Considerations for IRS examinations of ERC claims.

AuthorStigile, Cory

This column summarizes recent developments in the IRS's civil enforcement of the employee retention credit (ERC), with a focus on its examinations. The IRS has been active in alerting taxpayers and tax professionals regarding attempts to promote ERCs to ineligible taxpayers, recently including ERC schemes on its 2023 Dirty Dozen list (News Release IR-2023-71).Tax practitioners who worked to properly document and report these important credits regularly receive calls from clients regarding ERC solicitations. For their clients who have claimed an ERC, practitioners can help prepare for any IRS examination by reviewing which documents revenue agents are likely to request and knowing how they will review this information. Sec. 3134(1) provides a five-year statute of limitation for examination of taxpayers' ERC-related amounts, which gives the IRS additional time to conduct these examinations.

As background, the IRS published guidance in Notice 2021-20, Notice 2021-23, and Notice 2021-49 setting forth requirements for substantiation of eligibility and document retention related to each of the three iterations of the ERC in 2020 and 2021 (see also Nellen, "Documenting COVID-19 Employment Tax Credits,"53-1 The Tax Adviser 36 (January 2022)). Revenue agents will anticipate compliance with these documentation requirements. Accordingly, return preparers should retain the required information, having analyzed their clients' eligibility according to the differing ERC requirements between March 2020 and the end of 2021.

As indicated in the Dirty Dozen list, a substantive examination of ERC positions would be preceded by an initial inquiry into whether the ERC claim was part of a scam, including an identity-theft scheme. Consider establishing early in the examination that the payroll tax returns setting forth eligibility for the ERC were prepared by a longtime trusted adviser and return preparer or at least reviewed or referred by one.

It should be relatively clear whether an examination pertains to an ERC position, because the IRS's initial information document request (IDR) will likely refer to Form 941, Employer's Quarterly Federal Tax Return, (or Form 941-X, Adjusted Employer's Quarterly Federal Tax Return or Claim for Refund) for the period at issue and expressly state that the IRS needs to review documentation to determine whether the taxpayer is an eligible employer for purposes of the ERC.

As a procedural matter, although employers may have received advance payments of the ERC by filing Form 7200, Advance Payment of Employer Credits Due to COVID-19, the amounts under examination would be the credit amounts reported on an employer's employment tax returns, as they are the final credit amounts posted to the employer's tax accounts. Still, Form 7200 provided the Service an opportunity to review ERC information earlier in the filing period, such as the total number of employees to whom the taxpayer paid qualified wages, prior-year employee information, and information about other credits. Consider these prior representations as information is provided during the examination.

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