Employee Retention Credit (ERC) in 2026: Compliance, Audits, and Your Business Obligations

For business owners who claimed the employee retention credit during the pandemic years, 2026 brings significant new compliance obligations and increased IRS scrutiny. The employee retention credit remains one of the most valuable tax benefits for qualifying employers, but the landscape has changed dramatically. New filings are permanently closed, enforcement is intensifying, and audit risk has never been higher. This guide explains everything you need to know about ERC compliance, audit defense, and your business obligations in 2026.

Table of Contents

• Key Takeaways
• What Is the Employee Retention Credit?
• Why Is the Employee Retention Credit Permanently Closed?
• What Is Your Audit Risk in 2026?
• What Are Your ERC Compliance Obligations?
• How to Document Your ERC Claim
• What Are Your Recovery and Settlement Options?
• Uncle Kam in Action
• Next Steps
• Frequently Asked Questions
• Related Resources

Key Takeaways

• New ERC claims closed: The employee retention credit permanently stopped accepting new filings on January 31, 2024, ending an era of pandemic relief.
• Audit statute extended: The IRS extended the statute of limitations from 3 to 5 years for ERC claims, significantly increasing audit risk through 2029.
• Enforcement intensifies: The IRS is aggressively auditing ERC claims with stiff penalties for promoters and business owners who made improper claims.
• Voluntary correction preferred: The IRS encourages voluntary withdrawal or settlement over audit enforcement for businesses concerned about ERC eligibility.
• Documentation is critical: Robust financial records, contemporaneous documentation, and proper compliance support are your best defense in an ERC audit.

What Is the Employee Retention Credit?

The employee retention credit emerged from the CARES Act in 2020 as a pandemic relief program designed to encourage employers to retain their workforce during widespread business closures and economic shutdowns. The credit applied to qualifying wages paid to employees during government-ordered shutdowns or periods of significant decline in gross revenues.

How the Employee Retention Credit Worked

For each qualifying employee, businesses could claim a credit based on wages paid. The credit evolved over time, starting at $5,000 per employee in 2020 and adjusting in subsequent years. Eligible employers could claim the employee retention credit against payroll taxes, and the credit was refundable—meaning businesses could receive the credit even if they had no tax liability.

Eligibility hinged on two primary requirements: government-mandated shutdowns or temporary work suspensions, or a decline in gross receipts of 20% or more (later lowered to 10%) compared to the same quarter in the prior year. Businesses could claim the employee retention credit on Form 941-X (amended payroll returns) or claim the credit on current payroll returns if they had sufficient tax liability.

Evolution and Expansion

Congress expanded the employee retention credit multiple times through 2025, increasing the per-employee credit amount and extending the qualification periods. By the time the program approached closure, eligible employers could claim substantial refunds. This expansion led to widespread filing, with millions of employers claiming the employee retention credit across multiple years.

Why Is the Employee Retention Credit Permanently Closed?

The employee retention credit’s closure reflects a policy shift. Originally designed as temporary pandemic relief, the program became subject to widespread abuse and fraud. The IRS identified significant taxpayer non-compliance, with many businesses claiming the employee retention credit without meeting eligibility requirements or without properly documenting their claims.

Fraud and Compliance Issues

Tax preparers and consultants promoted aggressive employee retention credit strategies, sometimes encouraging employers to claim credits without solid legal grounds. Some promoters encouraged employers to claim the employee retention credit even if they received Paycheck Protection Program (PPP) forgiveness—a prohibited practice.

The scope of the problem became evident as audits and criminal prosecutions mounted. The IRS prosecuted tax professionals for promoting fraudulent employee retention credit claims. Several preparers received prison sentences for orchestrating schemes that cost the government billions in improper refunds.

The One Big Beautiful Bill Act Impact

The One Big Beautiful Bill Act (OBBBA), enacted in late 2025, formally closed the employee retention credit program effective January 31, 2024. The law prevents any new employee retention credit claims from being filed, protecting the IRS from additional fraudulent filings while establishing clear rules for businesses already in the system.

What Is Your Audit Risk in 2026?

