What ERC Records Should be Kept & How Likely is an Audit
Most people that have requested the Employee Retention Credit (ERC) are familiar with the process of requesting and receiving loan(s) under the Payroll Protection Program (PPP), as well of how a PPP loan is forgiven through the banks underwriting process. To obtain a PPP loan, a company would have worked with a lending institution, which assisted in calculating the credit, underwriting the loan, and submitting it to the SBA. Some banks have also helped with calculating forgiveness.
The Employee Retention Credit (ERC) is the reverse process. A company requests the money directly from the government (in this case the IRS not the SBA). Moreover, none of the administrative requirements for applying for a PPP loan are necessary for an ERC credit. However, the IRS is going to audit this aggressively, so it is important to be prepared.
This article will answer questions on what documents a business should keep for an IRS audit.
How likely is an audit?
At this point we do not know. What we do know is that because the ERCs are so valuable, and likely to be misunderstood and misapplied, Congress took the unusual step of extending the statute of limitations for the IRS to assess the amount attributable to the ERCs from three years to five years.
At this point, if a business takes substantial ERCs, it should expect an audit by the IRS.
What will happen during an audit?
The IRS will likely have a desk audit on smaller ERC claims or as an initial step in reviewing a larger claim. This is normally done at a local IRS office and is a logical move because these types of audits can be used to cover a few specific issues which the IRS outlines in each notice they send.
For larger claims, the IRS may do “field audits” which are audits conducted at a company’s place of business. These are termed “field audits” because from the IRS perspective, they are done “out in the field” as opposed to being done in their office.
Taxpayers can act on their own behalf or have someone represent or accompany them. For significant claims, it makes sense to hire a tax professional familiar with the process.
What will the IRS request in an audit related to the Employment Retention Credit?
The IRS has not begun the process of auditing the Employee Retention Credits, but we can expect them to request documentation to substantiate eligibility for the ERC. An employer/taxpayer who has taken ERCs should have documentation to verify eligibility.
Below are a few examples of records a business should keep to substantiate eligibility in case of an IRS audit.
- Verifying treatment as a large or small business, according to the law:
– Keep documentation verifying how an employer determined it was or was not a large employer.
– If determined to be a large eligible employer, keep work records and documentation showing that wages were paid for the time an employee was not providing service.
- Claiming the credit based on a reduction of gross receipts:
– Keep records to verify a significant decline in gross receipts.
- Claiming the credit based on partial suspension:
– Keep records of a governmental order(s) which caused a suspension of all or part of business operations.
– Keep records used to determine whether more than a nominal portion of operations (10% or greater) were suspended due to a governmental order.
- Calculating the credit:
– Keep records of employees’ qualified wages as well as health care expenses, if they were included as part of the credit calculation.
– Keep documentation to show how the amount of allocable qualified health plan expenses were determined.
What other documents should be saved?
If a business is audited, the IRS is going to request:
- Documentation related to the determination of whether the employer is a member of an aggregated group treated as a single employer for purposes of the employee retention credit and, if so, how the aggregation affects the determination and allocation of the credit.
The IRS will also request a copy of the tax returns filed (employment tax returns):
- Copies of any completed Form 7200 that the employer submitted to the IRS.
- Copies of the completed federal employment tax returns that the employer submitted to the IRS (or, for employers that used third-party payers to meet their employment tax obligation, records of information provided to the third-party payer regarding the employer’s entitlement to the credit claimed on the federal employment tax form).
How long should these records be kept?
In Notice 20-21 the IRS says “an eligible employer should keep all records of employment taxes for at least 4 years after the date the tax becomes due or is paid, whichever comes later. These should be available for IRS review.”
Because Congress has extended the statute of limitations, we are recommending that clients keep these records for 7 years.