Last week, the IRS has provided crucial guidance on how to properly handle ERC refunds and disallowances, especially for closed tax years, simplifying the process for affected taxpayers who claimed the ERC but were waiting for their refund prior to making adjustments to their income tax returns:
- New Procedure for Closed Tax Years (2020/2021):
- Taxpayers receiving Employee Retention Credit (ERC) refunds for prior, closed tax years (2020/2021) who haven’t amended their returns must now include the overstated wage expense amount as gross income in the tax year the refund was received.
- For example, a 2024 ERC refund related to 2021 wages means the 2021 overstated wages are added to 2024 gross income.
- Options for Open Tax Years:
- Taxpayers with open tax years can amend their returns, file an Administrative Adjustment Request (AAR), or a protective claim for refund to deduct the wage expense in the year the ERC was claimed.
- Alternatively, they can choose to report the refund as income in the year it’s received.
- Handling Disallowed ERC Claims:
- If the IRS disallows an ERC claim, taxpayers who previously reduced wage expenses can increase those expenses on their current tax return by the amount originally reduced, in the tax year the disallowance is finalized.
- Addressing Returned Tax Payments:
- The IRS clarified that taxpayers whose payments for amended closed year returns were returned can now use those refunded payments to cover the tax liability arising from including the overstated wages in the income of the year they received the ERC refund.