How to Avoid IRS Audit Warning Signs Related to the ERTC

July 27, 2023
Dayes Law Firm

The ERTC/ERC (Employee Retention Tax Credit/Employee Retention Credit) benefit, designed to compensate employers for keeping employees on payroll throughout the COVID-19 pandemic, can give your business a major financial boost. However, some small business owners report that their ERC application has led to an IRS audit. Why does this occur, and how can your business avoid generating IRS audit warning signs for ERTC?

Why Is the IRS Auditing ERC Claims?

The IRS is currently putting a lot of effort into filtering through ERC claims and auditing businesses that might have applied for the credit while failing to meet eligibility requirements. This is happening chiefly because some unscrupulous business owners have abused tax benefits and provided false information on their applications. The IRS has issued repeated warnings against unlawful ERTC claims. 

Moreover, eligibility criteria for ERTC may be complex. Many honest employers who apply for ERTC in good faith fail to understand eligibility requirements or make mistakes in their application, which could trigger an audit not just of your ERC claim but also of other aspects of your business. 

How to Avoid IRS Audit Warning Signs for ERTC

The IRS may decide to audit businesses or individuals who claim any credit, like the ERTC or Earned Income Tax Credit, completely randomly. However, IRS audits typically happen because something in the tax filing documents triggers suspicion. 

When assessing your ERTC claim, the IRS will focus on:

  • General eligibility of your business for ERTC
  • Scrutiny of the amount you claim as a tax credit

If your business was only partially suspended due to COVID-19 restrictions, you’d need to show that government orders led to a substantial negative impact on your business operations. 

Some red flags that could trigger an ERTC-related IRS audit include:

  • Any discrepancies in income or expenses between different tax forms your business files
  • Claiming a disproportionately large drop in gross receipts
  • Insufficient proof of disrupted business operations during the pandemic

If the IRS audits your ERTC claim and uncovers any errors, you could face an accuracy penalty of 20% or a penalty of 75% in case the IRS classifies your claim as civil fraud. That’s why it’s crucial to consult a reputable tax professional before you apply for ERTC and prepare any supporting documentation in advance, just in case you face an audit.

What to Do if Your Business Faces an IRS Audit

Working with a competent tax attorney can help you dodge the IRS audit warning signs for ERTC. However, even if you do everything right, the IRS may still choose to audit your business. If this happens, don’t panic; cooperate with the IRS officer, and consult your tax lawyer regarding your next steps. 

If the IRS is auditing your business to check your eligibility for the ERTC benefit, you may have to provide supporting documentation such as:

  • Evidence of your business operations suffering because of pandemic-related government restrictions
  • Documents recording your decline in gross receipts
  • Records of your employees’ income level during the pandemic
  • Any relevant tax filing documentation, like Forms 941 or 941-X

Dayes Law Firm: Helping Your Business Avoid or Handle an IRS Audit-Related to ERTC

At Dayes Law Firm, we can help you prepare and file your ERTC application to reduce the chance of an IRS audit. But if your business still faces IRS scrutiny, our experienced tax professionals can instruct you on complying with IRS requirements and help you navigate the audit process. 

Are you unsure whether any employee retention credit claimed by your business may trigger an IRS audit? Call 800-503-2000 for a free consultation on avoiding the IRS audit warning signs for ERTC.