By ercclaims August 28, 2025
Most businesses unknowingly commit errors when submitting Employee Retention Credit (ERC) claims, raising the risk of an IRS audit. These include miscalculating wages, misinterpreting rules on eligibility, and failing to provide the right documents. Having proper knowledge regarding these mistakes and how to sidestep them safeguards your business against penalties and unexpected fees.
New Warning Signs of Incorrect ERC Claims
The IRS has released five additional indicators that typically indicate an incorrect Employee Retention Credit (ERC) claim:
1. Fully Open Essential Businesses
Certain promoters encourage some businesses to apply for the ERC even if they weren’t qualified. If your business remained operating during the pandemic and didn’t experience an actual decline in revenue or a government shutdown, you probably don’t qualify for this claim. Minor adaptations, such as making the use of masks mandatory or washing hands, aren’t considered suspended operations.
2. No Evidence of a Government Mandate Impacting Operations
To qualify for the ERC, you need to prove that a government directive led to a full or partial suspension of your business. Most businesses have not provided sufficient information when requested to present proof. Without these documents, the IRS will not accept the claim.
3. Counting Wages of Family Members
Salaries remitted to immediate relatives — such as a spouse, kids, siblings, parents, in-laws, nieces, and nephews, or other members — are not qualified for the ERC claim. Applications including these salaries are overstated or not eligible at all.
4. Applying the Same Wages for Ppp Forgiveness And Erc
If your company received a Paycheck Protection Program (PPP) loan, then the payroll expenses you disclosed for that loan cannot be applied to claim the ERC as well. The credit is only for the remaining qualified wages not associated with PPP reduction.
5. Large Employers Claiming for Working Employees
Large corporations have different ERC rules. Employers with more than 100 full-time workers in 2019 (for 2020 claims) or more than 500 in 2019 (for 2021 claims) can recover only wages for employees when they did not work. Certain large employers incorrectly claimed wages for employees who continued working, which is strictly prohibited.
Former Indications of Incorrect ERC Claims
The IRS has also pointed out other red flags that frequently appear in ERC claims. Most of them are the result of misguided guidance provided by promoters, which has led businesses to make improper claims. Below are the key areas to look out for:
1. Claiming too Many Quarter
Some promoters advised companies to apply for the ERC for each quarter. In reality, only a few companies are eligible for all quarters. Each quarter needs to be reviewed thoroughly for eligibility.
2. Government Orders that Don't Count
A frequent error is saying you’re eligible for the ERC simply because there was a government order in your region, even if you weren’t actually affected by it. To be eligible, your operations must have experienced a full shutdown or had a partial shutdown because of COVID-19, directly because of the order.
Minor adjustments, recommendations, or OSHA communications are not included. You must also have documentation of how the order affected your company.
3. Inaccurate Employee Count and Calculations
Other employers have attempted to include everyone’s wages or have applied the same credit numbers for too many tax periods. Between the years 2020 and 2021, the regulations changed, and the wages must satisfy certain conditions to be eligible. Miscalculations commonly result in overclaiming.
4. Supply Chain Excuses
Most companies mention supply chain disruptions, it can backfire your ERC claim if no mot properly handled. The disruption needs to trace back to a government directive that impacted your supplier directly, and that order needs to satisfy IRS guidelines.
5. Claiming too Much of a Quarter
Even if a company was impacted by a shutdown, it generally only qualifies for ERC for the period of suspension, not for the whole quarter. Full-quarter claims are potentially overstated.
6. No Wages or Business Activity During Eligibility
ERC can only be claimed when wages are actually paid to employees during the qualifying period. Claims were filed by some companies that did not even exist during that time, which results in automatically getting disqualified.
7. "Nothing to Lose" Promoters
If anyone advises you to claim ERC since there’s no risk, then step back immediately, it’s a big red flag. Errors in claims can result in repayment of the credit, penalties, interest, audits, and additional expenses for correcting the error.
How to Know If You're Being Audited
Step one in dealing with an IRS audit is recognizing when it’s really happening. The IRS never calls, emails, or texts to begin an audit—they always mail an official letter. If you receive a notice regarding your Employee Retention Credit (ERC) claim, make sure that it includes the IRS letterhead and a notice number, like CP3118 or Letter 566.
That letter will typically detail what the IRS wants to see. For ERC claims, it’s often payroll history, evidence of qualification, and the calculations supporting your claim. Occasionally, the IRS might also ask for other documentation, which could mean they’re examining more than just the ERC.
