Did you file amended tax returns to claim the Employee Retention Credit (ERC)? Here’s what you should know if your claim is selected for examination by the IRS.

IRS enforcement efforts -

For the past few months, the IRS has been warning taxpayers that they will be stepping up enforcement and reviewing ERC claims possibly due to various ERC mills brashly pressuring ineligible companies to file claims or increasing their already filed claims for the credit. Unfortunately, due to stepped-up IRS enforcement, many companies with eligible claims will be selected for examination. Thankfully, if a company’s claim was properly documented when filed, being selected for examination should not be a cause for concern.

The examination letter the IRS is sending is accompanied by an information document request list which outlines “request items”. We have listed below some of the more significant items and any company who has claimed ERC credits should make sure they are properly prepared, in the event of an examination.

Significant Request Items –

1. “Copy of Form 941-X for all four quarters of 2020 and 2021, if applicable.”

Although the request letter will typically be for one tax year (either 2020 or 2021), the IRS will be asking for copies of amended 941-X forms for both years as part of their examination. The IRS will be looking for signs of ineligible ERC claims in both years, so companies should be prepared for ERC claims in both years to be examined.

2. “All tax returns for any related entities (if applicable) for the selected tax year.”

ERC refund claims are taxable in the year the ERC claim was generated. That means that any refunds from ERC claims should be picked up as taxable income on that year’s tax return.

In other words, if during 2022, a company files an ERC claim for wages paid in 2021 and receives the refund in 2023, the taxable ERC refund is required to be reported on the company’s 2021 tax return. It does not matter whether the taxpayer is on the cash or accrual basis for tax purposes. The company in this instance would most likely need to file an amended 2021 tax return to properly report the ERC claim.

The issue of whether or not an income tax return was amended to pick up the income from the ERC claim may come up under examination.

3. “Copies of the following documents will be requested for the applicable tax year: income tax returns, employment tax returns, forms W-2 and W-3.”

If one company of an aggregated group is selected for examination, the ERC claim for all companies in the aggregated group will be examined. Additionally, the IRS will be looking to see if all related entities were aggregated (where/when required) in assessing eligibility.

4. “If your operations were fully or partially suspended due to orders from an appropriate governmental Authority, please provide a copy of that order.”

Please remember, in the event a company qualified for the ERC on the basis of a qualified government shutdown order, copies of the specific shutdown order that a company is relying on will need to be provided to support ERC claims.

The so-called limited commerce or supply chain impact blanket eligibility that is not associated with any particular shutdown order that many ERC mills have used to qualify some companies is untested under IRS examination. Companies filing ERC claims under a shutdown order should make sure they have copies of the specific applicable shutdown order, with support showing the ways they were impacted financially and operationally.

5. Lastly, the IRS will likely ask for the engagement letter and proof of payment to the provider that prepared your ERC claim. They will be looking to see if they are experienced professionals and how they based their fees.

Do you have to take any action?

Again, if prepared properly, your ERC claims were designed to be IRS examination ready. So, there shouldn’t be any action you need to take. Most of the information the IRS is requesting should have been previously compiled and ready for examination.

Wondering if your ERC supporting documentation is IRS examination ready? We can help. Contact us.