The IRS has recently issued practical new guidance in the form of FAQs to address long-standing questions surrounding the Employee Retention Credit (ERC). This 2024 update provides much-needed clarity on how the ERC impacts wage expense deductions and outlines what taxpayers should do when claims are disallowed, or wage expenses were previously overstated. This article breaks down the latest Employee Retention Credit IRS guidance for 2024 to help businesses stay compliant and make informed decisions.
- Reducing Wage Expense for ERC Claims
The first newly issued FAQ does not provide new guidance, but rather it reiterates the long-standing guidance about the impact of the ERC on wage deductions. When claiming the ERC, taxpayers must reduce wage expense on their income tax returns for the year in which the qualified wages were paid or incurred. This is because the ERC represents a reimbursement for those wages and deducting them without adjustment would result in a double benefit. For more details, refer to Notice 2021-20, particularly sections II.F and III.L.
- Handling Overstated Wage Expense
If a taxpayer claimed the ERC but did not reduce wage expense for the tax year in which the wage expense was incurred, and the taxpayer receives the ERC in a subsequent year, they should include the overstated wage expense as gross income in the year they receive the ERC. This approach aligns with the tax benefit rule, which requires that if a taxpayer previously deducted an expense and later receives a reimbursement or credit for it, they must include that amount as income in the year they receive the reimbursement.
Example: Business A claimed a $700 ERC for 2021, did not reduce wage expense for 2021, and then received a $700 ERC payment in 2024; as a result, the $700 should be included in Business A’s gross income in 2024.
- Adjustments for Disallowed ERC Claims
If a taxpayer’s ERC claim was disallowed and they had already reduced wage expense for the credit amount, they can increase wage expense in the year the disallowance is final. Alternatively, the taxpayer may choose to file an amended return, an administrative adjustment request, or a protective claim for refund to deduct wage expense for the year in which the wage expense was incurred. This process provides relief for taxpayers who cannot amend returns due to expired assessment periods and ensures that wage expenses are adjusted accordingly.
Example: Business B applied for the ERC for the 2021 tax year and reduced wage expense on its 2021 tax return anticipating the credit would be approved and paid. However, in 2024, the IRS rejected Business B’s ERC claim. Business B accepts the denial, thus making it final. Business B does not need to amend its 2021 tax return. Instead, it can adjust its 2024 tax return by increasing wage expense by the amount previously reduced in 2021.
Since there is a limited timeframe to file amended returns or AARs, this approach eliminates the need for protective claims when the deadline for filing an amended return or AAR is approaching. It also provides relief for taxpayers who reduced wage expense in years for which the assessment period has expired and did not file a protective refund claim.
These three recently published FAQs provide helpful, practical guidance for taxpayers who have been struggling with how best to proceed regarding these open ERC related issues. Taxpayers who are still waiting to receive their ERC refund may feel some relief knowing that if it is denied, they will not be doubly impacted by the loss of both the wage deductions and the anticipated credit.
Navigating the complexities of the Employee Retention Credit can be challenging, especially with evolving IRS guidance. If you have questions or need support with ensuring your wage expense reporting aligns with current guidance or responding to IRS correspondence, don’t hesitate to reach out. Contact us today to discuss how we can assist you.