For many business owners, 2026 marks a critical juncture in ERC compliance. The IRS has made employee retention credit audits a priority, and the extended statute of limitations means businesses face heightened examination risk for longer periods.

Extended Statute of Limitations

Historically, the IRS had three years to examine most federal tax returns and issue assessments. However, for employee retention credit claims, the statute has been extended to five years. This means if your business claimed the employee retention credit in 2024, the IRS can audit the claim through 2029—a substantial extension that dramatically increases exposure.

The longer statute applies regardless of the year the credit was claimed. If you filed an amended return in 2023 claiming employee retention credit for 2020–2021, the IRS now has until 2028 to examine that claim. This extended window gives the IRS considerable time to investigate eligibility and documentation.

IRS Enforcement Priorities

The IRS has signaled clear enforcement intentions for the employee retention credit. The agency is systematically reviewing claims, prioritizing large credits and claims made by businesses using tax professionals or promoters who marketed aggressive positions.

Common audit triggers for employee retention credit claims include: claiming the credit while also receiving PPP forgiveness, claiming the credit with minimal wage documentation, claiming the credit despite no revenue decline, or using form processors or promoters with histories of improper claims.

What Are Your ERC Compliance Obligations?

If your business claimed the employee retention credit, you have an ongoing obligation to maintain complete records and be prepared to substantiate the claim. The IRS’s audit procedures focus on eligibility verification, wage calculation accuracy, and elimination of duplicate benefits (particularly overlaps with PPP credits).

Responding to IRS Notices

If you receive an IRS notice regarding your employee retention credit claim, respond promptly and completely. The IRS typically sends a notice requesting substantiating documentation, wage schedules, gross revenue calculations, or explanation of eligibility determinations. Failing to respond or providing inadequate documentation may result in claim disallowance and penalties.

The IRS has established a preferred approach: voluntary withdrawal of claims the business now questions, or voluntary settlement of disputed claims. Either path is superior to prolonged audit disputes, particularly given the complexity of ERC eligibility rules and the IRS’s clear enforcement posture.

Avoiding Penalties and Interest

If an audit disallows your employee retention credit claim, you face not only repayment of the credit but also interest and substantial penalties. The IRS can assess accuracy-related penalties of 20% plus interest at the current federal rate (typically 8-10% annually). For willful disregard of rules, penalties can reach 40%.

Promoters and tax professionals can face even steeper penalties—up to 50% of promoted credits—plus criminal liability. These severe penalties emphasize the IRS’s commitment to recovering improper ERC refunds.

How to Document Your ERC Claim

Documentation is your most powerful defense in an employee retention credit audit. The burden of proof rests with the business claiming the credit. If you cannot produce records supporting your claim, the IRS will disallow it. Here’s what you need:

Essential Documentation Checklist

• Government order documentation: Copies of federal, state, or local executive orders, public health orders, or other directives that suspended business operations or required reduced operations during specific periods.
• Wage records: Complete payroll records (Form 941, wage statements, timekeeping records) showing wages paid to each employee during the claim period, segregated by quarter and year.
• Gross revenue documentation: Audited or reviewed financial statements, tax returns, or contemporaneous accounting records showing gross receipts for the claim period and the comparison periods.
• Business closure or suspension records: Documentation of facility closures, operational suspensions, supply chain disruptions, or other factors affecting business operations.
• PPP loan documentation: If you received a PPP loan, documents showing which wages were forgiven under PPP (to exclude them from ERC calculations).
• Calculation workpapers: Detailed calculations showing how you determined the eligible wages, the credit amount, and how you avoided double-dipping with PPP or other credits.

How the IRS Evaluates Documentation

IRS auditors examine documentation to verify two key points: that your business met the eligibility criteria, and that your wage calculations are accurate. The IRS will cross-reference your claimed wages against Form 941 filings, W-2 records, and payroll reports. Any discrepancies trigger further investigation.

Contemporary documentation—records created during the period you’re claiming the credit—carries more weight than records created years later. Email correspondence, board meeting minutes, internal memos discussing the business impact of government orders, or payroll system reports all strengthen your audit defense. Generic documentation prepared specifically for the IRS examination raises red flags.

