Penalties & Consequences for Wrongfully Claiming the ERC Credit

Worried That You Claimed This Credit Incorrectly? Here’s What Can Happen

The news that the IRS has launched a program to audit ERC claims has panicked many business owners. What if you get audited? What if you fail? How long does the IRS have to audit these returns? If you’ve claimed the ERC, these may be the types of questions running around your mind. 

To help you out, we’ve put together this guide to ERC audit penalties and statutes of limitations. It explains how long the IRS has to audit your return, and then, it outlines penalties that you may face if you filed incorrectly. Want help now? Then, contact us at the W Tax Group today.

How Long Does the IRS Have to Audit ERC Claims?

The IRS has three to five years to audit ERC claims, but the clock doesn’t start until April 15 following the due date of the quarterly or annual payroll return. If you amended the return, the statute of limitations starts on that day. 

Most employers file their payroll tax returns quarterly. For 2020, that means that your returns were due on April 30, 2020, July 31, 2020, September 30, 2020, and Jan 31, 2021. Then, the audit statute of limitations started on April 15, 2021, and it runs to April 15, 2024. The IRS has this long to select your return for an audit.

In 2021, quarterly payroll tax returns were due on April 30, 2021, July 31, 2021, September 30, 2021, and January 31, 2022. For the first two quarters, the statute of limitations for these returns started on April 15, 2022, and runs until April 15, 2025. For the last two quarters, the statute of limitations started on April 15, 2022, and runs until April 15, 2027. 

Extension of Audit Statute of Limitations for ERC

The American Rescue Plan Act extended the statute of limitations from three to five years for ERC claims made in Q3 or Q4. At the time of writing, the statute of limitations for the other six quarters during which the ERC was available is still three years. However, some analysts expect the IRS to extend the audit statute for all ERC claims. 

Audit Statute of Limitations for Fraud

In cases of fraud, the IRS has unlimited time to audit your tax return for fraud. That means that if the IRS has any reason to suspect fraud on your account, they can audit these returns regardless of how much time has passed. Usually, the agency only goes back six years though.

Penalties for Failing an ERC Audit

If you fail an ERC audit, the IRS will rescind the credit and/or adjust any other mistakes made on the return. This will create an adjustment to your tax return that will increase the amount you owe. Then, the IRS may also add interest and penalties to your account. Here is an overview of some of the penalties you may incur:

Accuracy-Related Penalties

If the auditor believes that you were negligent in following the tax rules, they can apply an accuracy-related penalty. Generally, it is 20% of the tax that was understated due to negligence. For example, if you understated the tax due by $5,000, the penalty is $1,000. This type of penalty may also apply if you fail any other type of audit and the auditor suspects negligence.

Substantial Accuracy-Related Penalties

However, in cases of substantial understatement, the penalty is 20% of the tax that should have been shown on the return. In most cases, the IRS considers a substantial understatement for individuals as the greater of $5,000 or 10% of the tax due. For corporations, a substantial understatement is an understatement that exceeds the lesser of 10% of the tax due or $10 million.

To explain, imagine that you were supposed to owe $20,000, but when you filed the return, it only showed that you owe $5,000. In this case, you have understated the tax due by $15,000. This exceeds the threshold for substantial understatement. Thus, your penalty is based on the full tax liability of $20,000, making the penalty $4,000.

Civil Fraud Penalties

If the auditor believes that you fraudulently claimed this credit or committed fraud in other ways on your tax return, they will assess a fraud-related penalty of 75% of the understated tax. This penalty only applies to the portion of the understatement attributed to fraud. Fraud can include issues such as claiming this credit for fake employees or lying to the auditor during the ERC audit. 

Here’s an example, imagine that you understated the tax on your payroll tax return by $20,000, and the auditor says that half of it was related to fraud. In this case, your fraud penalty will be 75% of $10,000 so $7,500. 

Criminal Fraud Penalties

Criminal fraud penalties are very rare, and they only apply in severe cases. However, if this topic ever gets mentioned, you should hire a tax attorney immediately. The penalty can be up to a $100,000 fine with up to five years in jail. For corporations, the penalties are even more severe. 

Tax Preparer Penalties

If you charged someone else to prepare a payroll return with an ERC, you may be subject to tax preparer penalties. These penalties vary based on whether you made an honest mistake, acted negligently, or committed fraud. Tax preparers may incur penalties in addition to the taxpayer incurring penalties. 

Failure-to-Deposit Penalties

The auditor may also decide to apply failure-to-deposit penalties to your account. They may backdate these penalties to the due date of your tax return, or they may apply them after the audit assessment becomes final. Generally, late payroll tax penalties are 2% if you are one to five days late, 5% if you are six to 15 days late, and 10% if you are 16 or more days late. 

Interest

Typically, when the IRS assesses tax against you through an audit, they backdate interest to the due date of the return. Then, they apply interest at the rate that was applicable for each period. The IRS’s interest rate on unpaid taxes changes quarterly, and it’s the prime rate plus 3%. However, in cases where corporations underpay a substantial amount of tax, the interest rate is higher. 

How to Avoid ERC Audit Penalties

To avoid ERC audit penalties, keep the following tips in mind:

• Make sure that you have all of the documents to support your ERC claim.
• If you are selected for an audit, cooperate with the auditor and provide them with all of the paperwork that they request.
• Hire a tax attorney to help you through the ERC audit. They can help you communicate with the auditor, as they are very experienced with the process. 
• If you incur audit penalties, ask for penalty abatement. Be prepared to explain that you had reasonable cause for making a mistake and didn’t commit negligence. 
• Amend your payroll tax returns or look into voluntary disclosure if you know that you made mistakes on your tax return. 

Worried about ERC audit penalties? Then, contact a tax attorney. Whether you need a second look at a return, want help deciding if you should amend, or need audit representation, an experienced tax attorney can help you. 

Recourse If You Worked With an Unscrupulous Tax Preparer

A lot of unscrupulous companies popped up to make money on this tax credit. In most cases, they advertised aggressively with radio, internet, and TV ads promising business owners that they could get this credit. Then, when they got in touch with employers, they urged them to claim the credit whether or not they qualified. 

Generally, these companies don’t offer any audit protection, and if you incur fees or audit penalties, they won’t give you back the money you paid them. In some cases, they may even have closed up shop, and you won’t be able to find them. 

So, what’s your recourse in this situation? Unfortunately, you may not be able to avoid audit penalties. You are responsible for the information on your tax returns. That said, you may be able to find an empathetic IRS employee who may remove penalties for you. In this situation, it’s always best to work with a tax professional. 

Additionally, you should let the IRS know that you were conned into claiming the penalties. You can call them or file Form 14242 (Report Suspected Abusive Tax Promotions or Preparers). In some cases, you may be able to file a suit against the preparer for losses, but this can be a difficult process. 

Get Help With ERC Audit Penalties

Dealing with ERC audit penalties? Want help applying for penalty abatement? Worried about penalties and want help through an audit? Worried about an ERC audit and want someone to take a second look at your tax return? Then, contact us today. 

At the W Tax Group, our tax attorneys understand the complexities of the ERC. We can help you review your tax returns, get through an audit, apply for penalty abatement, and deal with any other ERC-related issues. Ready to chat? Then, let’s set up a 100% free consultation — contact us today to learn more.