Red Flags That You May Be Subjected to an ERC Audit
The IRS has announced that it plans to focus on ERC audits. That’s concerning for taxpayers because failing an ERC audit can be extremely expensive due to the high value of these credits. Additionally, if the auditor believes that you committed fraud or negligence, you can incur very high penalties.
To help you out, we’ve put together an overview of the ERC audit process, which explains what to expect if you’re selected for an audit. We encourage you to check out that page if you’ve been notified about an ERC audit.
However, in this guide, we’re going to answer questions for people who are worried about an audit. In particular, this post examines how long the IRS has to audit returns with employee retention credits (ERC). Then, it outlines red flags that may increase your risk of an audit, including working with an ERC mill. Finally, this post briefly explains whether or not you should apply for the ERC if you haven’t yet.
How Long Does the IRS Have to Audit ERC Claims?
The IRS has three years to audit most ERC claims, but it has five years to audit payroll returns with ERCs filed for the last two quarters of 2021. There is no deadline to audit returns when fraud is involved.
Here is the audit deadline for the seven quarters during which this credit was available.
- Q2 2020 — April 15, 2024
- Q3 2020 — April 15, 2024
- Q4 2020 — April 15, 2024
- Q1 2021 — April 15, 2025
- Q2 2021 — April 15, 2025
- Q3 2021 — April 15, 2027
- Q4 2021 — April 15, 2027
However, if you amend a payroll return, the three-year deadline starts the day you file the amended return. For example, say that you amend your Q3 2020 payroll return to claim an employee retention credit, and you make the amendment on April 15, 2023. Then, the IRS has until April 15, 2026, to audit that return.
Audit Statute of Limitations on Payroll Tax Returns
Normally, the IRS has three years from the April 15th that falls after the filing deadline to audit payroll returns. For example, your 2020 payroll returns were due April 31st, 2020, July 31st, 2020, October 31st, 2020, and January 31st, 2021. The clock starts ticking on April 15, 2021, and the IRS has three years from that date to start an audit.
Red Flags: Is My ERC Going to Be Audited?
The IRS may select your payroll returns for an audit if they have incorrect or incomplete info, discrepancies between other records, and/or excessive credits claimed. You may also be selected for an audit if you have a prior history of non-compliance.
Here are more details on red flags that may trigger an audit:
- Incomplete information — You didn’t provide all of the requested info on your original or amended returns.
- Incorrect information — For example, the 941X form has certifications that are not on the original 941 forms. If you checked the wrong certification boxes when you amended the return, you may be subjected to an audit.
- Inconsistent information — When you amend payroll returns, you must include the numbers from the original returns. If there are inconsistencies, you will be selected for an audit. Additionally, if there are significant inconsistencies between your 941 form, the W3 filed by your business, and/or your business income tax return, that’s also a red flag for audits.
- Excessive credits — If the amount of your credit exceeds the usual amount you pay in wages or is much higher than the credits claimed by similar businesses, the IRS is likely to notice and initiate an audit.
- Prior history of non-compliance — If you’ve been non-compliant on other business tax returns, made late payroll deposits, or filed late on a regular basis, the IRS may be more likely to look closely at your returns.
- Return filed by a known ERC mill — If your tax preparer is a known ERC mill, then the IRS is highly likely to audit your returns. Check out the following sections for more information on this risk.
If any of the above issues apply to your return, you may want to get ahead of the situation. Instead of waiting for the IRS to contact you about an audit, consider consulting with a seasoned tax professional. They can look over the returns you filed and help you decide if you should amend them to correct mistakes or leave them as they are.
What Is an ERC Mill?
An ERC mill refers to a company that was created for the sole purpose of claiming employee retention credits. These companies often encouraged employers to claim credits they weren’t eligible to claim, and then, they took a significant portion of the credit.
The IRS has named ERC mills one of its “dirty dozen” tax scams. This is a list of scams that the agency publishes every year. ERC mills were included because these companies lied to their clients about their eligibility for these credits, and then, they falsely claimed credits on behalf of their clients.
Red Flags That You Worked With an ERC Mill
If your usual accountant or bookkeeper filed your returns, then you obviously didn’t work with an ERC mill. Note that this doesn’t necessarily mean that your return was filed correctly. It just means that you didn’t work with a company that’s known to fraudulently claim these returns.
However, if you amended your payroll tax returns through a company that specifically focuses on ERC returns, you may have worked with a mill. That said, some of these companies provide a legitimate service, while others are shady.
Here are signs that you worked with a mill:
- The company was created solely to focus on ERC claims.
- The company advertised these credits aggressively over social media, TV, or the radio.
- The company’s reps told you that you would qualify for the credit before finding out any details.
- The company didn’t ask any questions about your eligibility. In particular, they didn’t ask about revenue declines or operational shutdowns.
- The rep didn’t ask for any proof that you could claim the credit.
- The rep didn’t ask how many employees you had in 2019 — That number was related to certain eligibility criteria.
- The rep didn’t ask you about your relationship with your employees — for example, you couldn’t claim this credit for relatives.
- The rep amended your payroll returns but not your business income tax returns — If you claim the ERC, you need to reduce the wage expense on your income tax return.
What If You Claimed the ERC Incorrectly?
If the IRS audits your payroll return, you could lose the credit, but even worse, you might incur audit penalties such as the accuracy penalty (20% of the underreported tax) or the fraud penalty (75% of the underreported tax).
After reading this, what if you determine that you most likely worked with an ERC mill and that you probably claimed the credit incorrectly? Then, you should fix the situation.
How to Fix an Incorrect ERC Claim
When you make mistakes on a tax return, you can address them through the IRS’s voluntary disclosure program. There are two different options in this program — one for criminal disclosures and one for non-criminal disclosures.
You can only make a voluntary disclosure if the IRS hasn’t contacted you about an audit. You must initiate the action. You can’t wait for the IRS to contact you first. However, this program has strict protocols and a lot of different implications. The IRS recommends consulting with a tax attorney before you do a voluntary disclosure.
Alternatively, you could just re-amend the payroll returns to reflect the correct information. This is sometimes called a “back door disclosure” and if you take this route, you should work with a trustworthy tax professional who understands this credit and can help you correct your returns.
Should You Claim the ERC Credit?
If you meet the criteria to claim the credit, you should absolutely claim it if you haven’t already. This credit was designed to help employers get through COVID, and at the time of writing, it’s still available. Take a look at these instructions for claiming the ERC.
The refund statute of limitations is the same as the audit statute of limitations — three years. That means you can amend your payroll returns to claim the ERC on 2020 returns up to April 15, 2024, and you can amend 2021 returns to claim this credit up until April 15, 2025.
Note that the extended audit deadline does not extend the deadline to claim a refund. Even if you’re eligible for employee retention credits for the third and fourth quarters of 2021, you only have until April 15, 2025, to claim them.
Keep in mind, however, that if you claim this credit, that effectively reduces how much you spent on wages. By extension, you need to reduce the wage expense on your business tax return accordingly. In most cases, that will lead to a tax bill, but generally, it will be much lower than the value of the ERC.
Get Help With ERC Audits, Amending Payroll Returns, and More
Business taxes are complex, and they’re even more confusing when you’re dealing with COVID-era credits like the employee retention credit. To protect your business, you need to file your returns correctly, and you need to ensure that you’re audit-proof.
Want guidance? Then, contact us at Damien’s Law today. Regardless of where you are at in this journey. We can help you. We are a boutique tax law and tax resolution firm. We work closely with all of our clients to ensure that they get high-quality services tailored to their specific situations.