Understanding Employee Retention Credit (ERC) and its Impact on Your Tax Return

Jun 15, 2023 | Affiliates

How is the ERC Reported on my Tax Return

According to recent IRS guidelines, the ERC should be reported on Form 1120-S, line 13g, Schedule K, and Form 5884. This results in a tax credit on K-1 that can be utilized for 2022 federal return taxes. The expiration date for ERC was extended from December 31, 2021, to September 30, 2021. This was through the Infrastructure Investment and Jobs Act.

Eligibility and Deductions

Until December 31, 2021, only businesses facing a partial or complete shutdown due to COVID-19 were eligible for ERC. You cannot claim both qualified wages deduction and wage credit for the same wage cost. However, you can still deduct the taxpayer’s portion of relevant Social Security and Medicare taxes during the reference period. While the ERC refund is not taxable during the eligibility period, earnings equivalent to the ERC amount are subject to expenditure disallowance regulations.

Is ERC Refund Taxable

If you have already provided proof of the earnings that will be used to claim ERC, you can calculate the ERC amount accurately. You may file an updated payroll tax return for eligible earnings in a subsequent tax year. But the wage expenditure disallowance must be imposed in the year of ERC claim filing, not when the payments are received. You may need to pay taxes owed due to the expenditure disallowance before receiving funds from the ERC refund, so it’s advisable to have alternative funds available.

Accounting for ERC

The ERCs for 2020 and 2021 are fully refundable credits against the employer component of Social Security taxes based on qualifying wages. The maximum credit is determined by the cap on qualified wages per employee. When accounting for ERC, consider the applicable accounting standard for revenue recognition. The ERC is considered a conditional grant, and employer eligibility is determined by meeting specific criteria during the calendar quarter in which the credit is requested.

Employee Retention Tax Credit Updates

While a significant number of small and medium-sized businesses are eligible for ERC, many are still unaware or misinformed about it. The ERC can be claimed based on revenue decrease or the impact of government-imposed COVID-19 restrictions. It is not limited to distressed businesses. Congress designed ERC to encourage businesses and organizations to maintain and hire employees. This helps them overcome the economic challenges posed by COVID-19.

Impact on Tax Return

ERC is a tax subsidy for qualifying salaries and can be claimed on federal employment tax returns, typically Form 941. If you didn’t claim ERC initially but later realized your eligibility, you can modify your Form 941. You can also apply for the ERC if your company received benefits from previous COVID-19 programs, including the Paycheck Protection Program (PPP). However, salaries used for PPP forgiveness cannot be used for ERC claims. Due to ERC, the Section 199A deduction may be limited for certain pass-through business owners.

ERC and Payroll Tax Expenses

Employers have been filing payroll tax rebate claims to benefit from the ERC. However, the ERC is subject to a deduction disallowance similar to section 280C of the Code, reducing eligible health plan costs by the amount of the credit. The recent Infrastructure Investment and Jobs Act changed the ERC, ending it for most businesses retrospectively on September 30, 2021. However, the ERC for the fourth quarter of 2022 is still available for recovering startup businesses.

In conclusion, while the ERC itself is not taxable, understanding its implications on taxable income and following the appropriate guidelines is crucial. Consult IRS resources and consider seeking professional advice to ensure proper reporting.

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