The Employee Retention Credit Effect On Your Income Tax

As a response to COVID, the federal government enacted the Employee Retention Tax Credit (ERTC) to help businesses retain their employees. However, many businesses did not claim the credit initially and instead filed or will file retroactively. As a result, they may be unfamiliar with how the ERTC affects their income tax return when claiming the credit, and once they receive payment.

What Is the ERTC?

The ERTC is a fully refundable tax credit for W2 employees that remained employed during the period from March 12, 2020, to September 30, 2021. The amount of the credit and the requirements that businesses must meet to qualify for the credit are addressed in our prior blog post on 7 Things Your Business Needs to Know About the Employee Retention Tax Credit.

How Does the ERTC Affect Taxable Income? 

The ERTC is not considered taxable income under Internal Revenue Code (IRC) Section 280C. Instead, it creates a reduction in wages in the amount of the credit. This reduction occurs in the year the wages were paid. For example, a credit claimed for any quarter of 2021 must be reflected on the 2021 tax return.

What Happens If the ERTC Wage Reduction Is Not Taken on the Business’s Income Tax Return?

If an income tax return was filed without reflecting the ERTC wage reduction, IRS Notice 2021-49 states that an amended business income tax return or administrative adjustment request (AAR) for partnerships must be filed showing the reduction in wages.

This is the situation many businesses are in today. They must seek a refund because they didn’t claim the credit in their original tax return. Businesses must file Form 941-X (Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund Form) to amend their return for each quarter that they failed to claim the credit. The ERTC cannot be taken on a later income tax return.

How Should Businesses Report Interest Paid By the IRS?

Once the credit is approved, the IRS will issue a refund including interest. Generally, ERTC interest payments are treated like other interest income and are subject to the regular interest rules under the Internal Revenue Code. Accordingly, a cash-basis taxpayer will report the interest in the year it was received, while an accrual-basis taxpayer will report the interest at the earlier of (1) receipt of the refund or (2) approval of the refund claim by the IRS.

How Does the ERTC Affect State Income Tax Returns?

While many states follow the federal treatment, some do not, so it is important to consult with your accountant.

What Information Should Businesses Provide to Their Accountants?

If you claimed the credit, you should let your accountant know the details and amounts of the claim. Funding Forward provides clients with a summary of the claim before filing which should be forwarded to your accountant which will reflect the necessary changes to your tax returns.

The ERTC rules are complicated and time-consuming to address. Our team at Funding Forward has extensive experience handling ERTC claims. We’ve assisted thousands of businesses recover over 1 billion dollars and can help you get the money you are owed. Contact us today for a consultation.