In early 2025, the IRS had a backlog of more than 1 million pending ERC claims and launched thousands of audits and hundreds of criminal investigations targeting questionable filings.

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The Employee Retention Credit (ERC) was created under the CARES Act as a refundable payroll tax credit for businesses hit by COVID-19 disruptions. At its peak, the ERC delivered more than $242 billion in refunds by early 2025.

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However, aggressive marketing campaigns by ERC mills increased improper claims. In September 2023, the IRS imposed a moratorium on new claims and shifted to enforcement mode. By mid-2025, audits had intensified, and thousands of businesses received letters of disallowance or recapture.

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With claim submissions now closed, 2025 has become the year when the IRS is actively scrutinizing past filings.

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This article offers a practical, step-by-step approach to preparing for potential IRS review, minimizing audit exposure, and responding confidently if your ERC claim is audited.

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Why the ERC Is Under Increased Scrutiny

As the ERC filing window has officially closed, the IRS has turned its focus from processing new claims to aggressively auditing past submissions.

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In May 2025, the agency announced it’s ramping up enforcement efforts and has even created a Voluntary Disclosure Program to encourage corrections before audits begin.

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Previously, a September 2023 moratorium on new claims highlighted a broader fraud concern, implying a deliberate move toward identifying improper or inflated claims.

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Here are reasons why the IRS is now focusing on ERC filings:

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Common Abuses and Misinterpretations of Eligibility

Many audits have revealed businesses misused the ERC by:

• Claiming credits without a significant drop in revenue or government-ordered shutdowns of operations.
• Misapplying government orders, for example, interpreting general recommendations or news coverage as qualifying orders.
• Broadly citing supply chain disruptions without proving suppliers were under official government closure  rather than simple delivery delays or cost increases.

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The Role of Aggressive ERC Promoters and Third-Party Services

The IRS has repeatedly flagged “promoters” or ERC mills that used slick marketing to pitch “risk-free” refunds, often charging hefty contingency fees (up to 25%). The agency named misleading ERC schemes among its “Dirty Dozen” tax scams in both 2023 and 2024.

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It warned taxpayers that inflated or ineligible ERC claims could trigger penalties, interest, or even criminal prosecutions.

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High-Risk Red Flags That Trigger ERC Audits

When the IRS focuses on ERC filings, it’s usually because something about the claim stands out; and not in a good way. In 2025, audit scrutiny has increased, with the IRS flagging improper or aggressive claims for detailed review.

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Below are the most common red flags that raise the chances of an audit. Knowing these can help you address potential issues before they’re on the IRS radar.

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Claiming ERC Without a Real Revenue Drop or Operational Suspension

The IRS flags ERC filings without strong evidence of a decline in gross receipts or a valid government-mandated suspension.

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For instance, "essential" businesses that continued operations (beyond minor safety protocols) often aren’t eligible. Lacking documentation that government orders impacted your operations substantially is an audit red flag.

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Applying for ERC While Also Receiving PPP Funds (Without Proper Coordination)

Claims that misuse wages already forgiven through PPP are highly scrutinized. Per guidance, you cannot double-dip (i.e., wages counted toward PPP forgiveness can’t qualify for ERC). Ensure you retroactively track this and file 941-X correctly.

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Missing or Inconsistent Documentation

Entries that don’t have backup (such as payroll records, quarterly Form 941 filings, or explicit government orders) are vulnerable. The IRS expects clear support showing which operations were suspended, when, and under what authority. General narratives and vague claims won't suffice.

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Retroactive or Rushed Filings Through Questionable Consultants

Aggressive promoters offering blanket ERC filings, especially for all available quarters, raise alarms. The IRS highlights "promoters convincing businesses to claim the ERC when they weren’t eligible," leading to high denial and audit rates.

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Claiming the Maximum Credit Without Solid Justification

A tendency to claim maximum credits (like full per-employee wage caps) without reflecting actual eligibility is red-flagged.

