IRS Launches ERC Correspondence Audits

ERC Strategies for PEOs: Understanding the potentially negative impact of IRS’s new tool for ERC enforcement.

The IRS, likely recognizing the limited resources available for ERC enforcement and the massive number of claims filed, quietly added another tool in late 2023. The IRS started
performing correspondence audits, meaning audits conducted solely through the mail, with no personal interaction between the taxpayer and the IRS. These types of audits have long been a target of criticism from IRS watchdogs.

The national taxpayer advocate, for instance, labeled correspondence audits among the “most serious problems” with the IRS. She explained the situation as follows:

Many taxpayers experience difficulties with correspondence audits. Once a return
is selected for examination, the IRS notifies the taxpayer by letter. Correspondence audit letters fail to provide a point of contact — the taxpayer is not given a direct phone number or the name of an IRS employee to contact. If no response to the initial contact letter is received, the IRS generally makes no effort to contact the taxpayer before making an adjustment, issuing a notice of deficiency, and closing the case. Taxpayers wishing to speak with someone regarding an audit are limited to calling a representative on a toll-free line. This process creates significant challenges for taxpayers and practitioners who need to reach the IRS to discuss their cases. Getting through on the IRS’s toll-free lines is difficult and timeconsuming. If the IRS initiates a call to the taxpayer or practitioner in response to correspondence, the taxpayer or practitioner is often unavailable. Getting back in touch with the IRS can be nearly impossible due to the IRS’s inability to leave detailed phone messages.

In the context of ERC claims, the IRS began sending Letters 6612 to various taxpayers in late 2023. These letters confirm that the IRS is auditing the ERC claimed, instruct the taxpayer to fully respond to the enclosed information document request (IDR), indicate that the deadline is days from the date on the letter, and enumerate four outcomes.

• First, if the materials provided in response to the IDR support ERC eligibility and
  amounts, the IRS will accept the Form 941 or Form 941-X.
• Second, in situations in which the materials fail to offer full support, the IRS will send an
  examination report explaining proposed adjustments, and the taxpayer can then dispute matters in various ways.
• Third, if a taxpayer decides to ignore a Letter 6612, the IRS will completely disallow the ERC claimed and not release any refunds.
• Finally, the IRS contemplates a fourth scenario in which taxpayers prepare their
  responses to the IDRs, suddenly realize they are not entitled to the ERCs previously sought, and want to withdraw their claims. When taxpayers experience this type of epiphany, they are supposed to “let the IRS know” and then get their “specific instructions” on how to give back their tax benefits.

Letters 6612 do not contain the name, title, or phone number of a revenue agent, tax compliance officer, or other IRS employee with whom the taxpayers under audit can communicate directly. The taxpayers must send all materials — including a potentially massive number of documents, questions, and anything else — to a generic IRS fax number or office.

The amount of data demanded by the IDRs is vast, of course. Among other things, they demand details about

1. whether the taxpayer was engaged in a trade or business;
2. how the taxpayer qualified under the governmental order test, with particular focus on the concepts of partial or full suspension of operations, as well as “nominal portions” of, and “nominal effects” on, a business;
3. how the taxpayer qualified under the gross reduced receipts test;
4. whether the taxpayer met the recovery start-up business
   standards during the third or fourth quarter of 2021;
5. how the ERC amounts were calculated;
6. how the “qualified health plan expenses” were determined and allocated;
7. characterization of the taxpayer as a small eligible employer or a large eligible employer;
8. which employees receiving wages were actually performing services for the taxpayer;
9. all “related parties” to the taxpayer or its majority owners;
10. loans applied for, received, or forgiven under the Paycheck Protection Program;
11. wages taken into account by the taxpayer in obtaining benefits under the Restaurant Revitalization Fund, the Families First Coronavirus Response Act, and so on; and
12. amended income tax returns showing reduced deductions for wages paid by the amount of ERCs received.

Things get worse when the IRS is scrutinizing multiple tax periods: The IDRs warn that “if multiple quarters are under audit, provide a response for each quarter [and] if you
don’t send a response for a quarter under audit, we’ll disallow the ERC for that quarter.”