IRS ERC Crackdown: 9 Red Flags Business Owners Must Review

The IRS is intensifying audits of Employer Retention Credit (ERC) claims. With over a million ERC applications received, totaling $86 billion in credits, the IRS is carefully scrutinizing each claim. Here are nine red flags that could trigger an audit of your ERC claim and what to watch out for.

Here are nine red flags that could trigger an audit of your ERC claim and what to watch out for.

1. Essential Businesses Operating During COVID-19

If your business was deemed essential and continued operations during the pandemic without a significant drop in revenue, your ERC claim might raise eyebrows. Essential businesses, like construction, healthcare, and grocery stores, often do not meet the criteria for partial or full suspension. The IRS will want to see evidence showing how COVID-19 affected your operations. If your business remained operational and your revenue stayed stable, you might not qualify for the ERC.

What to Do:

  • Document Your Operations: Keep detailed records of your business activities during the pandemic. This includes sales reports, customer interactions, and any changes to your operations.
  • Provide Clear Evidence: If you experienced disruptions, such as supply chain issues, make sure to document these instances clearly.

2. Inability to Prove Government-Mandated Suspension

To qualify for the ERC, businesses must show that a government order directly impacted their operations. For instance, if you were in the trade show industry and had contracts canceled due to government restrictions, you could use those contracts as proof. Without solid evidence demonstrating how a government order affected your business, the IRS may closely scrutinize your claim.

What to Do:

  • Gather Documentation: Collect documents that show the specific government orders that affected your business. This could include emails, official notices, or public announcements.
  • Make a Clear Case: Ensure that your documentation clearly connects the government order to your business’s operations.

3. Including Family Member Wages

If your business includes wages paid to family members of a majority owner in your ERC calculation, it could trigger an audit. The IRS requires that these wages be excluded from the ERC calculation. Therefore, it’s essential to review the data used to calculate the ERC and ensure family member wages are not included.

What to Do:

  • Review Payroll Records: Go through your payroll records and identify any payments made to family members.
  • Exclude Ineligible Wages: Make sure that any wages that do not qualify are removed from your ERC claim.

4. Using Wages for PPP Loan Forgiveness

You cannot use wages that were already applied for Paycheck Protection Program (PPP) loan forgiveness for your ERC claim. The IRS does not allow “double-dipping” – that is, using the same wages for two different benefits. Be sure to check the wages you used for PPP calculations to ensure they are not included in your ERC claim.

What to Do:

  • Track Your Wages Carefully: Keep accurate records of which wages were used for PPP and which are being claimed under the ERC.
  • Avoid Double Counting: If you used any wages for PPP forgiveness, ensure they are not included in your ERC claim.

5. Claiming Too Many Quarters

It’s important to remember that your business may not qualify for the ERC in all quarters. The IRS will review each quarter carefully to determine eligibility. If your gross receipts improved in a particular quarter, you might not qualify for that period. Ensure that you only claim eligible quarters to avoid issues.

What to Do:

  • Assess Your Revenue by Quarter: Review your gross receipts for each quarter during the eligibility period.
  • Claim Only Eligible Quarters: Only submit claims for quarters where you meet the necessary criteria for the ERC.

6. Non-Qualifying Government Orders

Voluntary business suspensions, where you choose to close without a government order, do not qualify for the ERC. If you shut down your business without an official mandate, your claim might be deemed ineligible. It’s crucial to confirm that your suspension aligns with government orders to support your ERC claim.

What to Do:

  • Review Suspension Reasons: Ensure that any suspension of business operations was due to a government mandate.
  • Clarify Your Business Decisions: Document any decisions made regarding business operations to show they were influenced by external factors.

7. Wages Not Subject to FICA

To qualify for the ERC, the wages you claim must be subject to FICA (Federal Insurance Contributions Act) taxes, which fund Medicare and Social Security. If your ERC claim includes wages not subject to these taxes, it may raise red flags during an audit. Verify that all wages in your claim meet this requirement.

What to Do:

  • Understand FICA Taxes: Familiarize yourself with which wages are subject to FICA taxes.
  • Check Your Payroll Reports: Make sure that the wages you are claiming for the ERC are indeed subject to these taxes.

8. Including Too Many Tax Periods

Some businesses can only claim ERC for wages paid during the suspension period, not the entire quarter. The IRS looks for clear evidence of the start and end dates of the suspension. Review your claim to ensure it accurately reflects the eligible periods.

What to Do:

  • Identify Suspension Dates: Clearly document the dates when your business operations were suspended.
  • Limit Claims to Eligible Periods: Ensure that your ERC claim only includes wages for the eligible timeframes.

9. Non-Existent Businesses or Fraudulent Claims

If your business did not exist during the eligibility period or you did not pay any wages, the IRS will see this as fraud. Accurate and truthful reporting is crucial to avoid severe penalties, including potential criminal charges.

What to Do:

  • Ensure Business Legitimacy: Make sure your business is properly registered and documented.
  • Report Honestly: Always provide truthful information on your ERC claims to avoid any issues with the IRS.

Navigating IRS Scrutiny

The IRS is actively investigating ERC claims and has already opened around 450 criminal investigations. If you receive notice from the IRS regarding your ERC claim, it’s essential to seek professional assistance immediately. A tax professional can help you navigate the complexities of IRS audits and ensure compliance.

Need Help?

If you’re facing an ERC audit, don’t hesitate to contact John Milikowsky at Milikowsky Tax Law for expert guidance. They can help you understand the audit process, address any issues, and ensure you meet all necessary requirements for the ERC. It’s better to be prepared and informed than to risk complications with the IRS.