ERC Audit Risk: Do You Qualify for VDP?

The Internal Revenue Service (IRS) recently announced their continued progress on about 400,000 Employee Retention Credit (ERC) claims representing about $10 billion. Although business owners and practitioners welcome any update on the status of pending ERC claims, many employers remain skeptical if they will receive their refund at all or if they will have to wait another year while IRS continues to work through the backlog of claims. The other segment of employers with ERC claims already processed worry if they will ultimately receive one of the ERC audit or claim disallowance letters.

For those with improper claims, the IRS reopened the Voluntary Disclosure Program (VDP) for ERC in August 2024, which would allow businesses to address and correct any discrepancies in their submitted ERC claim. The IRS has stated that the reopening of the disclosure program will run through Nov. 22, 2024, and the program would also offer a 15 percent discount for businesses who pay back their ERC credits for 2021 tax periods.

The ERC was created in 2020 to help businesses keep employees on payroll during the COVID-19 pandemic. The credit has helped millions of businesses, but it has also been targeted by scammers and promoters who have encouraged ineligible businesses to claim the credit.

As a result of this abuse, the IRS remains increasingly focused on ERC audits and Letter 105C Claim Disallowance and has continued to warn against potential scams related to the ERC in its “Dirty Dozen” list of scams. This means that we can anticipate the IRS to scrutinize ERC claims more closely in the future, including the audits of questionable or fraudulent ERC claims. The IRS has reported that thousands of ERC audits are already ongoing, with 460 criminal cases of potentially fraudulent claims totaling almost $7 billion.

What are the Risk Factors for an ERC Audit?

There are a number of factors that can increase your risk of an ERC audit. Some of these factors include the following:

• You claimed ERC for Q4 2021 as a Recovery Startup Business, but you filed income tax returns prior to 2020. Recovery Startup Businesses are only eligible for ERC if your business was started after February 2020.
• You filed Form 941-X but do not have an original Form 941 on file. Form 941-X is used to amend a previously filed Form 941. If you filed Form 941-X to claim ERC, you must have an original Form 941 on file for the period you are amending.
• You claimed ERC but did not report salaries/wages on your originally filed income tax return because you only hired Form 1099-MISC or NEC contractors. Funds paid to contractors are not eligible for ERC.
• You claimed ERC for Q4 2021, and your income tax return average gross receipts were reported in excess of $1 million. Recovery Startup Businesses are not eligible for ERC if their average gross receipts for the prior three taxable years exceeding $1 million.
• You filed for ERC for the 2022 tax year. ERC is only eligible for 2020 and 2021.
• You claimed ERC based on supply chain eligibility. Businesses that claim ERC based on supply chain eligibility must have experienced a more than nominal business impact in either gross receipts or the number of service hours worked by employees. The IRS is likely to scrutinize supply chain eligibility claims closely.
• The ERC amount for any employee was greater than $5,000 in 2020 or $21,000 in 2021. The maximum ERC amount per employee is $5,000 in 2020 and $21,000 in 2021. If you claimed ERC for an employee in excess of these amounts, your claim is likely to be flagged for review.
• You had more than 100 (or 500 if filing for 2021 ERC) average employees in 2019 and you claimed ERC for all employees. Large employers are only eligible for ERC if they paid employees who did not work. If you are a large employer and claimed ERC for all of your employees, your claim is likely to be flagged for review.
• You claimed ERC and did not consider the Paycheck Protection Program (PPP) payroll used for forgiveness. If you received PPP loan forgiveness, you must reduce your ERC eligible wages by the amount of PPP loan proceeds that were used to pay wages.

What To Do If You Are Audited?

If you receive notice from the IRS indicating you are subject to an ERC audit or Claim Disallowance, you will need to provide documentation to support your ERC claim. This documentation may include payroll records, tax returns, financial statements and documentation of your business’s impact from the COVID-19 government mandates, which should demonstrate any relevant revenue reduction, suspension of business operations and/or that you qualify as a recovery start-up business. You should also engage qualified tax professionals with proven experience in IRS representation to guide you and demonstrate that you were eligible to receive the ERC.

 Need Help Determining if You Should Apply for VDP?

Qualified tax professionals can take a second look at your ERC claim. A second look will review your claim’s eligibility, determine the accuracy of your claim and help determine if VDP is the best option for you. Also, if your ERC claim was prepared by a third-party provider, but you are concerned about their reputability, a second look can review the prepared claim for errors or miscalculations.

Windham Brannon Understands ERC Risk

Windham Brannon’s ERC Risk Assessment can help employers proactively review their ERC claim for peace of mind against potential audit or claim disallowance risk. Our professionals know the ERC and can help answer questions about ERC claims you would expect from a qualified professional services provider. Our Tax Controversy Practice possesses the technical expertise from former IRS agent experience, meaning we help you face controversy matters with confidence and support. We also have extensive experience in IRS audit representation, so if you are indeed faced with an ERC audit, our team can help you every step of the way, including gathering paperwork and documentation. For more information about determining your ERC risk, contact Tomika Bullet, Windham Brannon’s Tax Controversy Practice Leader.