What is an IRS Employee Retention Credit (“ERC”) Audit?

The Employee Retention Credit (ERC), also sometimes called the Employee Retention Tax Credit or ERTC, is a refundable tax credit for certain eligible businesses and tax-exempt organizations that had employees and were affected during the COVID-19 pandemic. The requirements to qualify for the ERC are different depending on the time period for which you claim the credit. The ERC is not available to individuals.

The IRS has recently been concerned about and focused on a large number of improper ERC claims and is closely reviewing tax returns that claim the credit. Taxpayers have been advised to review their claims and may potentially resolve incorrect claims.

Who Qualifies for the ERC?

The Employee Retention Credit is available to eligible employers that paid qualified wages to some or all employees after March 12, 2020, and before Jan. 1, 2022. Eligibility and credit amounts vary depending on when the business impacts occurred.

Generally, businesses and tax-exempt organizations that qualify are those that:

• Were suspended by a government order due to the COVID-19 pandemic during 2020 or the first three calendar quarters of 2021, or
• Experienced the required decline in gross receipts during 2020 or the first three calendar quarters of 2021, or
• Qualified as a recovery startup business for the third or fourth quarters of 2021

A self-employed individual who has employees and who otherwise meets the requirements to be an eligible employer may be eligible for the ERC based on qualified wages they paid to employees. Self-employed individuals can’t include their own self-employment earnings or wages paid to related individuals when calculating the credit. Eligible employers must have paid qualified wages to claim the credit.

Generally, qualified wages must be wages that are subject to Social Security and Medicare taxes reportable on a Form W-2 (and not amounts reported on another form, like the Form 1099-NEC). However, they may also include certain health care expenses you pay for your employees. Because qualified wages must be wages subject to Social Security and Medicare taxes, qualified wages do not include any amounts paid to independent contractors and reported on Form 1099-NEC, Nonemployee Compensation.

Eligible employers can claim the ERC on an original or adjusted employment tax return for a period within those dates.

For more information about eligibility and credit amounts, see the Employee Retention Credit – 2020 vs 2021 Comparison Chart.

How Can a Business Claim the ERC?

Eligible businesses that didn’t claim the credit when they filed their original employment tax return can claim the credit by filing adjusted employment tax returns. For example, businesses that file quarterly employment tax returns can file Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund PDF, to claim the credit for prior 2021 quarters. Generally, for 2020 tax periods, the deadline is April 15, 2024. For 2021 tax periods, the deadline is April 15, 2025.

Reminder: If you file Form 941-X to claim the Employee Retention Credit, you must reduce your deduction for wages by the amount of the credit for that same tax period. Therefore, you may need to amend your income tax return (for example, Forms 1040, 1065, 1120, etc.) to reflect that reduced deduction. 

Understanding an IRS Letter 6612

The IRS typically sends taxpayers letter 6612 when it audits a business with respect to its ERC. The letter states that the IRS is auditing your tax return reporting an adjustment or claim for refund and needs documentation to verify the Employee Retention Credit (ERC) you claimed. Furthermore, the IRS often will notify you that they are holding the ERC until the IRS makes a determination regarding the ERC audit.

Contact a tax attorney if you have received an IRS letter 6612 to discuss your options and best courses of action.