For those businesses and not-for-profit entities that haven’t considered eligibility for the Employee Retention Credit (ERC), there is still time. Here are a few items to pull together and consult with your advisors to see if there is an ERC opportunity:
- Compile 2019, 2020 and 2021 gross receipts reported by quarter and consider whether any quarters meet the gross receipts test which differs for 2020 and 2021.
- If you don’t qualify under the gross receipts criteria, consider whether you were shut down by a “government order” and were fully or partially suspended during 2020 or 2021.
- For entities that started operations after February 15, 2020, and had average annual gross receipts of under $1,000,000, consider whether you can qualify under a different set of rules as a “Recovery Startup Business.”
- Lastly, remember the rules are complicated and there is much more to it than what is in this short list. There are complex aggregation rules, and we must consider what wage expenses may or may not qualify, as well as look at any expenses used for other credits or PPP loan forgiveness. Be sure to consult your professional advisors!
For those businesses and not-for-profit entities that have filed for Employee Retention Credits in one or more quarters, it is important to maintain a file to support your claim should the IRS select your claim for audit. Here are some things to remember on ERC claims already submitted:
- For those that have submitted amended payroll tax returns reflecting a refund due from an ERC claim, the IRS is still backlogged, and it may take several months until you receive a refund. Smaller claims are expected to be processed in a shorter timeframe.
- Once the refund is received, you may be required to amend a prior year’s income tax return. Consult with your tax advisor and consider perhaps waiting to amend the return. Your ERC claim may be audited. Additionally, as more audits are completed, we may learn more about how the IRS is approaching these audits and whether certain claims are more vulnerable to adjustment. This is an unprecedented process, and we simply don’t know what to expect.
- The IRS has started to audit claims. Initial information requests for IRS audits of ERC claims are comprehensive and ask for detailed payroll records; PPP loan forgiveness records; employee leave records; and support for the eligibility under either the gross receipts test or the partial suspension rules from a government order. Expect these IRS audits to continue into 2023 and beyond. Speculation is that these audits may focus on industries that were essential and not required to shut down, as well as claims that are larger in amount.
- For firms that issued a study or consulting report, review the report in detail to understand the basis for the ERC qualification. Make sure you get all your questions answered and collect any supporting workpapers. For entities that qualified under the full or partial suspension rules, consider the following issues that would likely be asked as part of an IRS audit:
- What specific government orders were used to support the ERC claim? For example, some feel that ERC claims are allowed due to OSHA guidelines and CDC guidelines as being the government order. This approach is very broad-based and would appear to result in nearly everyone qualifying for ERC. We recommend a careful review of any ERC claim relying on the government orders and how they support your eligibility for ERC with your attorney.
- Additionally, does the consultant follow IRS Notice 2021-20; Notice 2021 23, and Notice 2021-49? Conversely, are you relying on an argument that is not supported by IRS guidance, but is instead based on their interpretation of the actual statute? For example, some believe the IRS guidance specific to the “more than nominal” test of 10% is not applicable because it doesn’t follow the intent of the actual law. Again, understand whether your ERC claim is based on this presumption versus the actual IRS guidance that has been issued. This is an important step in the process. Consult with your local tax advisor as appropriate.
- If your ERC claim was based on the gross receipts test, the IRS will require detailed workpapers supporting the reduction in gross receipts. The IRS will also want to reconcile these numbers back to filed tax returns. Have those workpapers and reconciliations prepared and collected now, not when the IRS begins an audit.
- We understand the Treasury Department may also investigate abusive ERC situations.
The bottom line is that CPAs need to be prepared and it is better to be prepared now, especially if you have a larger ERC claim, as it is widely believed the audit rate will be higher on larger claims. Work with your local advisors, as well as any firms that assisted you to collect all documentation to support your ERC claim.