Income taxes are paid on taxable income that a professional entity, company, or individual earns. How much of that income is taxable is calculated as the total income minus allowable deductions. One powerful deduction that you might enjoy is the Employee Retention Credit.
Current applicants might have specific questions. Can ERC funds be taxed? What is the entire tax process surrounding the ERC? The following guide is helpful to learn about Employee Retention Tax Credit taxable income.
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Are ERC Credits Taxable?
Is the ERC taxable? If you are eligible for ERC benefits, employer tax credits reduce pay-per-credit values as stipulated by IRC Section 280C. This reduction happens throughout the year that earnings were initially paid. Consequently, even for refunds you have yet to receive, 2021 credits must be shown on 2022 tax returns. Lots of states follow this federal approach. New York is a notable exception, and this state enables the deduction.
ERC benefits are 100% refundable for any eligible business able to keep its employees on the company payroll. Given how the Infrastructure Bill revised and amended many ERC rules, the updated regulations differ in many ways.
Assume the example of a typical employee being partially eligible for ERC benefits. In this case, the employee is entitled to the benefits whether or not he reports and pays federal employment taxes using a third-party provider. The credit's refundable element and the amount that lowers related employment taxes won't be included in the employer's gross income. With respect to salaries a third-party remits on behalf of an employer, that third-party payer isn't entitled to ERC benefits or credits.
For 2021 Applications
ERC benefits aren't taxable, but cost disallowance laws are in place that make it taxable. Many taxpayers were looking to claim ERC benefits from the start, but they had confusion on specific points. IRS Notice 2021-49 tried to clarify these points. Worker tips are now thought to be "qualified wages" as a means of measuring the checking the potential credit, which means companies can claim both ERC benefits and FICA tip credits when dealing with the same tips.
That announcement also helps businesses understand a timing problem regarding ERC benefits and labor expenditure adjustments. An employer can't deduct salaries or wages used in ERC calculations from their taxable income up the specific ERC amount throughout the specific calendar quarter in question.
Consequently, even for employers who filed ERC claims for the 2020 quarters, the tax liability modification equivalent to the ERC amount would have been included on the employer's federal income tax documents for that year. This would hold even when the refund claim was made in a subsequent year.
Businesses that didn't include modifications through their 2020 taxes found it necessary to go back and file amended tax returns later.
Expense permissibility is not a deduction or an item of revenue; it doesn't fit well with the principles in play here. Some taxpayers got PPP loans in 2020 and were still eligible for 2020 ERC benefits after the CAA met every condition of the 2020 ERC.
Even when actual credit computations weren't done until later, these taxpayers had already paid ERC-eligible wages and salaries before the end of the year, and the ERC credit amounts were determined with acceptable accuracy rates.
Expense disallowance happened in 2020 for refundable payroll credits, regardless of whether ERC benefits had been claimed for 2020 or 2021. Either way, they would be registered using a 2022 income tax return. Nothing stops ERC-related income from being deferred past 2022 for PPP or loan forgiveness.
Now that the 2022 tax filing season is here, entities must determine if they are eligible for ERC benefits. When a business qualifies, it must apply for ERC options as quickly as possible to get the refund process going. Payroll tax providers can work on behalf of their clients to file Form 941-X, but this isn't mandatory.
Even when an employer has offered accurate revision information, several payroll agencies are moving slowly to write Form 941-X if there are special safe harbor rules. This, unfortunately, wastes time for businesses already set back by IRS delays in return processing that impact the maximum credits available for eligible salary and wages.
How to Report ERC on Tax Return?
Per the most recent guidelines from the IRS, you should record ERC benefits using Form 5884 and Form 1120-S, line 13g, Schedule K. This will result in a K-1 tax credit that you can use for taxes on 2022 federal returns. When the Infrastructure Investment and Jobs Act was enacted, the expiration date for the ERC moved to September 30, 2021, back from the previous December 31, 2021.
Until December 31, 2021, only businesses categorized as recovery-starting enterprises could use the ERC option. This prevented taxpayers from getting wage credits and eligible wage deductions for the same wage-related expenses. The portion of related Medicare and Social Security taxes a taxpayer is responsible for is still deductible from federal tax returns during the ERC periods.