What Are Your Recovery and Settlement Options?

The IRS recognizes that many businesses claimed the employee retention credit based on advice from tax professionals, some of whom promoted aggressive interpretations. The agency has established pathways for businesses to correct errors without facing maximum penalties. Understanding these options is critical as 2026 unfolds.

Voluntary Claim Withdrawal

Businesses can withdraw employee retention credit claims they filed by submitting an amended return (Form 941-X) before the IRS initiates examination. Voluntary withdrawal eliminates penalties and interest in many cases. The downside is forfeiture of the credit—you return the full refund. However, if you’re uncertain about eligibility, withdrawal avoids years of audit exposure and the stress of defending a questionable claim.

The IRS prefers voluntary withdrawal to protracted audits. If the IRS has already notified you of an examination, withdrawal may still be possible and may limit penalties, though you lose any tax benefit.

Settlement and Compromise Programs

If you believe you’re entitled to part of the employee retention credit but question certain aspects of the claim, settlement may be possible. The IRS’s Appeals process provides a venue for negotiated resolution short of litigation. An experienced tax professional can represent your business in Appeals discussions.

Settlements typically reduce the credit amount in dispute, allow partial credit allowance with penalties, or establish a compromise payment schedule. Settlement avoids litigation costs and achieves faster resolution than trial, making it attractive for businesses facing significant audit exposure.

Uncle Kam in Action: Software Company Navigates ERC Audit and Secures Partial Settlement

Client Snapshot: A mid-sized software development company with 35 employees and $3.2 million in annual revenue claimed an employee retention credit of $128,000 for 2020–2021 based on government office closure orders and a 15% revenue decline.

Financial Profile: The company had no PPP loan but did receive an Economic Injury Disaster Loan (EIDL). Management decided to claim the employee retention credit after seeing similar companies file claims. They engaged a third-party payroll processor to calculate the credit based on the business’s wage data.

The Challenge: In late 2025, the company received an IRS examination notice regarding the employee retention credit claim. The IRS identified several issues: the government office closure order applied to the company’s landlord but not directly to the company (the business continued operations with a small on-site team), the company’s gross revenue calculation method was inconsistent with its tax return reporting, and wage calculations failed to account for wages paid to owners, which may not qualify.

The Uncle Kam Solution: The company engaged our experienced tax strategists to review the audit and develop a settlement strategy. We conducted a detailed audit defense review, gathered contemporaneous documentation about the impact of government orders on the business, and prepared corrected wage and revenue calculations. Our analysis determined that approximately 60% of the claimed credit was defensible—specifically the portion for the second and third quarters of 2020 when revenue declined meaningfully and government restrictions directly affected the company.

Rather than litigating a losing position, we negotiated a settlement with the IRS Appeals office. We conceded the portion of the claim lacking solid documentation but fought hard for the defensible portion. The settlement allowed the company to retain credits for the strongest quarters while paying back the questionable claims.

The Results:

• Tax savings: The company retained $76,800 in employee retention credit (60% of the original claim).
• Penalties avoided: By settling rather than litigating, the company avoided accuracy-related penalties that would have totaled $30,000+.
• Interest management: Settlement reduced the interest accrual period, saving approximately $12,000 in interest charges.
• Repayment obligation: The company repaid $51,200 (the disallowed portion) over an installment plan, minimizing cash flow disruption.

This is one example of how our proven tax strategies have helped clients navigate complex compliance challenges and minimize tax exposure through strategic planning and professional representation.

