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ERTC compliance requirements and documentation
Navigating the complex landscape of Employee Retention Tax Credit (ERTC) demands meticulous attention to compliance requirements and accurate documentation. Understanding and adhering to these parameters could well be the difference between claiming the prized financial assistance and enduring taxing audits.
Observations from the ERTC Compliance Landscape
“Employee Retention Tax Credit (ERTC) | Definition & Eligibility” from financestrategists.com and used with no modifications.
Common Misstep in ERTC Claims
Unwittingly, many businesses trip up when it comes to ERTC compliance. The most common misstep is often a misunderstanding of how to apply the eligibility criteria. The IRS strictly stipulates that businesses can only claim ERTC if they’ve experienced a 50% decline in gross receipts in a quarter compared to the same quarter in 2019 or if their operations are either fully or partially suspended due to government orders. Misclassification of employees or erroneous payroll calculations can also trigger compliance issues.
Emergence and Motivation behind ERTC Audits
In response to these frequent discrepancies in ERTC claims, the IRS has ramped up its auditing mechanisms. Here is where the real-world implications of missteps sink in. Failure to comply with the ERTC guidelines can lead to an IRS audit, a lengthy process that no business relishes.
Moreover, the IRS conducts these audits with the express intent of ensuring the accurate distribution of ERTC benefits. This ensures that only businesses experiencing significant hardships due to the COVID-19 pandemic are genuinely benefiting.
No wonder, then, the emergence of ERTC audits can be traced back to the mushrooming instances of inaccurate ERTC claims, often an off-shoot of inadequate understanding of the eligibility criteria and calculation mechanisms.
Fundamentals of an ERTC Audit
The Function and Goal of ERTC Audits
ERTC audits are specifically designed to verify compliance. The IRS uses these audits as a tool to ensure the proper and legal allocation of funds. This is a critical part of guaranteeing that the ERTC fulfills its intended purpose of helping businesses weather financial difficulties amid the pandemic.
Audit Process Overview for ERTC
Audits typically begin with the IRS reviewing your filed ERTC claims, backed by relevant documentation. Being prompt in response to IRS requests and maintaining accurate records of ERC calculations play a pivotal role in simplifying the process.
The next step could involve auditor interviews, wherein IRS officials may ask additional questions or seek clarity on certain aspects of your ERTC claim. Keep in mind, any signs of non-compliance with documentation or unresponsiveness can deter your ERTC claim’s acceptance.
ERTC audits might seem intimidating, but they need not be if businesses observe due diligence in compiling accurate and thorough documentation.
Avoiding Pitfalls in the ERC Application
Common Triggers for an ERTC Audit
It is crucial to be aware of what flags an audit for the IRS. Unusually large refunds, error-prone patterns in claimed credits, or businesses located in fraud-prone geographical areas could pique the agency’s interest. Furthermore, the IRS might also undertake a random audit of a company’s ERTC claim.
Preventive Steps for ERC Application Missteps
The best arsenal against potential ERTC audits is rigorous compliance from the get-go. Meticulous calculation, accurate documentation, and in-depth understanding of the ERTC guidelines are essential.
One effective way to avoid stumbling into an ERTC audit is to ensure regular consultations with tax professionals or IRS resources. This will help clarify any doubts regarding the complex mechanisms of ERTC claims and maintain an up-to-date understanding of the requirements and guidelines.
Lastly, keeping your payroll records and financial statements updated and accurate can help your business seamlessly sail through the ERTC application process while maintaining impeccable compliance.
Preparing for an ERTC Audit
Organizing Relevant Documentation for ERTC Audits
One idea I often share with businesses is to be always audit-ready. This simply means never letting your guard down when it comes to gathering, organizing, and making sense of your ERTC-related documentation. Accurate and organized records not only validate your ERTC claims but also make the audit process considerably less taxing, so to speak.
Key documents to have at your disposal include payroll logs, financial statements that affirm the reported drop in gross receipts, and compliance with government orders mandating full or partial suspension of operations. Evidence of your eligibility for ERTC, in essence.
Importantly, retaining all relevant documentation for at least four years is advisable, as the IRS can audit your claim within this period.
Interactions with the IRS During an Audit
It’s crucial to respect the audit process and the IRS officials guiding it. Their role is to clarify the process, not to intimidate or penalize you unnecessarily. Be prompt and courteous in your interactions, and don’t hesitate to ask about anything that is unclear.
In situations where you disagree with their assertions, remember you can seek external help or resort to the appeal process.
Navigating an ERTC Audit
Facing and Overcoming Audit Challenges
One of the trickiest parts of the audit can be the IRS interviews or the submission of additional documentation. But remember, the goal here is not to trip you up but to verify your ERTC claim’s integrity.
