The Employee Retention Credit (ERC) results in a credit which must be included in taxable income of the entity or individual receiving the credit FOR THE TAX YEAR IT RELATES TO.
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. Per IRS.gov:
“Treasury and the IRS are aware that this situation may arise, in part, due to the IRS’s backlog in processing adjusted employment tax returns (e.g., Form 941-X) on which the taxpayers claim ERTC retroactively. Based on applicable law, IRS guidance provides that an employer must reduce its income tax deduction for the ERTC qualified wages by the amount of the ERTC for the tax year in which such wages were paid or incurred. Taxpayers that claimed the ERTC retroactively and filed an amended income tax return reducing their deduction for the ERTC qualified wages paid or incurred in the tax year for which the ERTC is retroactively claimed have an increased income tax liability”
This release reminds taxpayers that, consistent with the relief from penalties for failure to timely pay noted in Notice 2021-49, they may be eligible for relief from penalties for failing to pay their taxes if they can show reasonable cause and not willful neglect for the failure to pay. In general, taxpayers may also qualify for administrative relief from penalties for failing to pay on time under the IRS’s First Time Penalty Abatement program if the taxpayer:
- Did not previously have to file a return or had no penalties for the three prior tax years,
- Filed all currently required returns or filed an extension of time to file and
- Paid, or arranged to pay, any tax due.
Many of our clients have received amounts in 2022 or 2023 which relate back to 2020 or 2021. These amounts received in later years will have to be included as income on an amended 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.
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 choose not to amend you would include the ERC amounts as income in the year received. If you decide to do this, you will assume the risk of the IRS auditing you and charging penalties. The penalties would not be eligible for relief and would be deemed negligent.
Please contact our office for an estimate of fees for these amended returns. These fees may vary depending on the complexity of the returns. 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.