If you have a response deadline from the IRS or are asked to schedule an appointment, it’s a sign that you are being audited. Catching these signs early provides an opportunity for you to get your documents in order and respond accordingly.
Options for Resolving Incorrect ERC Claims
If a company has found that its ERC claim is not accurate, there are a couple of options provided by the IRS to correct it. It has the ERC Withdrawal Program, where companies with pending claims are able to withdraw them entirely. Here, the IRS considers it as never submitted, and thus, no penalty or interest is charged.
Another solution is to correct a return if an employer overclaimed, which allows them to correct the mistake and fill the accurate amount easily.
What Is the ERC Audit Period?
The Employee Retention Credit (ERC) assisted numerous businesses throughout the COVID-19 crisis, but just like all tax credits, there are regulations, including the length of time the IRS can audit your claim.
Generally, the IRS has three years from the due date of your tax return or the filing date of it (whichever is later) to audit your claim. If you submitted an amended return, that three-year period begins again on the amended filing date.
However there are some exceptions. If the IRS thinks that there are any fraud or intentional errors in your ERC claim, there’s no time limit of when an audit can occur.
That is why it is crucial to file ERC claims properly and retain all documentation that supports your eligibility. Proper record-keeping can shield you from penalties in case the IRS audits your claim.
Navigating a Successful ERC Audit
If you ever receive an ERC audit notice from the IRS, panic not. Your best solution is to remain organized and to be prompt in your response. Begin by gathering the documents requested, such as payroll records and documentation stating your business was impacted by COVID-19.
Clear and prompt communication with the IRS is extremely important in this process. If you require additional time for gathering everything, it’s advisable to inform them beforehand rather than to risk missing the deadlines. Proactiveness and honesty will ease the audit process and prevent additional complications.
Myths Surrounding ERC Audits
There are numerous myths surrounding ERC audits that tend to generate unwarranted fear. Among the common myths is that all businesses that took advantage of the ERC will necessarily be audited. This isn’t the case. The IRS has no right to audit all businesses. Most audits result from red flags in the tax returns, not just because a business took the credit.
The next false belief is that only big businesses can get the ERC. The truth is that numerous small businesses can qualify for ERC if they have the requirements. Individuals are also concerned that an audit will always result in substantial fines or penalties.
Although penalties are inflicted in case of fraud or intentional errors, the IRS generally treats unintentional errors differently. If you have accurate records and comply with rules, you are able to decrease your audit risk and make the audit process much more smoother.
Key Documents to Prepare Before Responding
If the IRS audits your Employee Retention Credit (ERC) claim, the first step is to get all the right documents together. Having clear and organized records will make the process smoother and show the IRS that your claim is backed by solid proof.
Begin by gathering payroll documents for the period you reported the credit. These must accurately indicate what wages were ordinary pay and what were subject to the ERC. You will also require your Forms 941 (Quarterly Employment Tax Returns) corresponding to your claim periods.
Next, gather your financial statements, such as profit and loss reports. These help to confirm whether your business met the revenue decline requirement. If your eligibility was due to a government shutdown, include any official orders that restricted your operations.
It’s also best to include information on how you computed your ERC. Save worksheets, schedules, or records from your payroll firm. If a CPA or consultant worked with you, copies of their agreements or notes can also be useful in demonstrating how the claim was prepared.
Common Mistakes to Avoid During an ERC Audit
Navigating an Employee Retention Credit (ERC) audit can be nerve-wracking, but most issues resolve by preventing some common errors.
One of the most common Employee Retention Credit backlog is a lack of full or up-to-date paperwork. The IRS will be looking for payroll records, financial statements, ERC computations, and any PPP loan forgiveness forms if those are relevant. Inaccurate or missing records will damage your case.
The next mistake is misinterpreting the rules. Some companies take the credit without realizing they meet the revenue decline requirement or misunderstand how government shutdowns work for them, which can disqualify them from the claim.
It’s also important not to overlap ERC wages with PPP funds. The same wages cannot be used for both programs, so careful record-keeping is necessary. Deadlines are another area where businesses slip up. The IRS gives strict timelines, and ignoring them can lead to fines or even losing the credit.
Presenting faulty or exaggerated claims is also a red flag. Exaggerating wages or eligibility can lead to major penalties. Attempting to do everything alone without professional assistance can be dangerous since ERC regulations are very detailed. Having the assistance of a tax professional can simplify matters much more smoothly.
