Received your ERC funds? Here’s what to do next.

1. Will claiming the Employee Retention Credit create taxable income (or reduce a loss)? 

Yes. IRS Notice 2021-20 provides that an employer receiving an ERC refund should not include the credit in gross income for federal income tax purposes; however, under rules similar to Code Section 280C (which also applies to other tax credits, such as R&D credits), such employer should reduce their wage expense by such amount in 2020 and/or 2021, as applicable (but see Number 2 for the timing of making such adjustment).

If the company (or its owners in the case of a S-corporation, partnership or disregarded entity) was in a taxable loss position greater than the amount of the credit, a reduction of wage expense may only reduce their loss position for such year with no additional tax due because of the credit.

If the company was in a taxable income position in either 2020 and/or 2021 (or had a loss less than the credit), the reduction of wage expense related to the credit may result in an increase in federal taxable income for that year. The same would hold true to the extent that claiming the ERC shifted a company from a taxable loss to a taxable income position.

Note, however, professional fees paid in accordance with claiming the ERC may generally be deductible as ordinary and necessary business expense under Code Section 162 at the time the fees are paid or accrued.

2. For which years should I adjust or amend my federal income tax return? 

The IRS addressed this question in August 2021 via IRS Notice 2021-49. The guidance explains that the reduction in the amount of the deduction for qualified wages caused by receiving an ERC occurs for the tax year in which the qualified wages were paid or incurred.

However, on March 20, 2025, the IRS updated its ERC FAQs, providing important clarification and guidance on how to account for the corresponding income tax reporting. In these FAQs (see Income tax and ERC, Questions 1-3), the IRS provided taxpayers with some flexibility on how to resolve issues if they either (i) didn’t reduce their wage expense (in 2020 and/or 2021) and their ERC claim was allowed; or (ii) reduced their wage expense (in 2020 and/or 2021) and their ERC claim was disallowed.

If a taxpayer did not reduce their wage expense and their ERC claim was allowed and paid in a subsequent year: The IRS states that the taxpayer is not required to file an amended return (i.e., for 2020 and/or 2021). Instead, the taxpayer can include the overstated wage expense amount (i.e., the amount of the ERC received) as gross income on their income tax return for the tax year when they received the ERC.

• The IRS provides the following example: Business A claimed an ERC of $700 based on $1,000 of qualified wages paid for tax year 2021 but did not reduce its wage expense on its income tax return for 2021. The IRS paid the claim to Business A in 2024. In this scenario, Business A does not need to amend its income tax return for tax year 2021. Instead, Business A should account for the overstated deduction by including the $700 in gross income on its 2024 income tax return.

If a taxpayer reduced their wage expense but their claim was disallowed: The taxpayer may, in the year their claim disallowance is final (i.e., meaning you are no longer contesting the disallowance), increase their wage expense on their income tax return by the same amount that it was reduced. Alternatively, the taxpayer has the option, but are not required to, file an amended return, administrative adjustment requestion (AAR), or protective claim. This later-year adjustment is presented as a way to avoid the need for amended returns, especially when the statute of limitations has expired. For partial denials, any wage adjustments should reflect only the approved portion of the ERC claim.

• The IRS provides the following example: Business B claimed the ERC for tax year 2021 and reduced its wage expense on its income tax return for tax year 2021 because it expected the credit would be allowed and paid. In 2024, the IRS disallowed Business B’s ERC claim. Business B does not challenge the denial of the ERC claim and, accordingly, the disallowance is final. Business B does not need to amend its income tax return for tax year 2021. Instead, Business B can address this adjustment on its 2024 income tax return by increasing its wage expense by the amount of the previously reduced wage expense from its 2021 income tax return.

3. How do I address the expired statute of limitations?

The IRS guidance provided is particularly helpful given the 2020 statute of limitations to file an amended return expired on April 15, 2024, and the 2021 statute of limitations expires on April 15, 2025. Since the corrections above are made in the tax year the ERC and/or disallowance is received, taxpayers are not required to go back and amend prior year returns that may now be closed due to expired statute of limitations. Taxpayers who claimed the ERC but did not reduce their wage expense and subsequently received the ERC refund, are directed to include the amount of the ERC received in gross income in the tax year of receipt, even if the statute of limitations has expired for the original tax year.

4. Will I incur interest in connection with my ERC refund?

Maybe. If you make the wage expense adjustment on an amended income tax return (e.g., for 2020 or 2021), the IRS will likely assess an interest charge on any additional tax due. However, if you include the ERC received as a current year adjustment (as allowed under the IRS FAQ’s), there should not be interest assessed (as it would flow through the current year return as any other item and not relate to a prior year).

Please reach out to your Sagemont Tax representative to request a discussion with one of our tax experts.