IRS audits of employee retention credit claims impacting tax-exempt organizations

Although we all knew IRS examinations of Employee Retention Credit (ERC) claims were likely to occur, this possibility is now a reality as many not-for-profit (and for-profit) organizations are receiving these IRS notification letters. It is important to remember that just because an organization was picked for examination does not mean the ERC refund claim was erroneous. However, receipt of this correspondence does require an organization to revisit positions and computations supporting prior refund claim(s) – all in an effort to avoid having to repay amounts previously refunded or denial of a refund claim.

When organizations made their original ERC assessment, much time should have been devoted to ensuring eligibility was properly addressed and calculations were accurate. The possibility of the IRS now auditing these records is causing many organizations to revisit these complex questions as it relates to each quarterly payroll tax return which claimed the ERC. 

• Did the organization calculate its average full-time employees accurately?
• Were aggregation rules properly applied?
• Did the organization meet the reduction in gross receipts test?
• Was the organization subject to a full or partial government shutdown or suspension order?
• Were wages properly allocated to the various COVID relief programs – PPP, ERC, specific grants, etc. and no double dipping has occurred? 

As we have reviewed multiple Information Document Requests (IDRs) received by our clients and public communications concerning these audits, it is clear the IRS intends to continue its focus on ERC. With the IRS continuing to train up teams of specialists to specifically audit ERC refund claims, IRDs requesting detailed documentation, and the extended statute of limitations on the claims (from the typical period of 3 years from the date of filing to 5 years for certain quarters), it is clear the IRS is going to be looking at many organizations to ensure the refund claim is valid and further, of an appropriate amount.  

In addition to the details of the computation itself, the IRS is requesting documentation concerning the organization’s eligibility to claim the ERC. This eligibility memo is the most essential document in the ERC process since it provides the initial foothold for which the credit may be claimed. Along with the eligibility memo, additional support of the credit is required. For organizations with operations that were fully or partially suspended due to governmental orders, it is necessary to provide a copy of the specific order, and a detailed narrative covering how that order directly impacted the business. Where an organization is claiming the credit due to a significant decline in gross receipts during the calendar quarter for which the ERC was claimed, the detailed computation for each applicable quarter is required. Lack of adequate documentation will likely result in a denial and required repayment of a refund claim.

While the IDRs we have seen thus far do not specifically request source documents such as tax filings or financial statements, we also encourage clients to ensure all documentation ties to the financial records of the organization should it not have been done already. This review of existing documentation is being done in an effort to eliminate potential discrepancies between the supplied documents and financial data. In today’s world of management and employee turnover, it is much better to review and thoroughly document your organization’s ERC position with team members familiar with the decision-making process vs. being in a position of doing so when the IRS IDR arrives 2-4 years into the future.

With the possibility of IRS ERC examinations, now is the time to ensure your organization’s documentation and support for your refund claims are readily accessible. Even if your organization is not in receipt of an IRS examination notice, it is recommended that you take the time to review the adequacy of your records supporting the ERC claim. If you identify any missing documents or support that was analyzed in determining eligibility, it should be gathered and archived now. These simple steps may eliminate additional future time and effort should you receive an IRS examination notice.  

Please reach out to your Baker Tilly advisor if you have questions regarding the audits of ERC or other tax matters.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely.  The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.