Employee Retention Credit (ERC) on S Corp return

I'm finally getting around to filing ERC claims for 2021 and want to confirm my thinking is correct. Also have questions.
Assume cash basis S Corp and 2021 ERC $20,000 will be received in 2022:

On the S Corp 2021 tax return, wages are reduced by $20,000
M-1, line 3 expenses on books not on tax $20,000
M-2, AAA, line 5 reduction $20,000
Shareholder basis is a wash: ordinary income increase $20,000 and nondeductible expense increases $20,000

Bonus question. On CA tax return 100S
Full wages are deducted, adjustment on 100S, line 12, other deductions $20,000
CA M-1 and M-2 are a wash, CA ordinary income and nondeductible expenses both decrease $20,000 from federal
CA shareholder basis no change/wash/same as federal


In 2022 when ERC funds are received
On the S Corp 2022 tax return:
M-1, line 5 income on books not on tax $20,000
M-2, NOT SURE ABOUT THIS ONE - AAA or OAA addition $20,000?
Shareholder basis, NOT SURE ABOUT THIS ONE - no change or increase $20,000?

CA 2022
M-1, line 5 income on books not on tax $20,000
M-2 AAA or OAA increase 20,000?
CA shareholder basis?

Personally, I would enter a journal entry on the books to debit ERC receivable and credit salaries & wages expense. And then you don't have to mess with complications on the M-1 & M-2.

I know you said the corporation uses the cash basis, but does it actually help things to record income in 2022 when it's taxable in 2021? It seems like that's making it more complicated overall (taking both tax and accounting into account), when it seems like the purpose of the cash method (from an accounting perspective) is to simplify things.

In any case, you can have the books & tax be different, but you'll just have the adjustment on the M-1. No adjustments on the M-2. Your AAA will be temporarily different than Retained Earnings in that case. Shareholder basis follows the same rule as AAA here. You don't have a nondeductible expense (from a tax perspective); don't put anything on Sch. K line 16c. It's just a temporary timing difference.

"In any case, you can have the books & tax be different, but you'll just have the adjustment on the M-1. No adjustments on the M-2. Your AAA will be temporarily different than Retained Earnings in that case. Shareholder basis follows the same rule as AAA here. You don't have a nondeductible expense (from a tax perspective); don't put anything on Sch. K line 16c. It's just a temporary timing difference."

Do you mean if I book the JE you suggested, this would be the treatment? Or if I don't book the receivable to record the M-1?

If I record a receivable and reduce wages, then no M-1 and no M-2 adjustments in 2021?
But then CA needs to be adjusted.
What about shareholder basis? The wage reduction will increase SH basis in 2021 and nothing further needed in 2022?

If I don't record the receivable and go the M-1/M-2 route, then SH basis is a wash in 2021? And increased in 2022 when cash is received?

"You don't have a nondeductible expense (from a tax perspective)" Is this correct? The wage/payroll tax reduction is a nondeductible expense for tax which is run through M-2 AAA.

The reason I prefer the M-1/M-2 reporting is I use Lacerte and it makes automatic CA adjustments in 2021.
I'm not sure how to report cash received in 2022 if I stick with this reporting.

"In any case, you can have the books & tax be different, but you'll just have the adjustment on the M-1. No adjustments on the M-2. Your AAA will be temporarily different than Retained Earnings in that case. Shareholder basis follows the same rule as AAA here. You don't have a nondeductible expense (from a tax perspective); don't put anything on Sch. K line 16c. It's just a temporary timing difference."

Do you mean if I book the JE you suggested, this would be the treatment? Or if I don't book the receivable to record the M-1?

That would be for if you don't record a journal entry for the receivable.

If I record a receivable and reduce wages, then no M-1 and no M-2 adjustments in 2021?

Correct. By the way, in QuickBooks, we actually credit a sub-account of wages expense, so that you can easily tell at a glance what's going on.

What about shareholder basis? The wage reduction will increase SH basis in 2021 and nothing further needed in 2022?

Correct.

If I don't record the receivable and go the M-1/M-2 route, then SH basis is a wash in 2021? And increased in 2022 when cash is received?

Incorrect.
1. No matter which option you pick, you won't have anything funny on the M-2 adjustment. AAA follows the data that's on the K-1, not on the books.
2. Likewise for the shareholder basis: Basis at the end of 2021 will be higher than what you had originally, regardless of whether you make a journal entry in the books. Because it follows the income that's on the K-1, not on the books. So no, you won't have an extra increase in shareholder basis in 2022 when the ERC cash is received.

"You don't have a nondeductible expense (from a tax perspective)" Is this correct? The wage/payroll tax reduction is a nondeductible expense for tax which is run through M-2 AAA.

It's not a nondeductible expense, it's just a timing difference. Because if you don't make the journal entry in 2021 to recognize a receivable, you're going to credit something in 2022. Just like when you have more depreciation expense on the books than what's deductible on the tax return, you don't show a nondeductible expense on Sch. K line 16c.

