The IRS added five FAQs about the employee retention credit (ERC) on March 20, mainly discussing how to handle the pandemic-era credit on tax returns under various scenarios.
The FAQs are not authoritative guidance but do “provide us with answers to some of the questions we’ve been having around the issue of the statute of limitation expiring,” April Walker, CPA, CGMA, lead manager–Tax Practice & Ethics, AICPA & CIMA, said on an episode of the Tax Section Odyssey podcast that she hosts.
The ERC was designed to help certain businesses continue paying employees during the COVID-19 pandemic while their operations were either fully or partially suspended due to a government order or when they had a significant decline in gross receipts during the eligibility periods. It was generally available to eligible businesses from March 31, 2020, to Sept. 30, 2021, and to Dec. 31, 2021, for recovery startup businesses.
April 15 is the deadline for filing 2021 ERC claims.
The FAQs, added March 20, cover:
- Does the ERC affect an income tax return?
- Should a taxpayer have reduced the wage expense on their income tax return when filing for the ERC?
- What do taxpayers do when they claimed the ERC but did not reduce wage expenses on the income tax return, and the ERC claim was paid in a subsequent year?
- What can taxpayers do if the ERC claim was disallowed but they had already reduced the wage expense on their income tax return by the amount of the ERC they expected?
- How does someone report ERC fraud?
FAQ answers
While the IRS goes into more detail, the short answer to the first question, about whether the ERC can affect an income tax return, is yes.
“The amount of your ERC reduces the amount that you are allowed to report as wage expense on your income tax return for the tax year in which the qualified wages were paid or incurred,” the FAQ says. “Generally, most taxpayers claim wage expense as a deduction on their income tax returns. However, for some taxpayers, wage expense is properly capitalized to the basis of a particular asset or as an inventory cost.”
The second question also gets an affirmative response from the IRS.
“The amount of your ERC reduces the amount of your wage expense on your income tax return for the tax year in which you paid or incurred the qualified wages,” the FAQ says. “Generally, a taxpayer can’t deduct an expense as an ordinary and necessary business expense if they have a right or reasonable expectation of reimbursement at the time they paid or incurred the expense. Taxpayers who are eligible for the ERC have a right or reasonable expectation of reimbursement for qualified wage expense in the amount of the ERC.”
The answers for questions three and four get more complex. Walker explained the answer to the third question like this: “If you didn’t already amend your return, you can include the overstated wage expense as gross income on the income tax return for the year when the ERC was received.”
For example, if the taxpayer received the refund in 2024, Walker said: “Hopefully, depending on timing and plans for the underlying returns, this can be addressed on those 2024 returns, meaning — maybe it means filing an [individual return] extension — I have time to amend the business return and incorporate the changes on the individual return. … If [a refund] was received in 2025, then the opportunity exists to include that on the 2025 returns.”
For the fourth question, Walker discussed the scenario where a taxpayer received an ERC claim in 2022–2023 and the taxpayer reduced the wage expense on its income tax return for the year it claimed the ERC. Afterwards, the IRS denies the claim.
“In this situation, once [the disallowance] is determined to be final, then you are able to increase your wage expense on the income tax return in that year,” Walker said. As with the previous example, if the issue was settled in 2024, then the taxpayer’s business return should reflect that, Walker said. If the taxpayer didn’t extend filing, then they likely have to amend the return, she said.
For the fifth question, the FAQs provide instructions for reporting possible ERC fraud.
In November and December of 2024, the IRS added several FAQs involving improper claims for the ERC and how to withdraw those claims and how to determine if an ERC claim might be incorrect.
— To comment on this article or to suggest an idea for another article, contact Martha Waggoner at Martha.Waggoner@aicpa-cima.com.
