Required Documentation for the Employee Retention Credit
As the financial and operational challenges created by the COVID-19 pandemic begin to subside, many New Jersey and Pennsylvania-area businesses are starting to turn the corner. It was recently reported by the U.S. Bureau of Labor and Statistics (BLS) that New Jersey added another 21,500 jobs in September, which means the state has reclaimed 68% of the jobs lost during the pandemic. In Pennsylvania, the unemployment rate has fallen to 6.7%, with parts of the state reporting a better 6.3%. A key reason so many businesses were able to survive during recovery is federal COVID-19 relief programs such as the Employee Retention Credit (ERC). The payroll-based credit offers businesses subject to forced business closure or reduction in gross receipts to receive a credit against employee wages. The credit is claimed against quarterly payroll taxes and is taken by reducing taxes owed.
Unfortunately, the ERC is scheduled to expire on December 31, 2021. It doesn’t appear to be extended, as lawmakers are currently working on the Build Back Better Act, which may end the ERC retroactively to September 30, 2021. However, there have been several Congressional leaders pushing back against ending the credit early.
While businesses will be unable to continue claiming the credit, it does not mean additional attention should not be paid to ERC filings. Once the program concludes, the IRS will shift efforts to enforcement as concerns about inaccurate or fraudulent credit claims have been made. For example, it was found in the Treasury Inspector General for Tax Administration (TIGTA) report on COVID-19 that employer tax credits for the period ending in October 2020 there were $92M in potentially fraudulent claims. Given the limited scope of the investigation, it is likely the annual number is drastically higher.
Businesses that claim the ERC should be prepared to defend against an IRS inquiry. For this reason, it is essential to ensure the retention of appropriate documentation, which we take a closer look at below.
ERC Documentation Requirements
The IRS initially provided documentation requirements in IRS Notice 21-20 and appeared not to have made any subsequent changes. The requirements include documentation related to eligibility, such as copies of governmental orders, records used to determine a significant decline in gross revenues, the amount of qualified wages paid, and work documents showing that wages were paid to employees not providing services for a large eligible employer.
Businesses should also retain documents that show how the employer determined the eligible amount of qualified health plan expenses, information on how credit calculations were made, copies of completed Form 7200s, and copies of federal employment tax returns submitted to the IRS (for those that use third party providers to prepare and pay employment taxes).
For those that claimed an ERC advance, it is expected scrutiny will be more intense. For this reason, it is important to ensure the above information is available and the calculation details to confirm the business qualified for the advance.
The guidance also points out that all relevant documentation should be retained for at least four years after the taxes become due or are paid later. After that, all information should be readily available if requested by the IRS.
The ERC continues to be a valuable tax-saving tool for many businesses. Still, it is important when claiming the credit to ensure the necessary information is documented and organized as a safeguard if an inquiry is initiated. In addition, with the uncertainty of the credit’s future, the fact that the IRS is behind in processing refunds, and the need for cash flow now, those looking to take advantage of the credit should get their application in sooner rather than later.
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©2021 Klatzkin & Company LLP. The above represents our best understanding and interpretation of the material covered as of this post’s date. The content is provided for informational purposes only and does not constitute accounting, tax, or financial advice. Please consult your advisor concerning your specific situation.