I'm not sure how to report cash received in 2022 if I stick with this reporting.

You'll debit cash and credit something. I haven't looked into what GAAP says, I just stick with the tax method, which says you credit wages expense in 2021. But you're not using GAAP anyway, so you can credit whatever you like, so long as it's not misleading. So you could credit wages expense in 2022, or you could credit ERC income in 2022, or whatever.

Dr. ERC Receivable
Cr. Wages

Done. Book the interest in year received.

If I don't record the receivable and go the M-1/M-2 route, then SH basis is a wash in 2021? And increased in 2022 when cash is received?

Incorrect.
1. No matter which option you pick, you won't have anything funny on the M-2 adjustment. AAA follows the data that's on the K-1, not on the books.
2. Likewise for the shareholder basis: Basis at the end of 2021 will be higher than what you had originally, regardless of whether you make a journal entry in the books. Because it follows the income that's on the K-1, not on the books. So no, you won't have an extra increase in shareholder basis in 2022 when the ERC cash is received.

"You don't have a nondeductible expense (from a tax perspective)" Is this correct? The wage/payroll tax reduction is a nondeductible expense for tax which is run through M-2 AAA.

It's not a nondeductible expense, it's just a timing difference. Because if you don't make the journal entry in 2021 to recognize a receivable, you're going to credit something in 2022. Just like when you have more depreciation expense on the books than what's deductible on the tax return, you don't show a nondeductible expense on Sch. K line 16c.

I'm not sure how to report cash received in 2022 if I stick with this reporting.

You'll debit cash and credit something. I haven't looked into what GAAP says, I just stick with the tax method, which says you credit wages expense in 2021. But you're not using GAAP anyway, so you can credit whatever you like, so long as it's not misleading. So you could credit wages expense in 2022, or you could credit ERC income in 2022, or whatever.[/quote]

This article cites IRS Practice Unit on Adjustments to Stock Basis for S Corporations
https://www.tomtalkstaxes.com/p/tom-tal ... rch-4-2022
"The nondeductible wage expense has two other effects on the tax return:
It decreases the accumulated adjustments account (AAA) per Treas. Reg. §1.1368-2(a)(3)(C), and
It passes through to the S corporation shareholders as a nondeductible expense, thus reducing shareholder basis in the S corporation stock.
With respect to the shareholder basis adjustment, the IRS Practice Unit on Adjustments to Stock Basis for S Corporations discusses this on page 9:
The Effect of Credits on Stock Basis
Generally, a shareholder may claim credits passed through from an S corporation regardless of
the shareholder’s stock or debt basis. However, there are two situations in which claiming the
credit decreases basis:
1. Credits which require a reduction of an expense, and
2. Credits which require a reduction in the basis of an asset.
An example of the first category is the Research Credit, which requires the taxpayers who
elect the Research Credit to reduce the research and experimental expenditures by the
amount of the credit. That requirement creates a non-deductible expense at the S corporation
level that passes through to the shareholders and the non-deductible expense reduces the
shareholder’s basis."

According to this, AAA and SH basis are reduced for the ERC.
In my example the reduction to AAA and SH basis happens in 2021. They are both a wash as ordinary income is increased by the wage reduction and AAA & SH basis are also reduced by the nondeductible expense. From my understanding, the wage reduction is a permanent book tax difference. I don't think a reduced expense equates to a credit later received as temporary difference. It's true that it's a timing difference in cash flows, but a deduction and a credit don't create a temporary difference?
Let's assume this is correct for argument's sake. I'm then still unclear on the 2022 reporting.
There's needs to be a "reversing" M-1 adjustment in 2022. Would it be nontaxable income and therefore run through OAA on the M-2 and increase SH basis? Or just a book tax difference that doesn't hit the M-2 at all, but increases SH basis...not sure this makes sense.

Dr. ERC Receivable
Cr. Wages

Done. Book the interest in year received.

See my post #6

I agree with JR1, that's the easy way to do it (although if you want to convolute it, you can recognize ERC income in 2022 and have an M-1 adjustment for the temporary difference).

I don't agree with the article you cited.

Simple, Inc. is a cash-basis S corporation that claimed and received $50,000 in COVID-19 ERC as a recovery startup business... The shareholders collectively took $20,000 in distributions.
...
Assume Simple, Inc. had pre-ERC book net income of $30,000; after adjusting for the ERC, book net income increases to $80,000. If there are no other book-to-tax adjustments on Schedule M-1, then the net business income for tax purposes is also $80,000.

Based on these facts, the balance of AAA on 12/31/2021 should be $60k. There should be no $50k adjustment on M-2 line 5.

Here's why he's wrong: He's basing his logic on the fact that credits against income tax often result in turning deductible expenses into nondeductible expenses, which is true. But this is not a credit against income tax. It's a credit against payroll tax.