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For example, large employers often mistakenly include working employee wages, which are ineligible. To avoid scrutiny, ensure there’s consistency in wage counts and credit amounts.

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How to Prepare for a Potential ERC Audit

Gather and Organize All Payroll and Financial Documentation

Maintain a centralized, digital file with payroll records, quarterly Form 941 returns, Forms 941-X, general ledgers, and financial statements.

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IRS auditors usually request payroll summaries, timesheets, and proof of wages paid, so having everything neatly labeled and dated streamlines responses.

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Maintain Written Justification for Eligibility

For each quarter claimed, include clear, written explanations showing how you met ERC eligibility, such as gross receipts drops or government-imposed suspensions. Attach backup documentation like revenue reports or official shutdown orders. This addresses what IRS auditors look for.

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Keep Communication Records with Your ERC Service Provider or Accountant

Save all emails, memos, meeting notes, and contracts with third-party ERC consultants or your CPA. Documenting internal discussions, eligibility rationale, and tax calculations demonstrates due diligence and helps establish accountability under IRS Circular 230.

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Reconcile ERC Claims with Tax Filings and Amended Returns

Ensure Form 941-X adjustments align with payroll registers, revenue records, and federal tax returns. Confirm no overlap with PPP funds by cross-referencing loan forgiveness documentation (IRS auditors will examine these reconciliations.

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Double-Check Employee Counts and Wage Thresholds

Verify that you’ve included only eligible employees and wages in your ERC claim. Reconcile employee counts to payroll records based on 2019 averages, and ensure wage totals meet IRS-defined thresholds (e.g., wages subject to Social Security tax).

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How to Build Your ERC Audit Response Team

When facing an Employee Retention Credit audit, your response team can make the difference between a successful defense and costly penalties. Here’s how to assemble qualified professionals who understand the technical requirements and audit procedures.

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Team Members for ERC Audit Defense

Tax Attorney or Tax Controversy Specialist

A qualified tax attorney should lead your ERC audit response team. Look for professionals with specific experience in employment tax controversies and ERC compliance issues.

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Your tax attorney will manage IRS communications, assert applicable privileges, and develop your entire audit strategy.

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The main qualifications to consider include:

• Experience with IRS audit procedures and employment tax matters
• Knowledge of ERC regulations and recent IRS guidance
• Track record handling tax controversies similar to your situation
• Ability to communicate complex tax issues clearly to business stakeholders

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CPA with ERC Expertise

Your CPA is the technical backbone of your audit response, analyzing calculations, reviewing documentation, and ensuring compliance with ERC requirements. Choose a CPA who specializes in employment tax credits and has handled multiple ERC audits.

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The main CPA responsibilities include:

• Reviewing original ERC calculations for accuracy and compliance
• Organizing and preparing required documentation for IRS examination
• Analyzing payroll records and qualifying wage determinations
• Identifying potential issues before they become audit problems

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Internal Finance and HR Leadership

Your internal team members provide important institutional knowledge and operational context that external professionals cannot replicate. The CFO or controller should coordinate financial records, while HR leadership can explain employment decisions and retention strategies.

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Internal team contributions include:

• Providing historical context for business decisions during the pandemic
• Explaining operational changes and their impact on employee retention
• Gathering and organizing internal documentation and communications
• Serving as liaison between external professionals and company operations

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Advisors for Complex ERC Audits

Employment Law Attorney

For businesses with complex employment situations, an employment law attorney can provide valuable insights into compliance issues that may affect ERC eligibility. This is important for companies with union agreements, complex benefit structures, or significant workforce changes.

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Industry-Specific Consultants

Certain industries face unique ERC challenges that require specialized knowledge. Healthcare organizations, manufacturers, and retail businesses often benefit from consultants who understand industry-specific regulations and operational requirements.

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Financial Advisors for Cash Flow Management

ERC audits can result in significant repayment obligations. Financial advisors help businesses plan for various audit outcomes and develop strategies to manage potential cash flow impacts without disrupting operations.

