Will the IRS Tax the ERC Refund?
The ERC credit is not considered income for federal income tax purposes, but you must reduce any deductible wage expenses by the amount of the credit. ERC Specialists does not provide tax advice, so please consult with your tax professional regarding ERC funds received.
When the refund is received, the client will need to let their CPA know the amount. It will reduce their payroll expenses that can be written off. So, it is taxable to a certain extent. However, it isn't dollar-for-dollar. The company will in the end profit the amount, and that amount will flow through to owner's tax returns. Taxes are due depending on the tax bracket, and write-offs for each owner. This is something business owners will need to discuss with their CPA's when they receive the funds and have final amounts (the ERC funds will include interest paid out by the IRS). Receiving the credit far outweighs the tax amount on the funds. It is absolutely worth receiving the funds and paying in associated taxes that might incur.
The credits are to be recognized in the years they are claiming the credit. For example, if a customer is claiming the credit for Q3 2021 they will need to amend their 2021 company taxes to reflect the claiming of the credit.
Here's what the IRS notices have to say:
Section L. Special Issues for Employers: Income and Deduction (p. 92)
Q. 60: Does the employee retention credit reduce the expenses that an eligible employer could otherwise deduct on its federal income tax return?
A. 60: Yes. Section 2301(e) of the CARES Act provides that rules similar to section 280C(a) of the Code shall apply for purposes of applying the employee retention credit. Section 280C(a) generally disallows a deduction for the portion of wages or salaries paid or incurred equal to the sum of certain credits determined for the taxable year. Accordingly, a similar deduction disallowance applies under section 2301(e) of the CARES Act with regard to the employee retention credit, such that an employer's deduction for qualified wages, including qualified health plan expenses, is reduced by the amount of the employee retention credit. (An employer does not, however, reduce its deduction for the employer’s share of social security and Medicare taxes by any portion of the credit).
Q. 61: Does an eligible employer receiving an employee retention credit for qualified wages need to include any portion of the credit in income?
A. 61: No. An employer receiving a tax credit for qualified wages, including allocable qualified health plan expenses, does not include the credit in gross income for federal income tax purposes. Neither the portion of the credit that reduces the employer's applicable employment taxes, nor the refundable portion of the credit, is included in the employer's gross income.