FAQ: Tax Implications of the Employee Retention Credit (ERC)

two women talking
By Joe Sharpe | 03/16/2023 | 14 min read

The Employee Retention Credit (ERC) has been a valuable resource for eligible employers who have kept their employees during the COVID-19 pandemic. However, questions still arise regarding the tax implications.

Does the employee retention credit reduce the expenses that an eligible employer could otherwise deduct on its federal income tax return?

Yes. Section 2301(e) of the CARES Act provides that rules similar to section 280C(a) of the Code shall apply for purposes of applying the employee retention credit. Section 280C(a) generally disallows a deduction for the portion of wages or salaries paid or incurred equal to the sum of certain credits determined for the taxable year. Accordingly, a similar deduction disallowance applies under section 2301(e) of the CARES Act with regard to the employee retention credit, such that an employer’s deduction for qualified wages, including qualified health plan expenses, is reduced by the amount of the employee retention credit. (An employer does not, however, reduce its deduction for the employer’s share of social security and Medicare taxes by any portion of the credit).

Does an eligible employer receiving an employee retention credit for qualified wages need to include any portion of the credit in income?

No. An employer receiving a tax credit for qualified wages, including allocable qualified health plan expenses, does not include the credit in gross income for federal income tax purposes. Neither the portion of the credit that reduces the employer’s applicable employment taxes nor the refundable portion of the credit is included in the employer’s gross income.

It is worth noting that the credit dollars are not considered federal taxable income, but any interest paid by the IRS with the credits is taxable income. To avoid double dipping, the credit amount needs to reduce the wage deduction. The IRS views ERC as the company receiving back the wages it paid to employees, so they cannot also deduct those wages.

Reducing Wage Deduction in the Year of ERC Receipt

The IRS prefers that the ERC be removed from the year it came from, requiring an amended tax return. However, in practice, many companies claim payroll tax credits differently, and auditors often permit reducing the wage deduction in the year received. A 2019 article shows the IRS sending instructions to auditors regarding the proper year for claiming the Work Opportunity Credit, which is a similar payroll tax credit to permit reducing the wage deduction in the year received. This is a good precedent for similar payroll tax credits, including the ERC.

DISCLAIMER: The information provided herein does not constitute the provision of legal advice, tax advice, accounting services or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional legal, tax, accounting, or other professional advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation and for your particular state(s) of operation.