The IRS created confusion as to the timing of the when that credit must be taken into income, when received or the tax period to which the credit applies. Unfortunately, the IRS has taken the position that the income is taxable in the tax year/tax period to which the credit applies. (See actual language below)
Many of our clients have received amounts in 2022 which relate back to 2020 or 2021. These amounts received in later years will have to be included as income on a prior year return. This process is not easy and ultimately requires amended returns for the entity and the shareholders/partners as well. This also means that the tax was due well before the money was actually received. This underpayment of tax will result in penalties and interest. There is a process to apply for a penalty waiver with the IRS but unfortunately it is a manual one. With the backlog of work that the IRS currently has, we were hoping that they would change their position on this to simply include the amounts in income in the year actually received. Unfortunately that hasn’t happened and we don’t see any movement on this happening anytime soon.
At this time, we have to recommend to our clients that we include the ERC amounts in the year they relate to, not the year received. We are prepared to amend the applicable returns and apply for the penalty relief on the late payment of taxes related to the income reported in an earlier year.
If you ultimately chose not to amend you would include the ERC amounts as income in the year received. If you decide to do this, you risk the IRS auditing you and charging penalties. The penalties would not be eligible for relief at that time.
Please contact our office for an estimate of fees for these amended returns. These fees may vary depending on the complexity of the returns such as state tax returns or special allocations of income. Our estimate of fees will include both the amended tax returns and the penalty waiver request.
If you would like to discuss this further, we can set up a phone call. Please let us know if you would like to move forward with the amended returns.
Timing of Qualified Wages Deduction Disallowance
Section 2301(e) of the CARES Act, as explained in section III.L. of Notice 2021-20, and section 3134(e) of the Code provide the general rule that an employer’s deduction for qualified wages, including qualified health plan expenses, is reduced by the amount of the employee retention credit. The Treasury Department and the IRS have been asked about the timing of the reduction, specifically in the circumstance in which a taxpayer files an adjusted employment tax return to claim the employee retention credit for prior calendar quarters and has already filed a federal income tax return for the tax year in which the credit is claimed on the adjusted return. Under section III.L. of Notice 2021-20, a reduction in the amount of the deduction allowed for qualified wages, including qualified health plan expenses, caused by receipt of the employee retention credit occurs for the tax year in which the qualified wages were paid or incurred. When a taxpayer claims the employee retention credit because of the retroactive amendment of section 2301 of the CARES Act by section 206(c) of the Relief Act (relating to eligibility of PPP borrowers to claim the employee retention credit) or otherwise files an adjusted employment tax return to claim the employee retention credit, the taxpayer should file an amended federal income tax return or administrative adjustment request (AAR), if applicable, for the taxable year in which the qualified wages were paid or incurred to correct any overstated deduction taken with respect to those same wages on the original federal tax return. Section 2301(e) generally provides, in relevant part, that rules similar to the rules of section 280C(a) of the Code shall apply. Section 280C(a) requires tracing to the specific wages generating the applicable credit. See, generally, Treas. Reg. § 1.280C-1. To satisfy this tracing requirement, the taxpayer must file an amended return or AAR, as applicable.