The Employee Retention Tax Credit (ERTC) was a critical relief measure for businesses during the COVID-19 pandemic, offering substantial tax credits to help employers retain staff. However, the IRS has significantly increased its scrutiny of ERTC claims, leading to more audits and compliance reviews. Businesses that claimed the ERTC must be prepared to substantiate their eligibility and ensure they have the necessary documentation to avoid penalties.

In this post, we’ll cover why the IRS is focusing on ERTC audits, what businesses can expect, and how to prepare for an audit.

Why Are ERC Audits Increasing?

The IRS has ramped up ERTC audits for several reasons:

• High Volume of Claims – Billions of dollars in ERTC claims have been processed, increasing the likelihood of errors or fraudulent claims.
• Misinterpretation of Eligibility Rules – Many businesses relied on third-party consultants who may have misapplied the rules, leading to ineligible claims.
• Targeting of High-Risk Filings – The IRS is focusing on businesses with exceptionally large claims or those that filed ERTC claims after significant guidance changes.

Understanding ERTC Eligibility

The ERTC was available for businesses that met one of the following conditions:

• Full or Partial Suspension of Operations – The business was subject to a government-mandated shutdown that significantly impacted its operations.
• Significant Decline in Gross Receipts – The business experienced a substantial drop in revenue compared to pre-pandemic levels.
• Recovery Startup Business – A special category for businesses that began operations after February 15, 2020, and met specific revenue thresholds.

What to Expect in an ERTC Audit

If your business is selected for an ERTC audit, here’s what to anticipate:

• Request for Documentation – The IRS will ask for detailed records, including payroll reports, tax filings, and proof of eligibility.
• Review of Wages and Qualified Expenses – The audit will scrutinize how wages were calculated and whether they align with ERTC guidelines.
• Verification of Government Orders – If claiming the credit due to a government-mandated shutdown, the IRS may request evidence of how the order affected business operations.
• Interviews or Follow-Up Questions – In some cases, the IRS may ask for additional explanations or clarifications.

How to Prepare for an ERTC Audit:

1. Gather and Organize Documentation
Having thorough records is key to successfully navigating an audit. Ensure you have:

• Payroll records showing wages paid to employees during the qualifying period.
• Copies of Forms 941 (Employer’s Quarterly Federal Tax Returns) that reflect the claimed ERTC.
• Financial statements showing revenue declines.
• Documentation of government-mandated shutdowns, if applicable.
• Any correspondence with third-party advisors who assisted with the ERTC claim.
  
  

Businesses should reassess their ERTC claim to ensure compliance. If errors are found, consider:

• Filing an amended return to correct any discrepancies.
• Consulting a tax professional to determine if a voluntary correction is needed before an audit occurs.
  
  

If the IRS determines that your ERTC claim was overstated or ineligible, your business may need to repay the credit, possibly with penalties and interest. Establishing a financial contingency plan can help mitigate potential cash flow disruptions.

4. Work with a Tax Professional

Given the complexity of ERTC rules and audits, working with a CPA or tax advisor experienced in ERTC compliance is crucial. They can help:

• Assess your eligibility.
• Provide representation in the audit process.
• Develop a response strategy if the IRS challenges your claim.

Final Thoughts

With the IRS intensifying ERTC audits, businesses that claimed the credit must be proactive in preparing for potential scrutiny. By maintaining organized records, verifying eligibility, and seeking expert guidance, businesses can navigate audits with confidence and reduce financial risk.

If your business has received an ERTC audit notice or you have concerns about your claim, contact your CPA for professional assistance. If you have questions about compliance, leave a comment below, or feel free to contact me directly. I’m happy to help!