Lastly, attitude counts. Being hostile or refusing to disclose information only makes the audit more difficult. Remaining honest, responsive, and professional will always serve in your best interests.
Negotiating Penalties and Discrepancy Resolution
When the IRS discovers issues in an Employee Retention Credit (ERC) claim, it can be daunting. The issues could range from something as minor as a calculation error to something more critical, such as a misinterpretation of the rules. Other times, penalties could also be involved, but having an idea of what to do with the situation could ease the pressure.
First read the IRS notice very carefully. Next, compare their results with your own files to determine if the problem is a mistake on your part or a misinterpretation. If the mistake is from your side, try to identify the cause of the mistake such as incomplete documents or inaccurate filling. With the root problem in mind, gather documents to support your reply.
If there are penalties, don’t worry; you still have hope. In most instances, you can request a reduction of penalties, called “abatement,” by demonstrating that the error occurred despite an attempt to comply with the rules. Proper records and clear explanations can resolve confusion.
What Happens If the IRS Disallows Your ERC Claim
If the IRS rejects your Employee Retention Credit (ERC) claim, it can significantly affect your finances as well as your compliance history. You will usually be required to repay the credit you received, along with penalties and interest. That’s why it is crucial to know what you do next and how to react.
First, the IRS will issue you a formal notice stating why your claim was rejected. This may be due to missing or inaccurate documentation, failure to meet eligibility criteria, or miscalculations in determining the credit. You need to read the notice very carefully, so you can clearly identify where the problem is.
If your claim is rejected, here are some options for responding:
- Ask for Penalty Relief: If you think penalties were unreasonable, you can ask to have them lowered by proving reasonable cause.
- File an Appeal: If you don’t agree with the IRS’s penalties, you can use the formal appeal process to contest the rejection.
- Get Professional Assistance: Having a tax professional to assist you throughout the process can make everything much more smoother. They can examine your case, inform you of alternatives, and assist in presenting your case to the IRS.
A denied claim is stressful, but having knowledge of your alternatives and acting appropriately can make the process run better.
Appealing IRS Audit Decisions: Your Rights and Alternatives
Filing an appeal is the initial action, either in a formal written protest for adjustments exceeding $25,000, or with Form 12203 for minor disputes. The IRS Appeals Office will hear your case and allow you to present new evidence or re-examine your documents.
In case you’re not content with the decision of the Appeals Office, you can pursue mediation, settlement by accelerated procedure, or even proceed to the U.S. Tax Court or federal court, in this step it is highly recommended to seek professional advice to make everyone run smoothly.
Throughout the process, you have the right to communication, access to the records, and reasons for decisions, ensuring that your stand is considered.
Preventative Steps to Prevent Future IRS Audits
In IRS audits of Employee Retention Credit (ERC) claims, compliance is paramount. The most effective way of ensuring compliance is by maintaining accurate and well-organized records, including payroll statements, comparisons of revenues, and supporting documents showing the impact of COVID-19 impact on operations.
It’s also crucial to know the rules of eligibility in detail. Precision also matters, so calculations for claims should be double-checked to ensure wage amounts, qualification periods, and credit limits are reviewed properly. Since IRS policy on the ERC has evolved over time, staying current on recent developments is critical.
Lastly, steering clear of pitfalls—like reporting ineligible wages or misinterpreting requirements, these can avoid penalties and ensure a smooth and hassle free process.
Conclusion
ERC filing errors can be avoided by proper planning, accurate documentation, and good knowledge of the guidelines. Double-checking calculations, maintaining solid documentation, and asking for professional advice will reduce risk of audit for businesses. Being proactive not only assures compliance but also secures the credit with minimal hassle.
FAQs
What is the Employee Retention Credit (ERC)?
The ERC is a COVID-19 tax credit that helps to pay employee wages during qualifying periods.
Who is eligible for the ERC?
Businesses that experienced a substantial decline in revenue or government mandates to suspend operations are eligible for the credit.
Can PPP wages reported under PPP be used with ERC?
No, PPP loan wages cannot be used for ERC. You should go through the guidelines carefully.
How much time does the IRS have to audit ERC claims?
The IRS usually has 3 years from filing or the deadline, but there is no limit if fraud is suspected.
What if my ERC claim has an error?
You can correct errors by amending your return, withdrawing the claim, or participating in the Voluntary Disclosure Program ( if applicable).