Consider this a chance to clear the air about any potential misunderstanding or miscalculation. It is absolutely imperative to provide accurate information and avoid any misrepresentation during the audit to prevent any legal repercussions.
The Appeal Process in case of Audit Disapproval
Does a negative ERTC audit outcome signal the end of the road? Far from it! Businesses have the right to contest an audit’s findings through the appeal process.
Often, helpful IRS officers or independent tax professionals can assist you in navigating the appeal process, should you encounter unfavorable audit results.
Key Guidelines to Enhance ERTC Compliance
Consistent and Accurate Tax Credit Calculations
Consistency is just as important as accuracy in tax credit calculations. Define a standard procedure for your calculations and stick to it diligently to avoid any inconsistencies.
It’s equally important to remember that the ERC calculation is based on qualified wages and should reflect the workforce’s retention. To this end, maintain and frequently update a comprehensive record of all wages and related calculations.
Critical Role of Updated Payroll Records and Financial Statements
Another tip I can’t stress enough is to keep your payroll records and financial statements up-to-date. Many business owners underestimate the power these records wield in affirming your ERTC claim’s authenticity.
A sudden IRS audit will be much easier to handle if you have these documents at your fingertips. Remember that overlooking these critical documents can lead to unwelcome surprises during the audit.
Maintaining Proper Employee Classification and Reporting
Misclassification of employees for ERTC purposes is a common pitfall. As a business owner, it’s your responsibility to accurately classify your employees and ensure proper payroll reporting.
Inaccurate employee classification or misinformation can flag an audit and lead to complications reaching far beyond the denial of an ERTC claim.
Frequently Asked Questions
What is the maximum amount of ERTC that can be claimed?
The maximum amount of ERTC that a business can claim is capped at $26,000 per employee for 2021.
Can businesses apply for ERTC retroactively?
Yes, businesses can apply for ERTC retroactively. Reach out to a tax professional or the IRS for more specific guidance on the mechanics of retroactive applications.
What is the impact of receiving PPP loans on ERTC eligibility?
Historically, businesses that received PPP loans were not eligible for the ERTC. However, with the December 2020 passage of the Consolidated Appropriations Act, this restriction was lifted. Businesses can now claim both, though not for the same payroll costs.
Is there a specific decline in gross receipts required for ERTC qualification?
Indeed, ERTC rules specify that for a business to qualify, it must’ve experienced a significant decline in gross receipts. This means a drop of 20% or more in 2021 compared to the same quarter in 2019.
What does the ERTC audit process involve?
The ERTC audit process typically involves a review of your ERTC claims and related documentation, potential auditor interviews, and additional requests for information. In case of any query, IRS officers are there to guide you through the process.
To sum up, diligent documentation, robust understanding of ERTC guidelines, and accurate ERC calculations will go a long way in ensuring seamless ERTC claim processing and compliance. Harness the power of ERTC, but without overlooking compliance and documentation requirements.
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FAQ's
Most frequent questions and answers
The Coronavirus Aid, Relief, and Economic Security Act (also known as the CARES Act) was signed into law on March 27, 2020. It included two programs to assist businesses with keeping workers employed: the Payroll Protection Program (PPP) administered by the Small Business Adminstration and Employee Retention Tax Credit (ERTC) administered by the Internal Revenue Service.
PPP funds are distributed based on 2.5 months of payroll and a minimum of 80% of the funds must be used on payroll to be eligible for forgiveness. Additionally, PPP funds are not taxable as revenue and you may still take deductions for the payroll covered by PPP.
ERTC tax credits, however, are credits (or refunds) for a percentage of payroll in each quarter that you qualify. There are specific rules for determining eligibility by quarter, and limiting the dollars that can be claimed for each employee.
Initially with the CARES Act, employers could choose to apply for PPP or claim ERTC credits, but not both.
PPP was more beneficial than ERTC for most businesses (for reasons we won’t go into here) and so most businesses with under 500 employees received forgivable PPP Loans.
On March 11, 2021, The American Rescue Plan Act of 2021 was signed into law and included many modifications and expansions to existing elements of previous stimulus programs.
Noteworthy modifications for business owners included:
Businesses who applied for and received PPP funds could now also claim ERTC credits.
ERTC credits could be retroactively claimed for businesses that qualified in 2020.
ERTC credits were extended through 9/30/21 with lower qualification requirements.
The per-employee cap on qualifying wages increased from $10,000 for all of 2020 to $10,000 per quarter for the first 3 quarters of 2021.
The refundable credit amount increased from 50% of qualifying wages in 2020 to 70% in 2021.
So the short answer is “Yes” . . . you can claim ERTC even if you received PPP funds.
Unlike the Payroll Protection Program (administered by the Small Business Administration), there is actually no “application process” for the Employee Retention Tax Credits.
