CSG Law Alert: IRS Updates Employee Retention Credit FAQs
On March 20, 2025, the Internal Revenue Service (“IRS”) added five FAQs regarding Employee Retention Credits (“ERC”) arising from the COVID-19 Pandemic. These updates come as the impending statute of limitations deadline for 2021 ERC claims approaches.
The ERC was a refundable tax credit instituted to help eligible businesses and tax-exempt organizations continue paying its employees during the pandemic. A business was eligible for the ERC if (1) it was fully or partially shut down due to a governmental order during any part of 2020, or (2) the business’s gross receipts in any quarter of 2020 declined 50% or more relative to the same quarter of 2019. In addition to 2020, the ERC was also available for all four quarters of 2021.
April 15, 2025 marks the deadline for filing 2021 ERC claims and the new FAQs answer the following questions in advance of the deadline:
Does the ERC affect an income tax return?
Yes. The amount of a taxpayer’s ERC reduces the amount that the taxpayer is allowed to report as a wage expense on its income tax return on qualified wages paid or incurred during the relevant tax year. However, some taxpayers may capitalize their wage expense to the basis of a particular asset or as an inventory cost.
Should a taxpayer have reduced its wage expense on its income tax return when filing for the ERC?
Yes. The ERC reduces the amount of wage expense on a taxpayer’s income tax return for the year where the qualified wages were paid or incurred. Generally, a taxpayer is not permitted to deduct an expense as an ordinary and necessary business expense if it has a right or reasonable expectation of reimbursement at the time it paid or incurred the expense.
What happens when a taxpayer claimed the ERC but didn’t reduce its wage expenses on its income tax return?
The IRS suggests that a taxpayer should address overstated wage expenses by including the overstated wage expense amount as gross income on its tax return for the tax year it received the ERC. Under these facts, taxpayers are not required to file an amended return or administrative adjustment request (“AAR”) to address the overstatement.
Under the tax benefit rule, a taxpayer should include a previously deducted amount in income when a later event occurs that is fundamentally inconsistent with the premise on which the deduction is based. Thus, if a taxpayer received the ERC and did not reduce its wage expense on its income tax return, then the ERC claim and tax return may be inconsistent, resulting in an unwarranted double benefit.
What can a taxpayer do if its ERC claim was disallowed and it already reduced its wage expense on its income tax return by the amount of ERC expected?
If an ERC claim was disallowed, but the taxpayer had already reduced its wage expense on a previous income tax return for the year the ERC was claimed, then the taxpayer may increase its wage expense on the subsequent income tax return by the same amount that was reduced when the claim was made. Alternatively, taxpayers may file an amended return, AAR or protective claim for refund to deduct wage expenses for the year in which the ERC was claimed.
The IRS provides an example where a business claimed the ERC for tax year 2021 and reduced its wage expense on its income tax return for tax year 2021. The IRS suggests that if the claim was disallowed in 2024, then the business does not need to amend its income tax return for 2021, instead it can address the adjustment on its 2024 tax return by increasing its wage expense by the amount previously reduced on its 2021 return.
How does a taxpayer report fraud regarding ERC?
The IRS encourages taxpayers to report certain tax-related illegal activities relating to ERC claims, individuals who promote improper or abusive tax schemes and tax return preparers who deliberately prepare improper returns. Taxpayers can do so by completing Form 14242, Report Suspected Abusive Tax Promotions or Preparers and following the instructions for filing.