The IRS has been warning for months about improper Employee Retention Credit claims, and the audits are now underway. If your business claimed the ERC, particularly through a third-party promoter, you need to evaluate your exposure and prepare for the possibility of IRS scrutiny. Here is how to assess your risk and what to do about it.
Why the IRS Is Concerned
The ERC was designed for businesses that either experienced a significant decline in gross receipts or were subject to a full or partial suspension of operations due to government COVID-19 orders. What happened in practice was an explosion of claims filed through aggressive promoters who told nearly every business they qualified, regardless of their actual circumstances. The IRS has estimated that a significant percentage of claims, particularly those filed after the initial wave, are ineligible.
Red Flags the IRS Is Looking For
Your claim has higher audit risk if it was filed by a promoter who charged a percentage of the credit (rather than a flat fee), the promoter contacted you unsolicited (cold call, mailer, social media ad), you claimed the credit for quarters where your business was fully operational without government restrictions, your gross receipts did not actually decline by the required percentage, or the claim was based on a broad “supply chain disruption” argument without specific documentation tying the disruption to a government order.
How to Evaluate Your Claim
Pull your Form 941-X filings and review the basis for each quarter’s claim. For claims based on a decline in gross receipts, verify the math: compare quarterly gross receipts to the same quarter in 2019 (or 2020 for 2021 claims). The decline must be greater than 50% for 2020 quarters or 20% for 2021 quarters.
For claims based on a government order suspension, identify the specific federal, state, or local order that caused a full or partial suspension of your operations. “Supply chain disruption” alone is not sufficient; there must be a direct connection between a government order and the restriction of your business activities.
Your Options
If you believe your claim was valid, organize your supporting documentation and be prepared to respond to an IRS inquiry. If you have concerns about eligibility, the IRS has opened a Voluntary Disclosure Program that allows you to repay 80% of the credit received without penalties. For claims still in process, you can withdraw them before they are paid.
Do not ignore this. The IRS has made the ERC its top enforcement priority, and the consequences of an invalid claim range from full repayment with penalties to criminal prosecution for fraud. Get independent advice from a tax professional who did not file your original claim.