The Employee Retention Credit (ERC) provided critical financial relief to businesses during the COVID-19 pandemic, but for many employers, the story didn’t end when the checks arrived. The IRS has made it clear that ERC claims are a top enforcement priority, and audits, repayment demands, and disputes are becoming increasingly common. If your business claimed the ERC, understanding how to prepare for a possible audit and knowing where things can go wrong can minimize risk and make the path to your ERC refund as smooth as possible.

Why Is the IRS Paying So Much Attention to ERC?

The ERC was a refundable payroll tax credit designed to encourage employers to keep workers on payroll during the pandemic. Eligible businesses could claim up to $7,000 per employee per quarter at its peak in 2021, making it one of the most valuable relief programs available to small and mid-sized businesses. 

Because the credit was so generous and the eligibility rules were complex, a cottage industry of aggressive ERC promoters emerged that often charged large contingency fees to file amended returns for businesses that may or may not have actually qualified. As a result, the IRS believes that an unprecedented number of the ERC claims that were filed are improper, and in response, it has ramped up enforcement activity significantly in the past few years.

Common Issues That Trigger ERC Audits

Not every audit means the IRS believes you did something wrong, but certain patterns have drawn heightened scrutiny:

Reliance on a third-party promoter. The IRS has specifically flagged claims prepared by “ERC mills” which are companies that mass-marketed the credit without properly and responsibly analyzing each client’s eligibility. If your claim was prepared by one of these firms, this can be a red flag to the IRS that the underlying analysis of your ERC qualification may not hold up.

Qualifying under the “full or partial suspension” test. Your business can qualify for the ERC by one of the two pathways: 1) by demonstrating a qualifying decline in the business’s gross receipts or 2) by showing that a government order caused a full or partial suspension of your business operations. The full or partial suspension test is complex and fact-intensive and has been the source of widespread misapplication. Vague claims that the business experienced supply chain issues or suffered from general pandemic conditions will not be sufficient. Taxpayers must be able to directly tie a strict list of qualifying impacts on their business to a mandatory government order that restricts the business (not the business’s employees or customers).

Inflated wage amounts. Some promoters included wages that were used for other benefit programs, like the Paycheck Protection Program (PPP) loan forgiveness, which is prohibited. Others claimed ERC amounts that exceeded the amount of wages they reported on their payroll tax returns. These are missteps that the IRS is actively looking for.

Disputing an IRS Determination

The IRS may open an audit to take a closer look at ERC claims, or they may just send taxpayers a letter disallowing the claim. If the IRS fully or partially disallows your ERC claim, you have options. A notice of disallowance will typically include a deadline for filing a protest or pursuing other remedies. Depending on where the dispute stands, this could involve:

Appeals. The IRS Independent Office of Appeals provides a forum to present your case to an impartial reviewer without going to court. Many ERC disputes are resolved at this stage.

Tax Court. If Appeals does not resolve the matter, or if you prefer to litigate, you may be able to petition the U.S. Tax Court. In some situations, you might also pursue a refund suit in U.S. District Court or the Court of Federal Claims.

Penalty abatement. Even when the underlying credit is disallowed, penalties assessed in connection with an improper ERC claim may be subject to abatement if you can demonstrate reasonable cause (for example, that you relied in good faith on advice from a tax professional).

The procedural landscape for ERC disputes is evolving, and timing matters. Missing a deadline to protest or file a petition can permanently foreclose your appeal rights.

Key Ways to Prepare Now

If you haven’t been contacted yet, don’t assume you’re in the clear. The IRS has years to audit payroll tax returns, and unprocessed claims for ERC refunds can always be examined before the IRS pays the refund claim. IRS enforcement targeting ERC claims continues to evolve, so don’t assume your claims are approved or without error simply because the IRS hasn’t contacted you yet. 

Gather and preserve your documentation now. The burden is on you to prove eligibility, even if the IRS waits several years after filing to contact you about your claim. Start organizing your records, such as government orders, gross receipts data, and payroll records while you can still track those documents down. The more time that passes, the less likely it is that you will be able to locate key information if you are selected for an IRS audit. 

Act promptly and involve a qualified tax attorney if you receive an IRS notice. Response and suit filing deadlines are strict and may not be waivable, so missing a deadline can have disastrous consequences for your case. You want to protect your options as much as possible, so if you receive a notice from the IRS about your ERC claims, involve a qualified and experienced tax controversy attorney right away.

How Our Firm Can Help

Our firm represents business owners facing ERC audits, IRS examinations, and tax disputes at every stage, including responding to initial information requests through Appeals and, where necessary, litigation. We understand the complexity of the ERC rules and the enforcement environment the IRS has created, and we work to protect our clients’ interests while helping them navigate this process with clarity.

If you have received an IRS notice related to an ERC claim, or if you have concerns about a previously filed claim, we encourage you to reach out for a consultation. 

This blog post is provided for general informational purposes only and does not constitute legal advice. You should consult with a qualified attorney regarding your specific situation.