You simply claim the ERTC tax credit like you would any other tax credit – by asserting to the IRS that you can legally claim the credit.
When you claim a child tax credit, you do so by asserting this fact on your Form 1040 Personal Income Tax Return.
The difference is that when you claim an ERTC tax credit, you do so on your Form 941 Employer Quarterly Tax Filing.
For prior quarters, you must file an amended form (the Form 941-X) to reduce your current quarter’s tax contribution and request a refund of excess credits (which is highly likely).
Another perk of ERTC, is that since you can often estimate these credits in advance of distributing cash for payroll, you can file a Form 7200 to receive a cash advance to avoid waiting until the end of the quarter to apply for the refund.
Even though you may feel like revenue is back to normal, there are some items you want to consider before passing on this ERTC assessment.
First, even if revenues have returned to “normal” in 2021, you may have qualified in 2020 and you can retroactively claim those credits. That eligibility criteria in 2020 was based on revenue declines from 2019, or if your business was partially or fully closed due to governmental mandate.
Second, while your revenue may have returned to “normal” in Q1 2021, remember that we are comparing your Q1 2021 to Q1 2019. If 2019 was a year of growth for your business, then your revenue levels 2 years ago may have been much less than Q1 2020.
And lastly, if your revenues were down in Q4 2020 by just 20% compared to Q4 2019, then you may also be eligible for Q1 2021. There is a safe harbor provision that few advisors are talking about, and it means that many businesses are qualifying for $7,000 per employee in Q1 2021.
I know, it seems too good to be true, but the government wants to incentivize and reward you for keeping US residents employed and money flowing through our economy as we rebuild bigger and stronger than before.
You are most likely referring to a provision of the CARES Act that allowed employers to defer the deposit and payment of the employer’s share of Social Security taxes. Those deferrals must then be repaid – with at least 50% of the balance due by 12/31/21 and the remaining balance due by 12/31/22.
ERTC credits are NOT a deferral. They are dollar-for-dollar credits against wages you’ve paid. Not taxes you’ve paid, but actual wages.
These credits can offset future tax contributions or you can receive a refund check – it’s your choice.
And you will NOT have to re-pay these funds (unless, of course, you don’t provide adequate documentation in the course of an audit).
Your banker, CPA, or Financial Advisor was probably very helpful when it came to getting your PPP funds because they were effectively signing you to an SBA-guaranteed loan. The SBA paid the bank administrative fees based on the PPP loans they made, and so they were incentivized to educate you about the program and get all your paperwork in order.
Compared to the ERTC, the PPP program was also a rather simple calculation. 2 ½ times your average monthly payroll including health insurance and state unemployment taxes.
From the conversations we’ve had with bankers, they have no interest in involving themselves in your employment tax compliance. For them it is a liability and beyond their scope of services.
Your Payroll Service does an excellent job of executing the fundamentals of paying your employees, paying your employment taxes and filing your quarterly reports.
But computing your ERTC credits requires visibility into your P&L and PPP forgiveness applications. Not only that, but the complex requirements around eligibility and allocating ERTC credits at the employee-level while accounting for annual and quarterly qualifying wage gaps and . . . well, you can probably tell why Payroll Services are not offering to do all of this for you.
The Payroll Services that we’ve worked with so far are happy to provide the payroll registers that we need to perform the allocations. And they are happy to file the Amended Form 941-X with the IRS on our client’s behalf.
But that’s the extent of it.
In fact, most wise Payroll Services are asking clients to sign an indemnification waiver before submitting a Form 941-X because the Payroll Service can take no responsibility for the accuracy of the ERTC credits you are claiming.
For them to involve themselves in the intricacies of this calculation, it is a liability and beyond their scope of services.
Whether your tax accountant is a CPA or EA, he or she most likely only prepares your Federal and State Income Tax Returns. However, ERTC credits are claimed against Employment Taxes on Form 941, and cash advanced through Form 7200.
The complexity of the ERTC program is a beast unto itself and every tax accountant we’ve talked to has said they focus on staying up-to-date on the ever-evolving income tax code, and they can’t now become experts in the ERTC program as well.
If your tax accountant is comfortable determining your eligibility by quarter and year, computing your credits, and preparing contemporaneous documentation to support an IRS audit, then you should certainly let them handle all of this.
If you want a second set of eyes on this, we’re happy to take a look.
Your Bookkeeper should certainly have access to all the information that is needed for an accurate calculation of your legal ERTC claim. They will have your financial reports, payroll registers, and PPP loan forgiveness documents.
The Million Dollar Question is . . . Do They Have The Time?
So far, we have not found a bookkeeper who is able to take all this on, while handling the day-to-day of bookkeeping. If yours can, then take them up on their offer. We’re happy to take a second look.
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