Next Steps

• Conduct a claim review: If you claimed the employee retention credit, review the claim against current IRS standards. Gather all documentation supporting the claim and assess audit defensibility.
• Evaluate documentation quality: Compare your current records to the IRS’s documentation standards. If your records are sparse or generic, audit risk is elevated. Strengthen your defense now rather than during examination.
• Engage professional representation: If you received an IRS notice or have concerns about audit risk, consult with a tax professional immediately. Early intervention often produces better settlement outcomes.
• Explore voluntary correction: If you question your claim’s eligibility, evaluate withdrawal or settlement options before the IRS initiates examination. Voluntary action significantly reduces penalties and interest.
• Develop long-term compliance strategy: Use the ERC experience to strengthen your overall tax compliance posture. Implement better documentation practices and work with tax advisors to ensure future credit claims are defensible. Expert tax advisory services can help you navigate complex compliance requirements and avoid similar issues in the future.

Frequently Asked Questions

Can I still file an employee retention credit claim in 2026?

No. The One Big Beautiful Bill Act permanently barred new employee retention credit filings effective January 31, 2024. Any claim filed after that date will be denied. However, businesses can still file amended returns claiming the credit if they have not yet filed. The IRS will only accept claims for tax years 2020–2025, and the filing deadline for amended returns claiming the credit has already passed for most businesses.

What happens if I received a PPP loan and claimed the employee retention credit on the same wages?

This is a disqualifying overlap. Wages forgiven under the PPP cannot also be claimed for the employee retention credit. If you violated this rule, the IRS will disallow the ERC portion of the claim and assess accuracy-related penalties of 20%+. You must immediately review your claim. If you haven’t been audited, consider voluntary correction. If audited, this issue typically results in full disallowance of the ERC claim and substantial penalties.

How long can the IRS audit my employee retention credit claim?

The statute of limitations for ERC claims has been extended to five years. If you claimed the employee retention credit in 2024, the IRS can examine the claim through 2029. For earlier claims (2020–2023), the statute expires in the corresponding year plus five years. This extended period gives the IRS substantial time to investigate.

If the IRS disallows my employee retention credit claim, what penalties apply?

Disallowance triggers repayment of the credit plus interest and accuracy-related penalties. Accuracy-related penalties are typically 20% of the underpaid tax (the disallowed credit amount). Interest accrues at approximately 8-10% annually from the original claim date. For willful disregard, penalties can reach 40%. For gross negligence, penalties reach 40%. Substantial penalties make early resolution through settlement attractive compared to full litigation.

Can I withdraw my employee retention credit claim after the IRS begins examination?

Yes, but the treatment differs. If you withdraw before examination begins, the IRS typically waives penalties and interest. If you withdraw after examination begins, you can still withdraw, but you may face limited penalty relief. The sooner you act, the better. Consult a tax professional immediately if you’ve received an IRS notice regarding your ERC claim.

What documentation do I need to defend an employee retention credit claim in audit?

You need government orders affecting your business, contemporaneous financial records showing gross revenue for the claim period and comparison periods, complete payroll records segregated by quarter and employee, and detailed calculations showing how you determined eligible wages and the credit amount. The IRS will cross-reference your wage claims against Form 941 filings and W-2 records. Any discrepancies trigger extensive follow-up.

Is there a settlement program specifically for employee retention credit disputes?

No formal ERC settlement program exists, but the IRS Appeals office handles ERC disputes like other tax controversies. You can request Appeals consideration during examination. Settlement authority exists for reducing claimed amounts, allowing partial credits with penalties, or establishing payment arrangements. An experienced tax professional can negotiate on your behalf with the IRS Appeals office.

What are the criminal penalties for promoting fraudulent employee retention credit claims?

Tax professionals and promoters who knowingly promoted fraudulent ERC claims face criminal prosecution, conviction, and imprisonment. Several promoters have been sentenced to 5+ years in prison for orchestrating ERC schemes. These criminal enforcement actions signal the IRS’s commitment to prosecuting both tax professionals and business owners who engaged in fraud. This is not a civil matter—criminal convictions carry prison time and permanent professional consequences.

Related Resources

• Comprehensive tax strategy services for business owners facing audit risk or compliance challenges.
• Entity structuring guidance to optimize business tax efficiency and ensure long-term compliance.
• Resources specifically designed for business owners managing tax obligations and growth strategies.
• Official IRS employee retention credit information from the IRS newsroom.
• Client success stories showing how strategic tax planning delivers measurable results.

Last updated: January, 2026