Companies that received an Employee Retention Credit (ERC) refund must get ready for a possible IRS audit as the IRS starts to investigate Employee Retention Credit (ERC) claims. Remember that the IRS will only be able to determine a deficiency for ERC claims in the third quarter of 2021 under a specific five-year statute of limitations included in the American Rescue Plan Act (ARPA) (instead of the normal three-year period). This lengthier time frame signals that the IRS intends to examine many of these claims and might require this additional time to finish its task.
To that side, it’s critical to make sure you maintain thorough and complete paperwork when requesting an ERC refund, which must include documentation for the following:
- Qualifying quarters or portions of quarters
- Information on how the credit was calculated
- Payroll records supporting the ERC claim
Substantiating claims under partial suspension rules
The ERC allegations submitted in accordance with the partial suspension regulations will by far be the hardest to substantiate. A government order that demanded some sort of operating suspension is the main need that must be in place.
What, for these purposes, qualifies as a government order?
In accordance with IRS guidelines, directives from federal, state, or local governments are regarded as “orders from an authorized governmental authority” if they restrict trade, travel, or group gatherings because of COVID-19, which has an impact on how an employer does business. Orders that restricted operating hours and were issued by a State or local government with authority over the employer’s operations are examples of this (referred to as “governmental orders”).
What does not constitute a governmental order for these purposes?
- A state of emergency declared by a governmental authority, if it does not restrict travel, business, or group meetings in any way;
- A declaration that restricts these activities but does so in a way that does not interfere with how the employer conducts its trade or business; and
- Advice from the CDC or other health organizations.
How to document your claim for an erc refund under the shutdown rules
The second thing to consider is how to prove that a governmental order existed, had an impact on your trade, or affected your firm. It is frequently better for you to prepare a thorough justification of how the various government regulations and restrictions affected your firm as the business owner or corporate representative. Being the most familiar with the business activities, you or a representative may make the greatest assessment of this influence. Another option is to have the company’s legal counsel draft a memo explaining the particular government directives and how they contributed to the company’s closure. The legal statement should also describe how the company’s stance complied with IRS regulations.
Key factors to consider regarding the impact on your business operations are:
- Capacity restrictions
- Forced reduction in hours to comply with mandates (i.e., cleaning/sanitizing)
- A more than nominal portion of operations were suspended due to governmental orders (see below)
- Inability of employees to perform their jobs in a comparable manner
- Dates should be documented for any of the above factors listed as having impacted your business
To guarantee an accurate representation of the business impact and to give credibility to the explanation, this information should be documented concurrently with the development of the ERC calculations (not later upon audit).
Documenting the timeframe for qualification under the shutdown rules
In contrast to complete quarters qualifying under the gross receipts testing requirements, the timeframe for computing ERC salaries in the suspension under governmental orders is solely determined by the date(s) covered by the order. Wages no longer qualify if the order is lifted. Wages earned on or after May 30, 2020, for instance, do not qualify for the ERC if a government order that had a significant negative impact on a business is lifted on that day. Include a copy of the relevant governmental order, together with a list of the dates it applied to, in your paperwork.
Determination of a more than nominal portion
How is it determined that a government edict had an impact on a “more than nominal portion” of a business? How is it determined whether something had a “more than nominal effect” on how business was conducted? IRS guidance states that if either of the following conditions is met, your business operations are considered to constitute more than a minimal portion or effect on business operations:
The gross receipts from that portion of the business operations are not less than 10% of the total gross receipts (both determined using the gross receipts of the same calendar quarter in 2019); or
The hours of service performed by employees in that portion of the business is not less than 10% of the total number of hours of service performed by all employees in the employer’s business (both determined using the number of hours of service performed by employees in the same calendar quarter in 2019).
Key takeaways
The IRS guidance has not covered every aspect of the ERC, and certain parts of it (like the restrictions relating to the government shutdown) are arbitrary in nature. Due to this, it might be difficult to follow IRS regulations and support the ERC claimed in the event of an audit. If the business purchased an external ERC study, the study provider should be contacted for this documentation. You should still put together this documentation even if they don’t have it or won’t give it to you. To help you acquire this support, you might need to seek outside advice from a reliable expert.
