By Ashlee Hall, Esq., Director of Legal Services for Figure Financial, Inc.
Substantiation
noun
- evidence sufficient to establish a thing as true, valid, or real; proof.
Black’s Law Dictionary defines “substantiation” as “support of a claim or assentation by objective data or other proof of evidence.” In other words, substantiation equals documentation. In short, PROOF. In the ERC context, substantiation means documentation that supports the business’s eligibility position, qualified wage methodology, and credit calculation, among other things.
About a year after the ERC came into existence, the IRS released Notice 2021-20, which outlined the requirements to properly substantiate an ERC claim. This guidance, summarized in relevant part below, can also be used as a roadmap for what to expect in an IRS audit.
Although the IRS has set forth very specific guidance on the substantiation required for ERC claims, there are many business owners who filed an ERC claim but failed to adequately substantiate eligibility, either due to poor (or no) advice by their tax provider or simply a failure to understand these requirements. Notably, the IRS does not require any sort of substantiation – or proof – of eligibility for the credit upon filing. This has resulted in many ERC claims being paid to which the business owner was not entitled.
What is required?
According to the IRS, an eligible employer will adequately substantiate eligibility for the employee retention credit if the employer creates and maintains records that include the following information.
- Documentation to show how the employer determined it was an eligible employer that paid qualified wages, including:
- any governmental order to suspend the employer’s business operations;
- any records the employer relied upon to determine whether more than a nominal portion of its operations were suspended due to a governmental order or whether a governmental order had more than a nominal effect on its business operations;
- any records the employer used to determine it had experienced a significant decline in gross receipts;
- any records of which employees received qualified wages and in what amounts; and
- in the case of a large eligible employer, work records and documentation showing that wages were paid for time an employee was not providing services.
- Documentation to show how the employer determined the amount of allocable qualified health plan expenses.
- Documentation related to the determination of whether the employer is a member of an aggregated group treated as a single employer for purposes of the employee retention credit and, if so, how the aggregation affects the determination and allocation of the credit.
- Copies of any completed Forms 7200 that the employer submitted to the IRS.
- Copies of the completed federal employment tax returns that the employer submitted to the IRS (or, for employers that use third-party payers to meet their employment tax obligations, records of information provided to the third-party payer regarding the employer’s entitlement to the credit claimed on the federal employment tax return).
What should business owners do if they do not have these documents?
It is very important for business owners to gather these documents before the IRS initiates an audit. So far in the audits we have seen, the initial document request aligns with the guidance summarized above. Time is of the essence, as the further we get from the pandemic, the more likely it is that these documents may not be available, either from the business or from the government. For example, we have noticed that many jurisdictions remove governmental orders from their websites as time goes on and administrations change. Unless the tax provider archived governmental orders as we have, business owners that relied on the governmental order test to meet eligibility requirements but failed to save those orders could be out of luck.
How long should a business owner keep substantiation documents?
The IRS noted in its guidance that business owners should keep these documents and have them available for review in the event of an IRS audit for at least four years.
Sources: www.dictionary.com; Black’s Law Dictionary; IRS Notice 2021-20
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