Beware: ERC audit documentation demands are onerous
Misinformation about the Employee Retention Credit (ERC) is all over radio, TV, social media and the internet and has caught the attention of the IRS. A recent IRS Form 4564 Information Document Request (IDR) sent to an employer under audit for the ERC claimed for 3rd quarter 2020 was posted in redacted form on Twitter revealing the onerous documentation required to substantiate the claim:
Copy of worksheets and/or reconciliation used to compute the credits and other amounts included on the employment tax returns (each Form 941X) related to the credits.
Copy of the original Form 941 for 3rd quarter 2020 ended September 30, 2020.
A list of employees who were paid wages for which the Employee Retention Credit was claimed.
Whether any of the employees who received wages included in the Employee Retention Credit are related individuals.
The date and amount of wages paid to each employee for which the Employee Retention Credit was claimed.
For large employers, documentation on how the employer determined that the employees were not providing services.
Documentation that the business was eligible to claim the Employee Retention Credit (whichever of the following is applicable)
Documentation with the dates that operations were fully or partially suspended due to orders from an appropriate government authority limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to COVID-19 or a supply chain disruption caused a suspension. Provide a copy of any governmental order in effect during the period July 1, 2020, through September 30, 2020, highlighting the specific provisions of the governmental order causing the full or partial suspension of business operations. (Do not include recommendations by governmental or other authorities or other statutes, orders or other documents that are not related to COVID-19.)
Documentation that you experienced a significant decline in gross receipts [emphasis added] during the calendar quarter for which the Employee Retention Credit was claimed. Provide a complete copy of financial or earning statements detailing the gross receipts for the 3rd quarter 2020, as well as for the taxable quarter ended December 31, 2020, March 31, 2021, June 30, 2021 and September 30, 2021. Provide the name(s) of the affected employees, and the amount of wages paid to each worker for each date of the decline in gross receipts. [A "significant decline" is determined by identifying the first calendar quarter in 2020 (if any) in which an employer’s gross receipts are less than 50 percent of its gross receipts for the same calendar quarter in 2019. See Notice 2021-20]
Documentation that is a recovery startup business during the calendar quarter for which the Employee Retention Credit was claimed.
U.S. Income Tax Return for a Corporation for 2020 and 2021, for information only.
Copies of consolidated employment tax returns, and Forms W-2 for related entities (if the business is a member of an aggregated group),for information only.
Form 1040, U.S. Individual Income Tax Returns for the tax year(s) 2020 and 2021. Include all Schedules), for information only.
Copies of State Unemployment Tax Returns for the tax year(s) 2020 and 2021. (All 4 quarters - for information only).
Copies of all prior audit reports relating to income or employment taxes by any Federal or State Agencies.
Are any of the employees who were paid employee retention wages related individuals to a shareholder owning 50 percent of the capital and profits interest in the entity? If yes, please provide the name of the employee or employees.
Documentation whether the business received forgiveness of a PPP loan (if applicable)
Copy of the employer's forgiveness letter received from loan provider and/or SBA (if applicable).
Documentation related to any PPP loans and related forgiveness including what wages were included on that loan application. (Include a comparison to show which employee wages made up the PPP loans and which employee wages made up the Employee Retention Credits to ensure there was no overlap).
The IRS documentation requirements for ERC audits are onerous, however, according to an ASPCA Tax Digest post by Edward K. Zollars, CPA item 7(a) includes language that contradicts what many ERC scammers have been pushing, "Provide a copy of any governmental order in effect during the period July 1, 2020, through September 30, 2020, highlighting the specific provisions of the governmental order causing the full or partial suspension of business operations. Do not include recommendations by governmental or other authorities or other statutes, orders or other documents that are not related to COVID-19." Zollars contends that taxpayers who filed an ERC must show the, "specific order and be able to demonstrate that such order led to the full or partial suspension of business. Relying on mere recommendations from agencies like the CDC are inapplicable".
According to IRS Notice 2021-20 , Guidance on the Employee Retention Credit under Section 2301 of the Coronavirus Aid, Relief, and Economic Security Act, the IRS considers a partial suspension to require showing a more than nominal impact on the business. The IRS defines a "nominal impact" as, "A reduction in an employer’s ability to provide goods or services in the normal course of the employer’s business of not less than 10 percent will be deemed to have more than a nominal effect on the employer’s business."
What “orders from an appropriate governmental authority” may be taken into account by an employer for purposes of determining eligibility for the employee retention credit?
Governmental orders include:
An order from the city’s mayor stating that all non-essential businesses must close for a specified period;
A State’s emergency proclamation that residents must shelter in place for a specified period, other than residents who are employed by an essential business and who may travel to and work at the workplace location;
An order from a local official imposing a curfew on residents that impacts the operating hours of a trade or business for a specified period;
An order from a local health department mandating a workplace closure for cleaning and disinfecting.
Government orders do not include:
Statements from a governmental official, including comments made during press conferences or in interviews with the media, do not rise to the level of a governmental order for purposes of the employee retention credit.
The declaration of a state of emergency by a governmental authority is not sufficient to rise to the level of a governmental order if it does not limit commerce, travel, or group meetings in any manner.
Further, such a declaration that limits commerce, travel, or group meetings, but does so in a manner that does not relate to the suspension of an employer’s operation of its trade or business does not rise to the level of a governmental order for purposes of the employer’s determination of its eligibility for the employee retention credit.
Misinformation about the Employee Retention Credit is all over radio, TV, social media and the internet. These scammers lure taxpayers with promises of fast money, an "easy application process" and lie about eligibility in exchange for sizeable fees. Unfortunately, unwitting taxpayers selected for audit will learn the time spent filing an ERC will pale in comparison to assembling documentation to substantiate eligibility for the claim.
About the author
Mark W. Sullivan, EA founded Sullivan Consulting in 1998. He specializes in federal tax controversy representation, appeals and consulting on behalf of individuals, businesses, law, and accounting firms nationwide. In addition, he has served as the consulting and expert witness in numerous civil and criminal cases in multiple federal district courts.
Mark has an unlimited Enrolled Agents license and is admitted to practice before the Internal Revenue Service based on his extensive experience as a Revenue Officer in New York, NY, St. Louis, MO and Washington, D.C..
Copyright 2023 Mark Sullivan Consulting, PLLC.
Disclaimer: This article is for information purposes only and cannot be cited as precedent or relied upon in a tax dispute before the IRS.
Tax Digest - ASCPA, Edward K. Zollars, CPA, Thomas, Zollars & Lynch, Ltd, Kaplan Financial Education, May 9, 2023