By Christopher Migliaccio, JD, Partner
The IRS recently updated its guidance on how taxpayers should account for the employee retention credit (ERC) for income tax purposes. The guidance allows taxpayers to apply the ERC to current-year returns rather than the credit year. This provides significant relief for taxpayers who are only now receiving ERC funds, simplifying what could have otherwise been a difficult and costly process of recognizing the ERC for income tax purposes. Read on for more details of the March 20, 2025, IRS announcement.
Issue Addressed
The ERC is a payroll credit that certain eligible taxpayers were able to claim for wages paid in 2020 and 2021. Many taxpayers claimed these credits on amended payroll tax returns, but the IRS has been slow to process those returns. As a result, some taxpayers are just now receiving their refund checks, while others are still waiting.
IRS guidance has been clear that the ERC relates to the year the wages generating the credit were paid. The proper treatment has been a reduction in the wage deduction in the year of the credit. This means that a taxpayer only now receiving an ERC refund check would be forced to amend their tax return for the year the wages related to (2020 or 2021).
This caused a practical issue as the IRS delayed payments. Many taxpayers wanted to confirm that the IRS would actually process their ERC refund claim before amending their return, given the significant ERC review the IRS has undertaken over the last two years. However, taxpayers only have three years from the date of filing to amend tax returns; as a result, all 2020 tax returns filed timely or on extension have now passed the window to amend and 2021 returns were rapidly approaching (a timely filed 2021 return’s window to amend would end on April 15, 2025).
IRS Provides Practical Solution
The IRS guidance came in the form of an update to its ERC FAQs, specifically Question 2, Income Tax and ERC. The guidance makes clear that taxpayers do not need to file amended returns to address ERC received in a year subsequent to the original tax year but can include the amount in income in the year received. For example, a 2021 ERC amount received in 2024 can be included in gross income on the 2024 return. There is no distinction as to whether the taxpayer is on a cash or accrual basis.
The IRS reached this conclusion under the tax benefit rule – if a previously deducted amount is impacted by a later event (in this case, the ERC payment), the taxpayer should recognize income.
PKF O’Connor Davies Observation: The newly announced change comes as a welcome simplification for taxpayers who have waited a significant time for their ERC refund while also avoiding any arguments that the ERC amount could go untaxed because of expired statutes.
ERC Disallowance
The IRS also provided guidance that allows taxpayers whose ERC claims were disallowed in later years to address those changes in the year of the disallowance. However, this may not be beneficial unless that tax year is closed for amendments, as the disallowance would presumably reduce taxable income and generate a refund that would be paid with interest. So, for a disallowance in 2024 relating to a 2021 ERC amount, a taxpayer can weigh the various pros and cons of amending 2021 versus addressing the disallowance on the 2024 return.
Contact Us
PKF O’Connor Davies has helped hundreds of companies across a number of industries determine their ERC qualification, calculate their credit and help them file amended payroll tax returns. We’ve also assisted clients in contacting the taxpayer advocate about their ERC refunds.
If you have questions about the employee retention credit, contact your client service team or:
Christopher Migliaccio, JD
Partner
ERC Services Leader
cmigliaccio@pkfod.com