Small businesses have received over $1 billion in credits from the Employee Retention Credit program in 2021, after more than 30,000 companies participated. Providing a substantial credit of 50% up to $10,000 per employee (2020) or 70% up to $10,000 per employee per quarter (2021), this could reach a maximum of $28,000 for each employee by the end of the year. This leaves many with one main question: Is the employee retention credit taxable income? We'll now provide you with all the answers you need to know about your income tax and the Employee Retention Credit program.

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Refund Versus Tax

The Employee Retention Credit (ERC) is not a tax. Rather, it is a refundable tax credit for employers who satisfy certain criteria and have incurred certain eligible wages in calendar year 2020 or 2021. While the maximum credit per employee is  $5,000for 2020 and $28,000 for 2021, the amount of ERC available to a particular employer may be lower than those totals.

To avoid double-counting this credit when filing taxes, businesses must take various IRS actions into account. Any wages subject to theERC cannot be deducted from gross income. Additionally, businesses should not enter the credit into their applicable tax forms – nor should they include their fundable portion of the credit. It's important to read through Notice2020-21, Q&A 60-61 as well as FAQs 85 and 86 before filing taxes in order to ensure that your return is compliant with all IRS regulations pertaining to claiming the ERC.

Impact on Income Tax Return

If you are claiming the employee retention credit (ERC) for any of the 2020,2021 or 2022 quarters and have received a refund, you need to be aware that it creates a corresponding reduction in wages for the same period. This reduction will be reflected on your tax return for the year in which the wages were paid- so any 2021 credits should be shown on your 2021 tax return even if you have already received the refund.

If you did not claim ERC for a prior year and are instead making a new claim in 2022, adjustments cannot be accounted for in that year's tax return. Partnerships must file an amended administrative adjustment request and businesses must amend their income tax returns if they are claiming credit and adjusting wages.

ERC vs PPP on Federal Income Tax

Businesses that participate in the Paycheck Protection Program (PPP) may still be eligible to receive Employee Retention Credit (ERC).The Consolidated Appropriations Act (CAA) of 2021 provides clarity on how businesses can take advantage of both programs.

Under the CAA, PPP loan forgiveness related expenses are now deductible. This overturns IRS rulings and further clarifies the § 265 and §280C sections of the tax code - which regard expense reimbursement cases and tax credit reimbursements relative to expenses.

 It's important to note that claiming ERC for 2020 would not provide immediate use of funds, as this is a tax refund situation with no deferral of income after 2020. Businesses wishing to file for a 2020 ERC in2022 must also be aware that expense disallowance does not apply that year since it applies only to 2020.

In accordance with Revenue Ruling 2020-27, businesses hoping to claim the Expense Reduction Credit (ERC) must ensure that any tax-deductible expenses occurred in the same fiscal year as the credit was received. TreasuryRegulations §1.280C-1 further state that income recognition and deductions must be made on an accrual basis when 1) all events needed to determine the due payment or right of income are confirmed and 2) appropriate fees can be appraised with reasonable accuracy. Although determining eligibility for theExpense Reduction Credit (ERC) is a complicated process due to the difference between PPP and ERC--neither being considered an income or deduction--it is essential for those who wish to effectively utilize the credit.

2021 ERC Provisions

The 2021 Employee Retention Credit (ERC) offers increased credits for businesses with eligible employees. Qualifying wages of up to$10,000 per employee - or 70% of that amount - may be claimed by businesses with a lower gross receipts threshold, per quarter. For those claiming the 2020ERC, expense disallowance rules still apply. To avoid any issue regarding timing and expense disallowance, businesses should consider claiming the 2021ERC quarterly.

What if I Never Applied for ERC?

If you qualify for the Employee Retention Credit (ERC), you cannot claim it on your annual income tax return. As the ERC is no longer available, you must file an amended tax return using Form 941-X to be able to claim any credits which you are entitled to. The Internal Revenue Service (IRS)allows businesses three years from the date of their first Form 941 filing in order to submit an amendment. Therefore, if you have yet to file for ERC in2020 or 2021, there is still time to do so.

To file a claim, amend the Form 941 for each calendar quarter that may qualify for ERC throughout 2020 and 2021. To ensure that you do not miss out on any credits which you can potentially receive, we recommend that you consider employing a professional familiar with ERC returns who can guide and assist you through this process.

Do I Qualify for the ERC? 

Eligible employers for the Employee Retention Credit (ERC)are those whose businesses have been impacted by government orders issued in response to the pandemic. This can take many forms, from restrictions on commerce and travel to suspensions of group meetings or a significant decline in the business's quarterly gross receipts.

Qualifying wages paid by an employer during their eligible employer status are used to calculate the ERC - which may produce a refund that is larger than any payroll taxes actually paid, or any Paycheck Protection Program loans received.

Applying for the credit involves just a few straight forward steps; if you meet the requirements, you can receive this refund for qualifying wages paid throughout 2020 and through quarters 1, 2 and 3 of 2021.

So, Is the Employee Retention Credit Taxable Income?

The Employee Retention Credit is not considered taxable income, despite impacting your income tax return. Regardless, the advantages of claiming the credit are significant.

If you did not apply for the credit in 2020 or 2021 on your quarterly payroll tax returns, there is still an opportunity to do so. Contact us today to discuss your options and to schedule a consultation with one of our experts. We can answer any questions you may have and help you with filing amended forms for qualifying quarters.