Is the Employee Retention Credit taxable income? The employee retention credit was a major blessing for small businesses during COVID-19. This gave over 30,000 of them the opportunity to receive more than 1 billion dollars in credit. This significant credit amount benefitted these businesses immensely. How? They received 50% worth of refunds for as much as $10,000 of qualifying wages for each employee in 2020. This brought the overall amount for qualifying wages to $5,000 per employee.
An amendment in 2021 allowed eligible businesses to decrease as much as 70% for $10,000 of qualifying employee wages for each quarter. This totals the credit amount to a limit for $28,000 for each employee per year. Since such a high refund is available, this raises the question: is the employee retention credit taxable income?
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Continue reading this article to know all the essential information regarding Employee Retention Credit and Income Tax.
Is the Employee Retention Credit Taxable? – The connection between tax and refund
It is important to note that the employee retention credit is not exclusively a tax. On the contrary, it is a tax credit that is refundable for employee wages that qualify. For 2020, the rule suggests that the maximum limit for credit that a business could not exceed $5,000 per employee. On the other hand, the highest credit for each employee in 2021 is $28,000.
The process indicates that you remove the ERC for your total income. This credit becomes a part of the rules for expense disallowance, which comes under the IRS notice for tax 2020-21, FAQs 85 and 86, and Q&A 60-61.
Since so many rules are involved, you may feel overwhelmed. However, FAQ 85 claims that the IRS code refuses deduction for salaries to be paid as much as specific credits for a tax year. This comes with the requirement to subtract your total deductions by the credit amount for ERC.
Additionally, FAQ 86 claims that all employers who receive a credit tax for healthcare costs and qualifying wages should not incorporate the gross income credit for federal income tax. Therefore, you cannot opt for this credit while decreasing the employer’s relevant employment taxes. You also cannot include the credit’s refundable portion in it.
The impact of ERC on tax return for income
The IRS 280C does not relate the refund to be taxable. However, the amount for credit reduces the wages by the credit amount. This subtraction is centered on the year when you have paid the wages. Therefore, a 2021 credit shows across your tax return for 2021, regardless of having received the fund.
On the other hand, if you did not file for ERC in quarters of 2020 and 2021 and wish to claim in 2022, you can’t accommodate your wages to the 2022 tax return. Additionally, business partnerships should file a request for an updated administrative adjustment. Small businesses claim updated tax returns for income for years when they are not adjusting wages or claiming credit.
PPP vs. ERC regarding income tax (federal)
It’s notable that your business may be eligible to receive ERC even if it’s participated in the Paycheck Protection Program. The consolidated appropriations act of 2021 was updated to permit businesses to benefit from both programs.
This legislature law reversed the rulings set in place by the IRS and allowed reductions to PPP loan forgiveness. Additionally, the IRS opted for the reimbursement law for expenses and tax code of 265 to reflect their dedication. The ERC disallowance expense opts for the 280C that covers all reimbursements for tax credit and their connection to expenses.
The disallowance for PPP expense ruling took place in the same year when the borrower received their funds. Therefore, businesses which claim ERC 2020 cannot use their funds until they are in ownership of the refund.
If you attempt to claim ERC for 2020 in 2022, you are not eligible to take disallowance expense. Why? Because the disallowance expense specifically applies to 2020. After 2020, no income deferral related to ERC is valid. The reason is simple: businesses only fulfill requirements for claiming ERC in the year when they are eligible to claim the disallowance expense. This pertains to the Revenue Ruling 2020-27 and comes with the rule that an expense deduction must take place in the same year as when the business earns the credit according to the Treasury Regulations 1.280C-1.
The year that calls for the deduction and recognition for income must fulfill the following criteria because these are made based on accruals:
- The year when all the events that take place fix the taxpayer’s right to income or the liability of the one who pays the tax
- The year when you’re able to decide the number with adequate accuracy
Applying these rules to the process is fairly difficult because neither ERC nor PPP is a deduction or an income.
The ERC provisions in 2021
The 2021 ERC raised the allowable credit amount for each employee. Therefore, businesses can apply for 70% of each $10,000 for eligible wages for every quarter. Additionally, the gross receipts requirement has also decreased.
The 2020 ERC expense disallowance is also applicable to 2021. Since most businesses claim the 2021 ERC every quarter, the expense disallowance does not cause timing to be much of a problem.
What if a business hasn’t applied or filed for ERC?
It is important to note that you do not apply to claim your credit on the tax return for yearly income. Since ERC is not in the picture anymore, you must qualify for an amended return with Form 941-X if you want to claim any credits.
The government’s rule suggests that businesses submit an amendment up to 3 years from the initial filing of Form 941. Therefore, if you were not claiming your ERC in 2020 or 2021, you still have time to go for it.
Once you’ve decided to file a claim, you must amend the return for each 2020 and 2021 quarter that qualifies you for the ERC. Therefore, the ideal way to ensure you receive all of your credits is to reach out to a skilled individual with experience regarding ERC tax returns.
Conclusion: The employee retention credit is not taxable income!
The conclusion to the pressing question of whether or not the employee retention credit is taxable income is that it is not. However, it does affect your tax return for income. It is important to note that although this may be the case, the advantages of receiving the credit are much higher than the impact it may have on your business’ taxes. So the choice is yours!