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Team Coordination and Communication Strategy

Establish Clear Roles and Responsibilities

Define each team member's specific duties and decision-making authority from the outset. This prevents confusion during high-pressure audit situations and ensures efficient information flow throughout the process.

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Privileged Communication Protocols

Implement procedures to maintain attorney-client privilege and protect sensitive communications. All team members must understand which communications are privileged and how to preserve confidentiality during the audit process.

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Regular Team Meetings and Updates

Schedule consistent team meetings to review audit progress, discuss strategy adjustments, and coordinate responses to IRS requests. Regular communication prevents surprises and keeps all stakeholders informed of developments.

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Budget Considerations for ERC Audit Defense

Professional Fees and Cost Management

ERC audit defense can be expensive, especially for complex cases involving multiple tax years or large credit amounts. Establish clear fee arrangements with all professionals and monitor costs throughout the process.

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Cost-Benefit Analysis of Audit Defense

Evaluate the potential cost of audit defense against the risk of adverse outcomes. In some cases, negotiating a settlement may be more cost-effective than extended audit proceedings.

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Best Practices for Audit Risk Mitigation

With more than 84,000 disallowance letters already sent and thousands of audits underway, including potential criminal investigations, you must take proactive measures to defend your ERC claims.

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Amid substantial IRS staffing changes and updated rule clarifications released in March 2025, now is the best moment to implement strong compliance protocols. The tips below will help reinforce your ERC strategy:

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Work with Qualified CPAs or ERC Specialists (Not ERC Mills)

Partner with licensed CPAs or recognized tax professionals who specialize in ERC compliance, rather than aggressive “refund recovery” firms. These mills often use high-pressure sales strategies and may overlook eligibility details, thereby putting your business at serious risk.

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Trusted advisors, on the other hand, provide careful reviews and red flag detection (what the IRS looks for in audits).

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Conduct an Internal Audit or Third-Party Review of Your ERC Claim

Before the IRS comes knocking, assess your ERC submission. Whether done internally or through an independent reviewer, evaluate eligibility criteria, wage calculations, and documentation consistency. A comprehensive audit can reveal gaps and prevent costly audit letters or penalties .

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Stay Updated with IRS Guidance and ERC-Related News

Tax rules change and ERC guidance is no exception. The IRS’s March 20, 2025 FAQ updates clarified how to report wage expenses and address disallowed claims, including new rules about income recognition timing. Track IRS releases regularly so your approach stays compliant and defensible.

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Amend or Withdraw Questionable Claims if Needed

If your review reveals errors or if IRS guidance changes, make the necessary corrections. The IRS has encouraged businesses to withdraw or correct improper ERC claims to avoid penalties. Proactive amendments show good faith and reduce enforcement risk.

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Document Everything (Decisions, Interpretations, Sources, and Calculations)

A solid audit trail is your best defense in case of an IRS inquiry. Maintain detailed records including how eligibility was determined, which government orders or revenue metrics were used, and why specific wage amounts were claimed. Include contemporaneous communications with advisors for full transparency.

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What Records Should I Keep to Defend an ERC Claim During an Audit?

To defend an ERC claim during an audit, you'll need the following records to prove your eligibility and the accuracy of your credit calculations:

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Documentation Requirements

Government Orders and Operational Impact

Ensure you have documentation of the government order related to COVID-19 and how and when it suspended your operations. Keep:

• Original government orders (federal, state, local) that impacted your business
• Documentation showing how these orders affected your operations
• Internal communications and decisions made in response to government orders
• Evidence of partial or full business suspensions

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Financial Records for Gross Receipts Test

Have thorough records that show wages paid, gross receipts, government orders, and other required documents. Maintain:

• Quarterly gross receipts for 2020 and 2021
• Comparable prior year gross receipts (2019 for 2020 comparison)
• General ledger and income statements
• Sales records, invoices, and revenue documentation
• Bank statements supporting gross receipts calculations

