Get Your Top ERC Tax Questions Answered
August 11, 2021
At a glance
- The main takeaway: The IRS has released tax guidance regarding the Employee Retention Credit, creating confusion for business owners.
- Impact on your business: The general rule that an employer’s deduction for qualified wages is reduced by the amount of the employee retention credit — even though the credit won’t be received by employers until a subsequent year in many cases.
- Next steps: Be proactive and contact a tax expert to assess what this means for your unique situation.
The full story:
The Employee Retention Credit (ERC) has been a much-needed cash resource for businesses struggling under the weight of the COVID-19 pandemic. But one lingering point of confusion for many businesses has been the ERC’s taxability — especially since the IRS has released questionable guidance that actually seems to compete with the credit’s intent.
Here are some frequently asked questions to consider, plus a recent development from the IRS you should know.
Is the ERC considered taxable?
As we’ve discussed previously, the ERC is a fully refundable payroll tax credit designed to make it easier for businesses that, despite challenges posed by COVID-19, choose to keep their employees on the payroll. The ERC can be worth up to $5,000 per employee in 2020 and $7,000 per employee per quarter in 2021.
The ERC itself is not included in an employer’s gross income. However, the credit is subject to the “expense disallowance rules,” which apply to the wages used to calculate the credit. This technically means that the wage deduction is reduced by the amount of the ERC, and thus the credit is taxable.
What impact does the ERC have on your income tax returns?
Treating the ERC as taxable presents major challenges for businesses from a tax filing perspective. First, let’s consider flow-through entities, such as LLCs taxed as partnerships and S corporations. If you have not yet filed your tax return, the IRS has made it clear that the ERC amount should be a reduction from your expenses, thereby increasing taxable income, irrespective of your company’s method of accounting (i.e., cash versus accrual).
The trickier situation involves those entities who have already filed their tax returns; in some cases, the owners may have also filed their returns. The IRS has stated that the proper approach is to amend the entity’s tax return to reduce expenses for the ERC amount claimed. This presents a headache for partnerships, in particular, whose rules around amending tax returns are much more complicated today. Conversely, for S corporations, it is easier to amend a tax return. The same rules apply to corporations, though they are less complex since the tax return result will not impact the owners.
Remember that Aprio is here to assist you in sorting out these complexities for your particular business.
Has the IRS provided more insight on this matter?
On August 4, the U.S. Department of the Treasury and the IRS released some additional guidance for the ERC with IRS Notice 2021-49.
Though most of the Notice deals with the mechanics of calculating and filing the credit itself, it does address the wages issue, “doubling down” on the IRS’s position that the ERC amount will reduce the deductions allowed for qualified wages and will be taxable in the year the credit relates to.
The bottom line
So, what now? Since it’s unlikely that we’ll receive more guidance from the IRS on this matter, the best solution is to consult with a tax advisor who is particularly experienced in navigating the CARES Act programs and their relevant tax implications.
Remember, the original purpose and design of the credit was to provide cash advances to businesses and free up cash flow to continue to stay solvent throughout the ongoing pandemic. Having to pay income tax on a tax refund that you have not yet received seems contrary to the reason the ERC was created.
Aprio’s CARES Act team is proactively addressing this issue with all of our clients on a personal, case-by-case basis, exploring solutions that will present the best possible outcomes for their businesses. Our Tax and ERC teams are nationally recognized, with a deep understanding of the nuances and complexities surrounding the credit so you can rest assured that you’re working with experts who have your back.
Disclaimer for services provided relative to SBA programs and the CARES Act
Aprio’s goal is to provide the most up to date information, along with our insights and current understanding of these programs and regulations to help you navigate your business response to COVID-19.
The rules regarding SBA programs are constantly being refined and clarified by the SBA and other agencies In certain instances, the guidance being provided by the agencies and/or the financial institutions is in direct conflict with other competing guidance, regulations and/or existing laws.
Due to the evolving nature of the situation and the lack of final published rules, Aprio cannot guarantee that additional changes or updates won’t be needed or forthcoming and the original advice given by Aprio may be affected by the evolving nature of the situation.
You need to evaluate and draw your own conclusions and determine your Company’s best approach relative to participation within these programs based on your Company’s specific circumstances, cash flow forecast and business strategy.
In situations where resources are provided by third parties, those services should be covered under a separate agreement directly with that service provider. Aprio is not responsible for the actions of any other third party.
Aprio encourages you to contact your legal counsel to address the legal implications of the impact of the CARES Act and specifically your participation in any of the SBA programs.
About the Author
Justin Elanjian, CPA, is the Partner-in-Charge of Aprio’s Paycheck Protection Program (PPP) & Employee Retention Credit (ERC) Services. As a national PPP expert, prominent speaker and strategic business advisor, Justin helps both lenders and borrowers navigate the complexities of the PPP. He also helps his clients realize benefits from other stimulus package programs, such as the ERC, and is committed to strengthening his clients’ balance sheets and helping them achieve what’s next. Justin also leads a team of more than 50 professionals who share his passion for helping businesses maximize the federal COVID relief programs.