Is the Employee Retention Credit Taxable Income?

is the employee retention credit taxable income
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What is ERC?
The Employee Retention Credit (ERC) is a tax credit that was introduced by the CARES Act in March 2020 to help employers retain their employees during the COVID-19 pandemic. The ERC is available to eligible employers who have experienced a full or partial suspension of operations or a significant decline in gross receipts due to COVID-19.
More than 30,000 small businesses took part in the Employee Retention Credit (ERC) program, receiving over $1 billion in credits during 2021. The credit is substantial, refunding 50% of up to $10,000 in qualifying wages per employee in 2020; a maximum of $5,000 per employee.

The ERC was originally set to expire on December 31, 2020, but was extended multiple times and is currently available through the end of 2021.

A 2021 increase allows qualifying businesses to deduct up to 70% of up to $10,000 in qualifying wages per employee per quarter. This brings the total credit amount to a maximum of $28,000 per employee for the year. You may wonder, is the employee retention credit taxable income? with such a large refund available.

As with any government program, there are always many questions.  We will share everything you need to know about income tax and the ERC.

Refund vs. Tax

The ERC is not a tax. It is a refundable tax credit for qualifying employee wages.

The maximum credit a business can receive for 2020 is $5,000 per employee. In 2021, the maximum credit per employee is $28,000.

You omit the ERC from your gross income. The credit is subject to expense disallowance rules, subject to tax under IRS Notice 2020-21, Q&A 60-61, and FAQs 85 and 86

Understanding all these rules can be mind-boggling. FAQ 85 states that the IRS code disallows a deduction for wages paid equal to certain credits in a tax year. This requires you to reduce your aggregate deductions by the amount of the ERC credit.

FAQ 86 states that employers receiving a tax credit for qualifying wages and health care expenses do not include the credit in their gross income for federal tax. You do not enter the credit reducing the employer’s applicable employment taxes, nor do you include the refundable portion of the credit.

ERC Impact on Income Tax Return

While the refund is not taxable under IRC § 280C, the credit amount creates a reduction in wages matching the amount of the credit. This reduction occurs in the year the wages are paid, so a 2021 credit is reflected on your 2021 tax return, even if you have received the refund.

If you did not claim ERC for the 2020 or 2021 quarters and are making a claim in 2022, you cannot adjust wages on your 2022 tax return. Partnerships must file an amended administrative adjustment request. Businesses file amended income tax returns for years they are claiming credit and adjusting wages.

ERC vs. PPP on Federal Income Tax

Even if your business participates in the Paycheck Protection Program (PPP), it may qualify to receive ERC. Changes made by the Consolidated Appropriations Act (CAA) of 2021 allow businesses to take advantage of both programs.

The CAA reverses IRS rulings and allows deductions relative to PPP loan forgiveness. The IRS used expense reimbursement case law and § 265 of the tax code to make their determination. The ERC expense disallowance uses § 280C, which covers tax credit reimbursements and their relation to expenses.

PPP deduction disallowance occurred in the same year the borrower was receiving funds. Businesses claiming ERC for 2020 retroactively will not have use of the funds until they receive their refund.

If you file for 2020 ERC in 2022, you cannot take the expense disallowance this year because it applies to 2020. There is no deferral of income relating to ERC after 2020.

The reasoning is that the business satisfies requirements for receiving ERC in the year they can claim the deduction disallowance. Revenue Ruling 2020-27 applies, and an expense reduction must occur in the same year as when you earn the credit to comport with Treasury Regulations §1.280C-1 

Recognition of income and deductions are made on an accrual basis in the year when:

1) All events occur that fix the taxpayer’s liability for payment or the right to income, and
2) You can decide on the amount with reasonable accuracy

Applying the rules is not easy because neither PPP nor ERC is an income or deduction.

2021 ERC Provisions

ERC for 2021 increases the amount of allowable credit per employee. Businesses may claim 70% of $10,000 of qualifying wages per quarter. The gross receipts threshold is also lower.

The expense disallowance for 2020 ERC also applies to 2021. With the majority of businesses claiming 2021 ERC quarterly, timing is not as much of an issue for deduction disallowance.

What if I Never Applied for ERC?

You cannot claim the credit on your annual income tax return. Because ERC is no longer available, the only way to claim any credits you qualify for is to file an amended return using Form 941-X.

The government allows businesses three years from the date of the original Form 941 filing to submit an amendment. If you did not file for ERC in 2020 or 2021, there is still time to do so.

To file a claim, amend the return for every 2020 and 2021 quarter where you qualify for ERC. The best way to assure you receive all credits you are eligible for is to contact a professional familiar with ERC tax returns. 

Do I Qualify for the ERC?

Employers qualifying for ERC are those experiencing partial or full shutdowns of their business due to government orders during the pandemic. This includes any order impacting the business operations, such as commerce, travel, group meetings, or a significant decline in the business’s quarterly gross receipts.

Calculating the ERC requires using qualifying wages the business pays employees during the eligible employer status. The refund tax credits may be higher than the payroll taxes paid and larger than what the company may receive in PPP loans.

Applying for the ERC is easy and only requires a few simple steps to receive your refund.  You may be eligible to claim ERC for qualifying wages paid in 2020 and quarters 1, 2, and 3 of 2021.

Is ERC Taxable Income?

We started with the question: Is the Employee Retention Credit taxable income? The answer is no, but it does impact your tax return. The benefits of receiving the credit far outweigh its effect on your taxes.

There is still time to file if you didn’t apply for ERC on your 2020 and 2021 quarterly payroll tax returns. Contact ERC Today to schedule a consultation. We will answer any questions you have and assist you in filing amended forms for qualifying quarters.

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