Employee Retention Credit: You Got Your Check. Now What?
Employee Retention Credit: You Got Your Check. Now What?
Included in the $2.2 trillion Coronavirus Aid, Relief, and Economic Security Act (the CARES Act) was a new refundable employment tax credit, also known as the employee retention credit (ERC), which could amount to as much as $26,000 per qualified employee. The ERC is claimed by filing amended employment tax returns (Forms 941-X) for any applicable quarters. After an expansion of the eligibility test, ERC claims skyrocketed. Thousands of businesses have already received checks for their ERC, so now what?
Amend Your Return. The CARES Act provides for any employer which received an ERC, such employer’s deduction against income for qualified wages must be reduced by the amount of the credit. The CARES Act further provides rules similar to those of I.R.C. § 280C(a) apply. Section 280C(a) requires any credit be “traced” to the specific wages generating such credit. Applying this rule, the employer’s wage deduction must be reduced in the year the qualified wages generating the ERC were paid. This generally requires filing an amended federal income tax return or administrative adjustment request (AAR), as applicable.
Amended tax returns and AARs must be filed within three years of the date the income tax return was due to be filed (including extensions).
Request Penalty Abatement. By reducing the wage deduction, the employer’s taxable income in the prior year will increase. Taxpayers and tax professionals questioned whether the IRS would grant automatic relief from any penalties or interest imposed on the underpayment. At present, the IRS has declined to extend automatic relief, and in Notice 2021-49, merely stated any penalties for failure to timely pay or deposit tax will not apply if the taxpayer can show “reasonable cause and not willful neglect” for those failures. Since no mention was made of interest, and the IRS has been paying interest on refunds of employment tax with the ERC, interest will likely be imposed on the underpayment.
As for penalties, it is at least prudent, and may in fact be necessary, to request abatement of any penalties when filing the amended income tax return.
An April 18, 2022 news release indicated qualifying taxpayers could use the IRS First-Time Penalty Abatement program. Unwitting taxpayers may be utilizing this path to administrative relief, not realizing it can only be used one time. Since penalty relief would likely be granted under the “reasonable cause” exception of I.R.C. § 6664, such taxpayers would be better served taking that route and preserving the First-Time Abatement option.
Retain Records. The IRS has also directed taxpayers to retain all records in support of their ERC claim for at least four (4) years. Such records include: copies of governmental orders relating to the full-or-partial suspension test, records relating to the gross receipts test, payroll reports, and health plan expense sheets (if applicable).