Proper Recordkeeping Is Key to Substantiating Employee Retention Credits

The Employee Retention Credit (ERC) offers businesses crucial tax relief for retaining employees during COVID-19 disruptions. However, complex rules for calculating, qualifying for, and claiming the credit means the IRS will heavily scrutinize ERC claims. Meticulous recordkeeping and robust documentation are essential to validate credits and avoid costly audits or recapture of previously issued refunds. This article examines key areas employers must address to substantiate credits.

Determine Employer Eligibility

To qualify for ERCs, employers must first confirm they meet threshold requirements. Documentation should prove:

  • The business is not a tax-exempt entity prohibited from claiming credits, such as a government employer
  • Quarterly declines in gross receipts exceeded 20% of comparable 2019 levels to satisfy the impact threshold
  • Full or partial suspensions of operations occurred in 2020/2021 due to COVID-19 governmental orders.

Examples of substantiating documents:

  • Organization formation documents showing for-profit tax status
  • Quarterly financial statements from 2019/2020/2021 detailing gross receipts
  • 2020/2021 accounting records documenting quarterly revenue declines
  • Government orders requiring closure or restricted operations
  • Evidence of COVID-19 necessity for telework policies or reduced operations

Maintain Employee Payroll Records

The amount of ERCs hinges on qualified wages and health expenses paid to employees during eligible periods. Thorough payroll documentation is imperative.

Key data to retain:

  • Number of full-time equivalent employees (FTEs)
  • Proof of FTE calculation methodology
  • Employee payroll records evidencing wages paid during quarters
  • Documentation of qualified wages was excluded because work was performed
  • Health plan costs allocated to eligible wages
  • Evidence that unforgiven PPP loan amounts were excluded from credit calculations
  • Wage reports (W-2s, 940, 941) corroborating qualified wage amounts

Retain Credit Computation Details

Employers must also document precise credit determination, including:

  • Calculations of qualified wage amounts per employee
  • Maximum credit limitations applied ($10,000 annually in 2020, $10,000 quarterly in 2021)
  • Figures showing 50% (or 70% for Q3/Q4 2021) credit rate applied to qualified wages
  • Addition of allocable health expenses to yield total credit amount
  • Confirmation credits were not claimed for wages used for PPP loan forgiveness
  • Evidence of credit carryforward for any excess not able to be applied currently

Formal Policies for Claiming Credits

Implement formal ERC protocols detailing:

  • Who determined eligibility and credit computations
  • How qualified wages and health costs were identified
  • What substantiation was required for claims
  • Who reviewed and approved claiming credits on 941s
  • Process for amending prior 941s to claim credits
  • Procedures for reconciling with PPP loan applications and forgiveness

Robust Change Management Process

Instituting change management controls creates stronger documentation such as:

  • Records of amended 941 filings and new ERC claims
  • Explanations for changes from original credit claims
  • Evidence that changes were properly reviewed and approved
  • Reasons for claiming credits for new quarters

Centralized Documentation Repository

Maintain a centralized repository of ERC records including:

  • Eligibility assessments and gross receipts documentation
  • Employment and payroll data to support qualified wage amounts
  • Documentation of qualified health expenses
  • Credit computations and limitation schedules
  • Change management records for new/amended claims
  • Formal claiming protocols, reviews, and approvals
  • Other memorandums, communications, or calculations

Thorough documentation not only helps defend ERC claims on IRS audits, but enables efficient responses to reduce time and audit costs.

Best Practices for Verifying Contractor ERC Eligibility

Many businesses engage independent contractors and need to determine if the amounts paid qualify for ERCs. Follow these best practices:

  • Obtain documentation that contractor business experienced required COVID-19 impacts
  • Review contracts to confirm canceled services due to your COVID-19 disruptions
  • Request evidence of Form 1099 reporting for services
  • Require contractors to provide their own ERC computations based on COVID-19 impacts
  • Verify contractor wages were not also claimed by another party

Documentation Requirements for Nonprofit Organizations

Tax-exempt nonprofits are eligible for ERCs but face additional documentation requirements including:

  • Substantiating status as a tax-exempt organization under IRC Section 501(c)
  • Documenting any unrelated business taxable income (UBTI) generated
  • Maintaining records that taxable wages were not paid from federal government grants or assistance
  • Proving wages were not used to claim other credits like the Work Opportunity Tax Credit

Conclusion

Meticulous documentation and record retention is obligatory to support Employee Retention Credits claimed. Key focus areas include confirming eligibility, documenting qualified wage amounts, detailing credit computations, instituting robust claiming protocols, and retaining substantiation in a centralized repository. Verifying contractor eligibility and satisfying special nonprofit requirements warrants extra diligence. With the IRS poised to heavily scrutinize ERC claims, thorough recordkeeping is imperative to validate credits and avoid adverse audit results. The critical tax relief offered by Employee Retention Credits merits the time investment to proactively maintain proper documentation.

Responding Efficiently to IRS Audits of ERC Claims

Upon launching an Employee Retention Credit audit, the IRS will issue detailed Information Document Requests (IDRs) seeking substantiation of eligibility and credit computations. Structured recordkeeping enables rapid access to required documentation.

Best practices for responding to ERC audits include:

  • Centralizing documentation ahead of time in anticipation of IRS reviews.
  • Assigning responsibility to accounting/finance staff familiar with ERC claims.
  • Reviewing IDR requests immediately and clarifying any ambiguity with the IRS agent.
  • Gathering documentation from various internal sources to be as responsive as possible.
  • Maintaining meticulous schedules that tie records to specific IDR questions.

-Highlight key corroborating documents that fully support the criteria under review.

  • Working with tax advisors to ensure IDR responses satisfy IRS requirements.
  • Proactively communicating with the IRS agent to expedite the process.
  • Asking for extensions or clarification if any IDR seems unreasonable or unclear.

Common reasons ERC claims are denied:

  • Failure to respond timely or provide adequate documentation.
  • Inability to evidence quarterly gross receipts threshold declines.
  • No records of required full or partial COVID-19 shutdowns.
  • No documentation for PPP loan coordination or amended 941 filings.
  • Incomplete proof of qualified health expenses tied to eligible wages.
  • Unreliable substantiation of qualified wage amounts per employee.

By maintaining proper documentation and responding promptly and comprehensively, employers can successfully validate Employee Retention Credits claimed on IRS audits.

Frequently Asked Questions

Q: What records are needed to confirm a sufficient decline in gross receipts?

A: Quarterly financial statements from 2019/2020/2021 showing revenues, as well as accounting records detailing the quarterly gross receipts decline percentage calculations.

Q: What documents should I maintain for qualified wages?

A: Employee payroll records, wage reports (W-2s, 940, 941), proof of excluded amounts for work performed, and health plan costs allocated to eligible wages.

Q: How long should I retain ERC documentation?

A: Records should be kept for at least 6 years after claiming the credit per IRS requirements. Retain documentation through at least 3 years after the extended statute of limitations.

Q: What if I claimed credits and then received PPP loan forgiveness?

A: Keep detailed reconciliations and amendments showing wages were not double-dipped under both programs.

Q: What documents evidence a COVID-19-related governmental shutdown?

A: Maintain copies of any COVID-19 governmental orders requiring full or partial closure or suspensions of operations.

Helpful Resources:

  • IRS Form 941 Instructions – reporting Employee Retention Credits
  • IRS Disaster Assistance page on COVID-19 – updates on documentation relief
  • AICPA Tax Practice Guides on documentation processes
  • Employee Retention Credit Coalition tips on documenting eligibility

Thorough documentation and recordkeeping are key to substantiating valuable ERC claims. Following the IRS taxpayer guide on recordkeeping requirements can help employers maintain proper support.

Note:

Affiliate Disclaimer: From time to time, I will promote, endorse, or suggest products
and/or services for sale that are not my own. My recommendation is ALWAYS based on
My personal belief is that the product and its creator will provide excellent and valuable
information or service. This may be based on a review of that product, my personal or
professional relationship with that person or company, and/or a previous positive
experience with the person or company whose product I am recommending. In most
cases, I will be compensated via a commission if you decide to purchase that product
based on my recommendation.

Leave a Comment

Your email address will not be published. Required fields are marked *

Scroll to Top