ERC refunds aren't taxable during applicable eligibility periods. However, earnings equal to ERC amounts will still fall under expenditure disallowance regulations at the federal level, with eligible wages and salaries summed up as such.
More About Claims
Before the fiscal year ends, users must provide or witness earnings they use for ERC claims. They also will have enough information to determine their ERC amounts accurately through the appropriate program. Taxpayers can file updated returns for payroll taxes in the following years for the eligible earnings. However, wage expenditure disallowances must be imposed for years when ERC claims are filed instead of when payments are received.
In such cases, the party in question must revise previous income tax returns to adjust for wage deduction refusal. When you consider how long the IRS takes to process updated returns for payroll taxes on eligible wages, you might have to pay taxes resulting from the expenditure disallowance before you get your ERC refund monies. Budget for these taxes using alternative funds that you can access.
How to Handle Accounting?
The 2020 and 2021 ERCs are refundable credits you can get back from the employer portion of Social Security taxes, but that is based on the amount of qualifying salary or wages that you incurred as one of the eligible employers. The maximum credit available is based on the qualified wages cap of the employee in question. Should your business become eligible for ERC benefits, then you need to consider which particular accounting standard will determine the recognition of revenue.
Consult Contributions Received and Contributions Made and Accounting Standards Update Subtopic 958-605 to see how recording such revenue is deemed permissible. ERC refunds are often treated like a conditional grant, given that entities will only transfer assets after getting past the qualifying barrier protecting qualified improvement property. There are typically one of two different criteria applied to establish employer eligibility. A minimum of one has to be satisfied for the calendar quarter the credit is being requested.
1. A Government Order or Restriction Wholly or Partially Shuttered the Facility
ERC benefits might be applicable when an establishment has to limit business hours, partially suspend operations, or entirely shut down. Companies that don't meet this description aren't eligible, per the IRS. Many businesses were in critical condition until their supplies of goods and materials were disturbed to such a degree that they couldn't keep operating. Remote work did allow many businesses that closed to keep operating in virtual spaces.
2. There Was a Dramatic Drop in Gross Receipts
When comparing a specific quarter, a business had to see gross receipts cut in half or more. Starting in 2022, companies needed to see more than a 20% drop in their gross revenues in the first two quarters compared to the first half of 2020. If a company is new, then the IRS permits that entity to use gross revenues from the initial quarter as their baseline for quarters that don't have comparable 2020 data.
How ERC Credits Impact Tax Returns?
ERC benefits are tax subsidies for qualifying wages and salaries your business pays employees. The credits can apply to employment taxes, including Medicare, FICA, and withholding. This credit was created to help employers who had deductible wage expenses maintain their payroll and staffing in the event that their professionals couldn't work during the pandemic.
Congress started the ERC with the CARES Act in March 2020. This was just one of several policies put into place to help businesses struggling with the pandemic. Congress later enlarged the ERC program through several pandemic-related relief bills. Employers can claim ERC benefits through excess wages on employment tax returns submitted to the IRS. You usually use Form 941 as part of your Quarterly Federal Tax Return.
If you didn't initially claim ERC benefits but realized later that you did or could have, then you make Form 941 modifications. If your benefit exceeds the taxes due, you can request the IRS decrease your pay in advance. This law can apply to establishments with 500 full-time employees or fewer for 2019. Request this advance using Form 7200. File this prior to the end of any month following the quarter when you paid out qualifying wages or salary.
You can still apply for ERC benefits even if you got relief from earlier pandemic programs. Congress relaxed the previous limits through CAA law, so you can still determine eligibility for ERC benefits even if your business took out PPP loans. However, you can't claim ERC benefits for the same wages and salaries you qualified for PPP debt forgiveness. These terms apply to both 2021 and 2022 PPP loans, and they also cover retirement plans.
If your business is eligible, then you can claim ERC and FFCRA credits both for retirement plans. Having said that, you can't claim both of these credits off of the same wages and salaries in a quarterly tax return for qualified company income. You and other individuals who are self-employed will need to separate which business income deductions are qualified for each credit.
Do Benefits Lower Deductible Wages?
