ERC Audit Penalties and Assessing your Audit Risk
The IRS has announced that it plans to focus on ERC audits over the next few years. The agency has trained about 300 employees to handle these audits, and at the time of writing, the IRS is sending out ERC audit notices to business owners who claimed this credit.
If you’ve already received an audit notice, reach out for help today. The tax attorneys at Wiggam Law can help you navigate the ERC audit and get the best results possible. So that you know what to expect, this post looks at ERC fines and penalties. Then, it explains how long the IRS has to audit payroll tax returns with ERC claims.
ERC Audit Penalties
Failing an ERC audit carries the same types of penalties and fees as any other IRS audit. If you fail an ERC audit, the auditor will remove your credit from the tax return. This will create a tax liability, and you may also incur the following fees:
The accuracy-related penalty is 20% of the underreported tax. To explain, imagine that you fail the audit and lose the ERC which increases your tax bill by $10,000. Therefore, if the auditor assesses an accuracy-related penalty, it will be an additional $2,000 penalty.
You don’t automatically get an accuracy-related penalty if you fail an ERC audit. The IRS usually only applies this penalty if you were negligent about following the tax laws.
Tax Fraud Penalty
The IRS has announced that it is going to review ERC claims for criminal and civil tax fraud. The penalty for civil tax fraud is 75% of the unreported tax. So, if the audit increases your tax bill by $10,000, this penalty would be an additional $7,500.
Criminal tax fraud charges are rare, but if the IRS brings criminal charges against you, you can face up to five years in prison, and the penalties can be up to $100,000.
The failure-to-pay penalty is typically 0.5% of your tax liability. If the auditor decides to apply this penalty, the IRS may backdate the penalty to the date that you should have paid the tax. In some cases, the auditor may decide to apply the failure-to-deposit penalty instead. This penalty can be up to 10% of your unpaid tax.
Additional Financial Consequences of ERC Audits
The ERC penalties aren’t the only financial consequences you may face if you fail an audit. Taxpayers claimed the ERC on employer tax returns such as the 941 and 944, but these credits also had implications on filers’ business income tax returns. When you claim the ERC, you are supposed to reduce the wage expense on your business tax return.
Depending on the situation, this can have a few different implications during the audit. Take a look at the following scenarios.
Imagine that you pass your ERC audit, but during the audit, the auditor decides to look at your business income tax returns, and they see that your wage expense includes payroll taxes that were eliminated due to the credit. In this case, the auditor will update your business tax return, which will increase your tax liability. You may also incur penalties related to the under-reported tax.
Now, imagine that your business income tax return reflected the ERC credit accurately. However, you fail the ERC audit, and the auditor disallows your employee retention credit. Now, you should amend your federal income tax return to increase your wage expense, but unfortunately, you only have three years to amend tax returns to claim a refund.
If it is past the three-year deadline, you will lose the chance to claim the overpaid tax. The deadline to claim refunds from 2020 tax returns is April 15, 2024, and the deadline to amend 2021 tax returns is April 15, 2025. If your audit is happening near these dates, try to make sure that it gets wrapped up before these deadlines so that you can amend your returns as necessary.
Statute of Limitations on ERC Audits
Normally, the IRS has three years to audit business tax returns. For payroll tax returns, the timer starts on April 15th, the year after the filing period. For instance, quarterly payroll tax returns are typically due on April 30th, July 31st, October 31st, and January 31st for the first, second, third, and fourth quarters of the year. Then, the statute of limitations for these returns starts on April 15, and it expires three years later.
How Long Does the IRS Have to Audit Tax Returns with ERCs?
The IRS has extended the statute of limitations on payroll returns for Q3 and Q4 2021 to five years. These returns were originally due on November 1, 2021, and January 31, 2022, and the statute of limitations started on April 15, 2022. This means the IRS has until April 15, 2027, to audit these returns.
At the time of writing, the IRS has not extended the statute for the other six quarters where employee retention credits were available. This means that the IRS currently has until April 15, 2024, to audit ERC claims from 2020, and it has until April 15, 2025, to audit ERC claims from the first two quarters of 2021.
Is the IRS Going to Extend the Statute of Limitations for All ERC Claims?
While it has yet to be approved, the IRS has included a request to extend the statute of limitations on ERC returns with its 2024 proposals. Analysts believe it’s highly likely that Congress will agree to extend the statute of limitations.
The agency has hundreds of thousands of unprocessed amended payroll tax forms for those years. This backlog creates a strong argument for the IRS to extend the statute of limitations for ERC audits.
What is the Statute of Limitations on Fraudulent Returns?
If fraud is involved, there is no statute of limitations to audit tax returns. For instance, say that the IRS audits your 2021 Q2 payroll tax return, and the auditor discovers that you committed fraud on the return. Then, the agency decides to audit your 2020 payroll returns. The agency can audit these returns whether the statute of limitations has expired or not.
Potential Issues with the Statute of Limitations on ERC Audits
The expanded statute can potentially create problems for people who fail their ERC audits. If the IRS auditor disallows your ERC claim, you lose the credit and will incur a tax liability. However, if you reduced the wage expense on your income tax return by the amount of the credit, you can theoretically amend your income tax return to increase the wage expense if you lose the credit.
If you can amend your business income tax return, you will be able to recoup some of the money you lost when the auditor disallowed the ERC. Unfortunately, however, you only have three years to amend a return after filing, and the extended statute of limitations on ERC audits can make this problematic.
To give you an example, say that the IRS audits one of your 2020 payroll tax returns in 2025. You fail the audit, and the IRS removes the credit from your return. At this point, you could amend your 2020 return so that it’s correct, but because it’s been more than three years, you won’t be able to get a refund.
Some analysts believe that the IRS may change its normal processes to reduce the threat of taxpayers facing this issue, but at the time of writing, the agency hasn’t issued any official statements.
ERC Audit Risk
The IRS plans to audit a significant number of these returns. Many of the audits will be random, but the IRS may target amended returns prepared by ERC mills. Wondering if your return is likely to hold up to an audit? If you claimed the credit correctly and you have supporting documents, you should be able to withstand an audit.
However, if an ERC mill amended your payroll tax return, here are some signs that they may have filed an incorrect return:
- They told you that you qualified for the credit before even talking to you about your situation.
- They told you that you qualified based on suspended operations, but based their conclusion on limited analysis and your operations were never suspended.
- They told you that all businesses in X category qualified for ERCs.
- They based their fee on the amount of your credit.
- They claimed that the IRS trained them to help people claim this credit.
The above criteria don’t necessarily mean that you filed an incorrect return. However, we can help you assess your risk if you’re unsure. Then, depending on the situation, we can help you correct the returns or prepare for an audit.
Generally, if you make a mistake on your tax return, you should contact the IRS proactively. Reaching out to the agency before they contact you can help you minimize penalties and/or avoid criminal exposure.
If you’re currently working with a company to amend your payroll returns to claim the ERC, we can give you a second opinion on the credit. Our tax attorneys are well-versed in the requirements for claiming this credit, and we can ensure that your claims are accurate.
Get Help with ERC Audits
Are you facing an ERC audit? Are you worried about the penalties and interest that may incur? Concerned that your return may be selected for an audit? If you have answered yes to any of these questions, contact us for help today. At Wiggam Law, we help people find solutions for all kinds of tax problems.
The ERC is a complex tax credit, but we’ve been following the IRS’s rules and updates from the beginning and are ready to help. Contact us to schedule a consultation today.