ERTC Compliance: How to Avoid IRS Penalties and Audits

The Employee Retention Tax Credit (ERTC) has provided businesses with substantial financial relief, offering refunds of up to $26,000 per employee for keeping workers on payroll during the COVID-19 pandemic. However, with increased IRS scrutiny, businesses must be careful to comply with ERTC regulations to avoid penalties and audits.

As the IRS cracks down on incorrect or fraudulent ERTC claims, many businesses that filed without fully understanding the requirements may be at risk of facing an IRS audit, repayment demands, or even legal consequences.

In this guide, we’ll cover:
✔ Common ERTC compliance mistakes that trigger audits
✔ How to properly document your claim to avoid penalties
✔ IRS red flags and warning signs for fraudulent filings
✔ Steps to take if your business is audited for ERTC

If you’re unsure whether your ERTC claim was filed correctly, now is the time to review your compliance and avoid costly penalties.

1. Why ERTC Compliance Matters

While the ERTC was designed to help businesses recover from COVID-19-related financial setbacks, many companies unknowingly filed incorrect claims, either through misinterpretation of the rules or bad advice from third-party “ERTC mills.”

🚨 IRS Warning: The IRS has issued multiple alerts warning businesses about aggressive ERTC promoters encouraging ineligible claims—leading to a rise in audits and penalties.

💡 Key Takeaway: If you filed for the ERTC, review your claim now to ensure compliance before the IRS does.

2. Common Mistakes That Can Trigger an IRS Audit

Many businesses innocently make errors on their ERTC claims, which can result in IRS audits, penalties, or forced repayment of funds.

🚨 Mistake #1: Claiming ERTC Without Meeting Eligibility Requirements

To qualify for ERTC, businesses must meet one of two criteria:

✔ Revenue Decline Test

• 2020: Gross receipts declined 50% or more in a quarter compared to 2019.

• 2021: Gross receipts declined 20% or more in a quarter compared to 2019.

✔ Government Order Test

• Business operations were fully or partially suspended due to COVID-19 government orders.

• Capacity restrictions, supply chain disruptions, or reduced working hours qualify.

🚨 Red Flag: If you claimed ERTC without a significant revenue drop or without documented government-mandated restrictions, your claim may be flagged for an audit.

🚨 Mistake #2: Double-Dipping ERTC and PPP Loan Wages

✔ You cannot claim ERTC on the same wages that were covered by forgiven Paycheck Protection Program (PPP) loans.
✔ You must separate PPP-covered wages from ERTC-eligible wages to avoid IRS penalties.

🚨 Red Flag: If your business used 100% of payroll for both PPP forgiveness and ERTC, the IRS may review your claim for double-dipping violations.

🚨 Mistake #3: Incorrectly Calculating Qualified Wages

✔ The IRS only allows specific types of wages and benefits for ERTC calculations.
✔ Independent contractors, owner wages (in some cases), and certain benefits do not qualify.

🚨 Red Flag: If you overestimated your payroll costs, the IRS may recalculate your credit and demand repayment.

🚨 Mistake #4: Trusting Third-Party ERTC "Mills" Without Verification

✔ Many businesses hired ERTC firms that promised large refunds without verifying eligibility.
✔ The IRS has warned against scam ERTC companies that submit false or exaggerated claims.

🚨 Red Flag: If your business relied solely on an ERTC promoter’s calculations, double-check your claim before the IRS does.

💡 Pro Tip: If a third-party firm charged a high upfront fee or took a percentage of your refund, that’s a warning sign your claim may have been exaggerated.

3. How to Ensure Your ERTC Claim is Compliant

If your business filed for ERTC, taking the following steps can help prevent future IRS issues and ensure you’re in compliance.

✅ Step 1: Review Your Original ERTC Filing

✔ Recalculate your qualified wages to confirm accuracy.
✔ Check revenue decline data and verify it matches IRS requirements.
✔ Ensure that PPP wages were not included in your ERTC claim.

✅ Step 2: Gather Documentation to Support Your Claim

Having strong records reduces the risk of an audit and makes it easier to defend your claim if challenged.

✔ Financial Statements (to prove revenue decline).
✔ Payroll Records (showing wages paid during eligibility periods).
✔ Government Orders (if claiming under the suspension test).
✔ ERTC Calculation Worksheets (detailing how you arrived at your credit amount).

💡 Pro Tip: Keep all ERTC-related records for at least 5 years in case of an IRS audit.

✅ Step 3: Consult a Tax Professional to Review Your Claim

✔ If you used a third-party firm to file, get an independent CPA or tax expert to review your claim for accuracy.
✔ If errors are found, you may need to amend your tax return and return excess funds to avoid penalties.

🚀 Better to fix mistakes proactively than wait for an IRS audit!

4. What to Do If You’re Audited for ERTC

If the IRS selects your business for an ERTC audit, don’t panic—follow these steps:

📌 Step 1: Respond Promptly to IRS Requests

✔ If you receive a Notice of Examination, respond by the deadline to avoid penalties.
✔ Provide all requested documents, including payroll records and financial statements.

📌 Step 2: Work With a Tax Expert

✔ Hire an experienced tax professional or CPA who understands ERTC compliance.
✔ Avoid handling the audit alone—a tax expert can help negotiate with the IRS.

📌 Step 3: Be Prepared for Adjustments or Repayment

✔ If errors are found, the IRS may reduce your credit or demand repayment.
✔ In some cases, penalties and interest may apply—but early cooperation can help reduce penalties.

🚨 Worst Case Scenario: If fraud is suspected, the IRS could impose severe financial penalties or even criminal charges.

5. How to Fix an Incorrect ERTC Claim

If you discover that your ERTC claim was inaccurate, correcting the issue now can help you avoid major penalties later.

✔ Step 1: File an amended payroll tax return (Form 941-X) to correct the ERTC amount.
✔ Step 2: Repay excess credits to the IRS if necessary.
✔ Step 3: Work with a tax professional to ensure full compliance going forward.

🚀 Proactive corrections can prevent audits and reduce penalties.

Stay Compliant & Protect Your Business

The IRS is increasing audits of ERTC claims, making compliance more important than ever. Businesses that filed without fully understanding the eligibility rules should review their claims now to ensure they are accurate and defensible.

💡 Key Takeaways:
✔ ERTC audits are on the rise due to fraudulent claims and IRS crackdowns.
✔ Review your claim for compliance—double-check revenue decline, payroll, and eligibility.
✔ Gather supporting documents to defend your claim if audited.
✔ If errors are found, amend your return NOW to avoid major penalties.
✔ Consult a tax professional to ensure your business is protected.

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