When the IRC and its regulations are looked at closely, it appears that Section 199A deductions might be limited for some pass-through entities. Specifically, the effective federal tax rate changes from 30% to 37%. The Tax Cuts and Jobs Act, or TCJA, introduced the Section 199A deduction. It was intended as a compromise after serious public outcry where pass-through entity owners might have the corporate tax rate drop from 35% down to 21%.
When the government decided not to directly lower the tax rates of pass-through entity owners, federal lawmakers and officials did create a fictional deduction as high as 20% when pass-through company revenue satisfied certain stipulations. Pass-through entity owners might use the Section 199A deduction to lower the federal effective tax rate they face from 37% down to 30%.
Will ERC Lower Payroll Costs?
Quite a few taxpayers have spent a lot of time calculating their ERC eligibility and then filing applications for refunds. Many businesses impacted by the pandemic have been able to file rebate claims for payroll taxes. In taking advantage of this tax credit through the March 2020 CARES Act, they've enjoyed badly needed boosts to their cash flows.
In the CARES Act, Section 2301(e) states that there are restrictions when submitting ERC applications similar to Internal Revenue Code Section 280c. That usually forbids reducing a portion of any wages paid equal to the total of specified credits computed for a particular taxable year. Consequently, Section 2301(e) from the CARES Act states that the ERC is subject to an identical deduction disallowance by the ERC amount. That includes eligible healthcare costs.
The Infrastructure Investment and Jobs Act seriously changed the ERC. The ERC was retrospectively eliminated for many establishments starting September 30, 2021. Before that, the deadline had been December 31, 2021. However, recovering starting firms can still access the ERC through the final quarter of 2022. A Recovery Startup Business with operations starting on February 15, 2020, or after might have annual gross sales of less than $1 million.
Key Takeaways
The ERC isn't a tax itself, but it does relate to payroll taxes and other matters that factor into your business tax returns. Review all your documentation to look at your taxable income to see when you might qualify, and look particularly hard at the periods when the pandemic impacted your business.
Suppose your business suffered a loss of gross receipts or went through seriously diminished activity due to the pandemic or government restrictions during the pandemic. In that case, you might have lost a lot of money. ERC benefits are one way to get some of that money back. The federal government wanted to reward businesses and companies that kept employees on the payroll to help prevent a total economic collapse from taking place.
Even though the days of lockdowns and social distancing are past, you can still go back and determine eligibility for specific quarters. File amended returns to claim credits that still help your business now.
Learn more about ERC benefits and how your business might be eligible for this tax credit. Getting the ERC might help your business with financial relief from pandemic-related costs.
Get Assistance from a Trustworthy Company
If you have not already filed for ERC yet, then you need to consider doing it right away, as the sunset date for 2020 is April 2024, and April 2025 for the 2021 year. Ignore solicitations, as there are many ERC scams out there. Instead, consider a trusted, experienced provider in the USA that has a proven track record of filing application and receiving refunds for their clients.
Our team spent hundreds of hours researching providers and narrowed it down to a list of the top 3. ERC Specialists wins the top spot because they have successfully processed and received the most legitimate refunds and have excellent online reviews. Omega Accounting Solutions comes in at a very close second option because of their legitimacy and customer service. ERC Today comes in third.
We are confident in recommending these providers perform an ERC analysis for you, but always remember to do your research on a company if you consider hiring them.
4.3 of 5 stars
The company specializes in ERC tax refunds and has long experience obtaining the maximum amounts for clients. The team at ERC Specialists has a deep understanding of the ERC program's workings as well as the field of payroll taxation. Their application is fast and simple, and it removes the guessing factor from applying for ERC tax refunds.
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Note: ERC specialists uses a back office partner firm called LINQQS. When you click the link to start an ERC evaluation, you will see a LINQQS qualification form.
4.3 of 5 stars
Omega Accounting Solutions is the best ERC company on the list. They offer bridge loans, which make up for their potentially year-long processing time for customer refunds. They've already helped more than 2,000 clients and have excellent reviews online
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4.1 of 5 stars
Besides offering their customers a fast and simple way to claim ERC tax money, ERC Today's team charges no fees to find out if you qualify for a refund in the first place. They work fast to get your paperwork to the IRS. The client portal is safe to use, and there is dedicated customer support available. Those are just some of the reasons this company receives uniformly high marks from its many clients.
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