While the IRS hasn't (and likely won't) release exact figures, it's important to note that most tax filings have a 3-year statute of limitations for audits. However, the timeline for ERC audits was expanded to 5 years by the American Rescue Plan Act (ARPA).
If we read between the lines, nearly doubling the statute of limitations for their audits implies that the IRS will be taking more time to review these claims.
Claims that contain certain risk factors are somewhat more likely to be audited. These factors include things such as:
Claiming a larger refund amount
Eligibility claimed under a government shutdown order, particularly for partial suspension
Companies that may be susceptible to the IRS's aggregation rules
However, while each of these risk factors could increase your likelihood of triggering an ERC audit, you shouldn't let them hold you back from making your full claim. As long as you document all aspects of your claim, you should have nothing to worry about if the IRS chooses to audit your business.
What will an ERC audit cover?
Eligibility for the ERC program is based on several qualifying factors, and each of these factors is open for scrutiny in an audit. If you are audited, you will need to be able to back up your claim with proof of:
Initial eligibility based on gross receipts or government shutdown orders
Qualifying quarters (or portions of quarters, if qualifying under shutdown orders)
Qualified employee wages
The calculation of your claim
Here at ERC Go, we stand behind the accuracy of our calculation. However, it will be your responsibility to provide the supporting documentation necessary for all other aspects of an audit.
Some of the initial documentation requests from the IRS have included things like payroll journals, previously filed tax forms, lists of employees and owners, PPP loan forgiveness applications, employee health plan expenses, and more.
What kind of proof will I need for eligibility based on gross receipts?
If your ERC claim in any quarter is based on a decline of gross receipts, you will need to prepare and save any documents or records you used to calculate those gross receipts.
Some of the IRS's initial audit requests have included documentation such as spreadsheets that provide a detailed line by line breakdown of all line items used to calculate gross receipts, as well as how that breakdown was reconciled with yearly gross receipts.
One important thing to note about the calculation of gross receipts for an ERC refund is that it isn't necessarily the same as calculating gross receipts for your business's account books.
You will need to make sure the gross receipts calculated for each quarter match the IRS's definition of gross receipts, which includes:
Total product sales (minus returns and allowances)
All amounts received for services
Income from investments, including interest, dividends, rents, royalties, and annuities
In addition, the IRS has also stated that, if applicable, gross receipts for ERC purposes do not need to include PPP loan forgiveness amounts, shuttered venue operator grants, or restaurant revitalization grants.
What kind of proof will I need for eligibility based on government shutdown orders?
Claiming an ERC refund under the criteria of a government mandate is often a little bit trickier to document.
For starters, you have to find proof of a government mandate for your area.
And then, if your business was only partially suspended, you will also need to document that your business was more than nominally affected.
How do I document government shutdown orders?
In case of an IRS audit, you will want to already have a copy of the actual government shutdown order, plus a record of the dates it was in effect. The orders can come from either the federal government or your state or local government, and should either:
Restrict group meetings
Limit commerce, or
Reduce hours of operation
Outside of these parameters, things like interviews, press conferences, or statements made by government officials do not count as government shutdown orders, and state of emergency or other declarations only count if they limit travel, commerce, or meetings in some way.
Finally, guidance from health departments or the CDC must be accompanied by actual shutdown orders in order to constitute a government mandate.
How do I document the impact of a government shutdown order?
In order to support your ERC claim eligibility under a government order that partially suspended your business, you will need to document how the order(s) impacted your business.
Some of the factors you may want to consider including in your explanation could include things such as:
How capacity restrictions affected your ability to do business
Employees being unable to complete all functions of their job in a comparable manner
Work hours and productivity being affected by mandates for cleaning, sanitizing, etc.
Which portions of your business operations were suspended, and
Why those portions were such an important part of your business
You will also want to include the dates that each of these factors impacted your business as part of your documentation.
How do I document that my business was "more than nominally" impacted by a partial shutdown order?
If your business was only partially suspended or shut down by a government order, you have an additional responsibility to provide documentation and proof that the impact on your business was "more than nominal."
The IRS's proposed guidelines for measuring nominal impact are:
The suspended portion of a business constituted 10% or more of the business's total gross receipts for the same calendar quarter in 2019
The hours worked by employees in the suspended portion constituted 10% or more of the business's total employee hours for the same calendar quarter in 2019
However, these guidelines are not meant to serve as a baseline standard. The IRS has confirmed that, based on the unique facts and circumstances of your business, it could still qualify as nominally impacted even if neither of these specific situations apply.
One such example could be in regards to government suspension orders affecting your business's suppliers. If your supplier is ordered to suspend operations in their area, and you are unable to secure alternate suppliers, your business may be considered nominally impacted.
Regardless of which metric your business uses to demonstrate nominal impact, you will need to supply documents that help quantify the impact you are claiming.
f you're using the IRS's proposed criteria, for example, you should gather documents that support either the gross receipts or employee hours for the suspended portion in both the quarter(s) you're claiming and the corresponding quarter in 2019.
Who should write my explanation of impact?
Usually the business owner—or their representative—is best equipped to write the explanation of impact for your business. As the owner, you are the most likely to have a clear, overarching view of how your business has changed and been affected by government orders.Alternatively, you could have your business's legal team write a memo. In it, they should cite the specific government orders that affected your business and explain how your business's response to those orders adhered to the IRS's proposed guidelines legal memo that cites specific gov orders and how position followed IRS guidance.
Why do I need to document dates related to government shutdown orders?
Recording the dates of government mandates—and how long they impacted your business for—is important because the IRS has said that only wages paid to employees during the time the order was in place can be counted as qualified wages for the ERC.
Basically, if a government order ended in the middle of a quarter, you can only claim the portion of wages paid up until that date, instead of those paid over the whole quarter like you can for ERC claims based on the gross receipts test.