The Employee Retention Credit (ERC) was a significant relief measure for businesses during
the COVID-19 pandemic. However, due to widespread fraudulent claims, many businesses are now facing audits and are required to repay the credits along with penalties and interest. This situation is particularly challenging for taxpayers who used the ERC refunds to pay off tax debts, only to be later charged penalties and interest when forced to repay the inappropriately claimed ERC.
Audit Process and Its Implications
Audit Initiation:
IRS Investigation: Due to the high volume of potentially fraudulent claims, the IRS has increased its focus on ERC applications. Businesses that received the credit are more likely to be audited.
Notification: Businesses selected for audit receive a notification from the IRS, outlining the scope of the audit and requesting documentation to support their ERC claims.
Audit Procedure:
Document Examination: The IRS reviews payroll records, revenue reports, and other
financial statements to verify the accuracy of the ERC claim.
Eligibility Assessment: Auditors check whether the business met the necessary
criteria, such as experiencing a significant decline in gross receipts or a government-
mandated shutdown.
Claim Accuracy: The IRS ensures that the amount claimed is accurate and that no
errors or false information was submitted.
Consequences of an Unfavorable Audit
Repayment Requirements:
Immediate Repayment: Businesses found to have improperly received the ERC must
repay the full amount. This repayment is often required quickly, creating financial strain.
Penalties: In addition to repaying the credit, businesses may face penalties, including
accuracy-related penalties.
Interest: Interest accrues on the amount owed from the date the original credit was
issued until repayment is completed, significantly increasing the total amount owed.
Financial Impact:
Operational Strain: The financial burden of repaying the ERC, along with penalties and interest, can severely impact a business's operations, potentially leading to reduced
staffing, delayed projects, or even the risk of bankruptcy.
Credit and Reputation: Businesses undergoing audits may find their creditworthiness questioned, making it harder to secure loans or investment. Additionally, the reputational damage from being associated with fraudulent claims can affect relationships with clients and partners.
Tax Debt: After the audit is completed, the new debt will be categorized as an IRS tax
debt owed. The company will now have to work with the IRS to pay back the money
owed.
Personal Liability: If an audit is complete and an assessment is made, that
assessment may include Trust Fund tax that can be personally assessed by the
IRS to the individuals determined to be willful and responsible for the liability
accrual. If this occurs, the IRS will evaluate the collection potential from not only
the business but also any/all personally assessed individual(s).
As it stands, the IRS has not outlined any specific parameters for resolution of debts
stemming from ERC audits. This may change in the future but, at this time, all traditional
resolution options are available to taxpayers. The IRS may limit these resolution options
in the future for debts arising from ERC audits.
Resolution Options for Affected Businesses
Description: This option allows taxpayers to settle their tax debt for less than the full
amount owed if they can prove that paying the full amount would create financial hardship.
Eligibility: Businesses must demonstrate that they cannot pay the full amount or that
paying it would create economic hardship.
Application: Submitting an Offer in Compromise involves a detailed application process where the IRS reviews the taxpayer's income, expenses, assets, and liabilities.
Description: Penalty abatement provides relief from penalties for taxpayers who can
demonstrate reasonable cause for failing to comply with tax laws.
Eligibility: Businesses may qualify if they can show that they had reasonable cause,
such as significant illness, natural disasters, or relying on erroneous advice from a tax
professional.
Application: To request penalty abatement, businesses must file a written request with the IRS, explaining the circumstances that led to the non-compliance.
Description: An installment agreement allows taxpayers to pay their tax debt in monthly installments if they cannot pay the full amount at once.
Eligibility: Most taxpayers qualify for an installment agreement, but the terms depend on the total amount owed and the taxpayer's financial situation.
Application: Businesses must apply to the IRS, detailing their financial situation and
proposing a monthly payment amount.
Description: If businesses realize they have made errors in their ERC claims, they can
amend their tax returns to correct the mistakes.
Benefits: Amending returns before an audit can demonstrate good faith and may result in reduced penalties.
To learn more about your options - contact us for a no-hassle. free consultation with one of our tax experts.
Conclusion
While the Employee Retention Credit aimed to support businesses during a difficult time, it has also led to significant challenges due to widespread fraud. The financial and operational impacts of audits and repayment demands can be severe, particularly for those who used ERC refunds to pay off tax debts. Businesses affected by these issues should seek professional advice to understand their resolution options, such as Offer in Compromise, penalty abatement, and installment agreement, to mitigate the adverse impact on their financial health and operations.
LMU Consulting Group's Role: For businesses navigating the complexities of ERC audits and repayments, the tax professionals at LMU Consulting Group offer expert guidance and support.
By leveraging their experience, businesses can better manage their audit responses and
explore strategies to minimize financial burdens. If you need assistance, consider contacting
LMU Consulting Group to help address your ERC-related challenges.
