New IRS FAQs Ease Tax Reporting Burden for ERC Claims

On March 20, the IRS issued updated FAQs addressing the income tax return impact of the Employee Retention Credit (ERC). While some of the newly published guidance is a significant departure from previous guidance, it is largely viewed as taxpayer-friendly.

Key Changes: New Reporting Flexibility for ERC Income and Relief for Denied Claims

Two main changes are addressed in the updated FAQs:

1. Taxpayers who did not reduce their wage expense on the income tax return to which the wages related can include the credit amount as gross income for the year when the ERC is received.

• • Prior guidance stated that the ERC credit reduces the wages in the period that the credit relates to. For example, if a business claims a 2021 ERC credit, then the wage expense on its 2021 income tax return must be reduced.
  • The IRS notes that this is still the law. However, it gives taxpayers who have not done this an “out” to avoid filing an amended income tax return.

2. Taxpayers who have reduced wage expenses on their income tax returns and later have that claim disallowed may deduct the wages in the year that the claim disallowance is final rather than filing an amended return.

• • This had not previously been addressed in IRS guidance, leaving many tax practitioners concerned that the only remedy was to deduct the wages in the year they were incurred. Because this disallowance could come after the closure of the income tax return statute of limitations, many practitioners recommended filing protective refund claims.

Why This Matters: Practical and Financial Impacts

Treatment of wage expenses or inclusion of gross income

Prior to the newly released FAQs, the IRS stood by its position that the ERC should reduce wages in the year that the credit relates to. While this position is supported by the statute, it was impractical for taxpayers who either did not realize they qualify until after they filed their income tax return and/or taxpayers who waited months or years for their refund.

The option to forgo an amended income tax return will save taxpayers professional fees for amending tax returns as well as interest and penalty that would have been due.

Denial of credits

The IRS has not weighed in on this topic previously, so the new guidance is welcomed. Practically, deducting the wages in the year of denial would be administratively easier. However, the legal basis for this position is not entirely clear, so taxpayers may be wise to still file a protective refund claim. Even if this is an option, taxpayers may still want to file an amended tax return to recoup interest on the taxes paid and to take advantage of a higher tax rate year. How to handle the deduction associated with an ERC denial will be a facts-and-circumstances determination as to whether an amended return is beneficial. Thus, taxpayers should still consider a protective refund claim.

State Tax Implications May Vary

In light of the new FAQs – specifically those addressing the federal income tax return implications of the ERC – it is important to evaluate how state tax treatment might be affected. A taxpayer’s treatment of wage expense and/or refunds on the federal return (original or amended) will likely have some impact on state tax reporting, and that impact will likely not be the same across all states.

ERC reporting is complex, and the conformity and presentation varies by state. Therefore, it is recommended that taxpayers work with a practitioner to ensure the credit it being maximized.

IRS FAQs Offer Guidance – But Not Legal Certainty

It is generally reasonable to rely upon IRS FAQs for tax return reporting positions, but it is important to note that these FAQs are not binding, legal authority and are subject to change. There is risk that future IRS guidance and positions could change the FAQs. The level of authority of guidance being relied upon is a factor to consider when taking tax return reporting positions.

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