On March 20, the IRS updated its Frequently asked questions about the Employee Retention Credit (ERC) page in an effort to answer taxpayer questions in the midst of income tax return filings.
At the onset of the COVID-19 pandemic, Congress enacted the ERC to support struggling businesses and exempt organizations impacted by government-imposed restrictions by providing a tax credit intended to keep employees on the payroll. While many utilized this lifeline to keep their businesses afloat, the future consequences that the credit would have on their income tax returns was far from taxpayers’ minds.
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. According to Notice 2021-20, taxpayers eligible for the ERC have a right or reasonable expectation of reimbursement for qualified wage expense in the amount of the ERC, meaning that the amount of a taxpayer’s ERC reduces the amount they’re able to report as wage expense on the income tax return for the tax year in which the qualified wages were pair or incurred.
How Taxpayers Are Being Affected
As more claims have entered the processing pipeline, two groups of taxpayers have risen to the surface with growing concerns about what this means for them ahead of the filing deadline.
- Those who have claimed the ERC but did not reduce their wage expenses as the ERC was paid in a subsequent year; and
- Those who have already reduced their wage expense by the amount of ERC they expected, but part of the claim was disallowed.
The IRS advises that if a taxpayer finds themselves in either of the above groups, the simplest solution is to follow the instructions below (also found in the Income Tax and ERC section of the FAQ page).
Those who have claimed the ERC but did not reduce their wage expenses as the ERC was paid in a subsequent year
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- Taxpayers are no longer required to file an amended return to address the overstated wage expense; instead, they can include the overstated wage expense amount as gross income on the income tax return for the tax year when the credit was received.
- If the taxpayer capitalized wages or did not otherwise experience a reduction in tax liability for the overstated wage expense, they may need to make other adjustments such as a reduction in basis for capitalized wages
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Those who have already reduced their wage expense by the amount of ERC they expected, but part of the claim was disallowed
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- If the ERC was disallowed and the taxpayer had reduced the wage expense on its income tax return for the year the ERC was claimed, they may increase their wage expense on the income tax return by the same amount it was reduced when the claim was made.
- If a taxpayer is choosing to contest the disallowance and/or is actively arguing against the disallowance, they are unable to make this adjustment
- For taxpayers not contesting the disallowance, this process gives relief to those who previously reduced wage expenses in tax years for which the assessment period has expired and the taxpayer did not file a protective refund claim
- Alternatively, if the assessment period has not expired, taxpayers may file an amended return, AAR or protective claim for refund to deduct wage expense for the year in which the ERC was claimed.
- If the ERC was disallowed and the taxpayer had reduced the wage expense on its income tax return for the year the ERC was claimed, they may increase their wage expense on the income tax return by the same amount it was reduced when the claim was made.
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What if My Claim Has Not Been Processed?
Taxpayers with open claims do not need to take action at this point and should await further notification from the IRS regarding processing. The IRS cautioned taxpayers who filed ERC claims that the process will take time, highlighting that processing speeds will not return to the levels that occurred in 2023, but should increase from those in 2024. The IRS has also cautioned taxpayers that calling its toll-free lines will not necessarily be fruitful, as additional information regarding claims is generally not available as processing work continues.
Inconsistencies Unveiled
While this guidance is aimed at clearing up questions many taxpayers may have, the “solution” has only raised concerns since it contradicts earlier guidance released by the IRS. Previously, taxpayers were told they had to amend the tax return for the year in which the credit was being claimed; now they’re being told to make the reduction of wage expense in the year which the credit is received. The FAQ page provides a disclaimer that the information provided is only for general guidance and that notices, forms and instructions are the authority for technical guidance. Although the latest batch of FAQ answers provide a much-needed solution to many taxpayers, the direct contradiction to the previously released notices leaves questions surrounding the best source for guidance on this topic.
As further guidance is issued, the Schneider Downs Credits & Incentives team will continue to monitor the situation and provide updates. If you have any questions, please reach out to your SD contact(s) or Matthew Werner at [email protected].
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