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Payroll and Employee Records

Ensure all relevant documents related to the ERC are in order, such as payroll records, tax returns, and other supporting documentation. Keep detailed:

• Payroll registers for all applicable quarters
• Employee records showing full-time vs. part-time status
• W-2 forms for all employees
• Documentation of qualified wages paid to each employee
• Records of health plan expenses allocated to employees

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Tax Filing Documentation

Forms and Calculations

Worksheets supporting how the ERC was calculated and reported on Forms 941-X (remember, credit limitations should have been applied on a per-employee basis). Maintain:

• Original Forms 941 (quarterly employment tax returns)
• Amended Forms 941-X claiming the ERC
• Detailed ERC calculation worksheets
• Supporting schedules showing per-employee credit limitations
• Documentation of any other payroll tax credits claimed

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Professional Documentation

If you used a tax professional or ERC service provider:

• All correspondence with your tax preparer
• Engagement letters and fee agreements
• Any analysis or reports prepared by professionals
• Documentation of due diligence performed

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Operational Records

Business Operations Documentation

• Board meeting minutes discussing COVID-19 impacts
• Management decisions related to business operations
• Communication with employees about operational changes
• Vendor contracts and supplier agreements affected by orders
• Lease agreements and property-related documents

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Employee Retention Evidence

• Documentation showing efforts to retain employees
• Records of employees who were furloughed vs. terminated
• Evidence of continued employment during suspension periods
• HR policies and procedures implemented during the pandemic

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Streamline ERC Audit Readiness with Chore

Startups often struggle to compile payroll records, benefits data, and compliance documents (all important for surviving an ERC audit). That’s where Chore comes in as your fractional operations partner.

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With a dedicated Chore CEO embedded within your team, you get an operational back office that’s:

• Comprehensive in scope: From payroll and HR to finance ops, compliance, equity filings, and benefits administration it covers all audit critical bases.
• Expert-driven yet cost-efficient: At roughly a third of the cost of an internal hire, it saves you approximately $150,000 in labor while reclaiming up to 500 hours annually for focus on growth.
• Built for scale: Whether you’re filing 1099s, setting up wages across states, managing payroll taxes, or maintaining audit-ready documentation, Chore brings SOPs, checklists, and compliance rigor from day one 

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In terms of ERC, Chore ensures you’re always prepared to:

• Accurately calculate and report qualified wages, track eligible employees, and manage tax filings.
• Maintain clear documentation paths (from employee records to government orders and revenue reports) to justify eligibility.
• Respond quickly to IRS audit inquiries, with organized digital records, audit response templates, and a single expert point person coordinating your entire back office.

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Book a free demo with Chore to discover how we can help you build an ERC audit-ready back office.

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FAQs

Why is the IRS increasing ERC audits in 2025?

The IRS is increasing ERC audits in 2025 due to widespread abuse and fraudulent claims that surfaced after the program's expansion during the pandemic. Here's why:

• Increase in questionable claims
• Billions in payouts at risk
• New funding and enforcement focus
• Increased whistleblower activity
• Ongoing criminal investigations

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Will using a third-party ERC service provider protect me from liability?

No, using a third-party ERC service provider does not protect you from liability. Even if you relied on an external consultant or ERC “expert,” your business is legally responsible for the accuracy of your Employee Retention Credit claim. The IRS holds the taxpayer (not the preparer) accountable for any errors, misrepresentations, or fraudulent claims. If the provider submitted a false or inflated claim on your behalf, you could still face audits, penalties, interest, and potentially even repayment of the credit.

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What should I do if I suspect my ERC claim may be incorrect?

If you suspect your ERC claim may be incorrect, here’s what you should do immediately to reduce your risk of IRS penalties or audits:

• Stop any pending or future filings
• Review your claim with a qualified tax professional
• Reconstruct and verify eligibility
• Amend or withdraw the claim if needed
• Keep all documentation and communications