In updated FAQs, the IRS has announced a new procedure for taxpayers who receive an ERC refund related to wages paid in prior tax years, but have not filed an amended return to reduce their wage expenses for the year the wages were paid (2020 and/or 2021). (www.irs.gov/coronavirus/frequently-asked-questions-about-the-employee-retention-credit#incometax)
ERC refunds issued
For situations where the prior-year return is a closed year, taxpayers must include the overstated wage expense amount as gross income on their income tax return for the tax year the ERC refund was received. This means that if a taxpayer receives an ERC refund in 2024 related to 2021 wage expenses, they must include the 2021 overstated wage expenses as gross income on their 2024 tax return. The IRS also reiterates that taxpayers in this situation remain eligible for penalty relief. (IR-2022-89)
For open tax years, taxpayers may file an amended return, administrative adjustment request (AAR), or protective claim for refund to deduct their wage expense for the year in which the ERC was claimed. Alternatively, these taxpayers could elect to report the refund as income in the year it is received.
Many taxpayers were filing amended returns and paying associated taxes due for the closed tax year only to have the IRS return the tax payments because the tax year was closed. These taxpayers now know that they can cash these refund checks without repercussion and use these payments to pay the resultant taxes due when the wages are reported on the tax return for the year the ERC refund was received.
ERC credits disallowed
The IRS also provided guidance for taxpayers whose ERC was disallowed, who had previously reduced the wage expense on their return for the year the ERC was claimed. These taxpayers may, in the year the ERC claim disallowance is final, increase their wage expense on their income tax return by the same amount that it was reduced when they made their original ERC claim.
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