taxpayers can incur penalties. This highlights the shared responsibility in ensuring tax compliance.
Other Penalties: Claims for ERC on Forms 941 and 944 also have implications for business income tax returns. Specifically, these claims necessitate a reduction in reported wage expenses, which must be accurately reflected in tax filings.
Understanding the full scope of these penalties is crucial for business owners and their legal advisors. The significant financial and legal repercussions associated with erroneous or fraudulent ERC claims underline the importance of thorough documentation, precise reporting, and proactive compliance measures.
Can I Appeal the IRS’ Decision?Yes, you can! However, when facing an ERC audit, there are several avenues available to address the auditor's findings.
First, you can agree with the auditor's changes and pay any additional tax owed. This straightforward approach resolves the matter quickly but may not always be in your best interest if you believe the findings are incorrect. Alternatively, you can request a meeting or call with the auditor to discuss their findings. During this discussion, you have the opportunity to provide any additional documentation that supports your argument and clarifies your situation. This collaborative approach can often lead to a resolution without further escalation.
If these initial steps do not lead to a satisfactory outcome, you can file a formal protest requesting an appeals conference. The official appeals process involves the IRS Office of Appeals reviewing your case to make a new determination, with the aim of resolving the dispute without litigation.
There are two types of appeals you can pursue:
Small Case Request: For ERC adjustments of $25,000 or less per tax period, you can submit an informal “small case” request. This involves providing a brief statement explaining the reason for your dispute with the auditor’s findings, along with any supporting documents. This process is designed to be less formal and more streamlined.
Formal Written Protest: For adjustments over $25,000, you must submit a formal complaint. This detailed document should outline the case and present the legal arguments for qualifying for the ERC, backed by comprehensive evidence and documentation.
Each of these options provides a structured pathway to contesting and potentially overturning the auditor’s findings, ensuring that your position is thoroughly reviewed and fairly considered by the IRS.
Navigating the intricacies of an ERC is not a simple undertaking so always consult the advice of a tax attorney. Our tax litigation attorneys at Brager Tax Law Group, who are former IRS attorneys will guide you through the complexities of your ERC claim to mitigate risks and ensure adherence to tax regulations.