Dr. ERC Receivable
Cr. Wages

Done. Book the interest in year received.

Agreed...this is how I've done it too

Dr. ERC Receivable
Cr. Wages

Done. Book the interest in year received.

Agreed...this is how I've done it too

Me three!

Ok, so the consensus here is to book a receivable and I appreciate everyone's feedback.

I'm gonna go with the M-1 & M-2 as that's how Lacerte handles and it's easier to leave as is for CA reporting.

I disagree that ERC is a temporary difference for federal. The deduction is permanently disallowed. I see it as a nondeductible expense.

I disagree that ERC is a temporary difference for federal. The deduction is permanently disallowed. I see it as a nondeductible expense.

It's a non-expense, not a nondeductible expense. If you get reimbursed for an expense, there's no expense. They got reimbursed for the wages - there's no expense for the reimbursed portion.

Since there's both no expense and no deduction, there is not a difference between books and tax. (Unless you mess with the timing like with your original plan, and then you would have a temporary difference.)

I disagree that ERC is a temporary difference for federal. The deduction is permanently disallowed. I see it as a nondeductible expense.

It's a non-expense, not a nondeductible expense. If you get reimbursed for an expense, there's no expense. They got reimbursed for the wages - there's no expense for the reimbursed portion.

Since there's both no expense and no deduction, there is not a difference between books and tax. (Unless you mess with the timing like with your original plan, and then you would have a temporary difference.)

I reread your post #8
"Here's why he's wrong: He's basing his logic on the fact that credits against income tax often result in turning deductible expenses into nondeductible expenses, which is true. But this is not a credit against income tax. It's a credit against payroll tax."

I guess you're saying that a credit to a corp against wage deduction is considered an expense reimbursement and results in no sh basis adjustment. Where a credit passed through to a shareholder against income tax, like R&D credit, results in a nondeductible expense for wages on the corp level.
I think that makes sense.
What confused me was the IRS faq https://www.irs.gov/newsroom/covid-19-r ... -deduction

85. Does the Employee Retention Credit reduce the expenses that an Eligible Employer could otherwise deduct on its federal income tax return?
Yes. Section 2301(e) of the CARES Act provides that rules similar to section 280C(a) of the Internal Revenue Code (the "Code") shall apply for purposes of applying the Employee Retention Credit. Section 280C(a) of the Code generally disallows a deduction for the portion of wages paid equal to the sum of certain credits determined for the taxable year. Accordingly, a similar deduction disallowance would apply under the Employee Retention Credit, such that an employer's aggregate deductions would be reduced by the amount of the credit as result of this disallowance rule.

86. Does an Eligible Employer receiving an Employee Retention Credit for qualified wages need to include any portion of the credit in income?
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.

I thought this means the treatment for ERC is similar to the RD credits, but if you take a position that it's a reimbursement then what you're saying makes sense.
I wonder why Lacerte makes the automatic M-2 adjustment and treats ERC as a nondeductible expense. Coding error?

I wonder why Lacerte makes the automatic M-2 adjustment and treats ERC as a nondeductible expense. Coding error?

You keep mentioning this, but I use Lacerte and haven't experienced this.
Are you sure you're not entering it to Lacerte as some other kind of credit?

I wonder why Lacerte makes the automatic M-2 adjustment and treats ERC as a nondeductible expense. Coding error?

You keep mentioning this, but I use Lacerte and haven't experienced this.
Are you sure you're not entering it to Lacerte as some other kind of credit?

In S corps, screen 15, under Salaries and wages there a field "Less: employee retention credit claimed on employment tax return"

Interesting.
I'm just reviewing a return with ERC and the amount is entered there. The only result is the wage deduction is reduced by that amount. There's no entry to Sch M-1 or M-2.

Interesting.
I'm just reviewing a return with ERC and the amount is entered there. The only result is the wage deduction is reduced by that amount. There's no entry to Sch M-1 or M-2.

Then your return must has an override, check input screen 30, Sch. M-1 Adjustments for Refundable Employment Tax Return Credits: 1=Yes, 2=No.
The default in Lacerte is to record automatic sch M-1 and M-2 adjustments for ERC unless there's an override.

Sorry but I'm dredging up an old thread. Looking for a simple approach to an ERC refund on an 1120S for 2021.
Here's what I think the group consensus is after reading the above comments (post #10):

ERC claimed on 941 for Q1-2021 wages. Cash received of $50k in late 2021. Entry: debit cash, credit wages.
No M-1, no M-2 impact.

Correct.

Interesting.
I'm just reviewing a return with ERC and the amount is entered there. The only result is the wage deduction is reduced by that amount. There's no entry to Sch M-1 or M-2.

Thanks for the info. I now see where to put each year's ERC in Lacerte. That entry reduced wages and net income; then the offset went to Nondeductible expenses on Schedule K and also K-1. So SH basis increased with increase in income but decreased with non-deductible expenses; so a wash to basis and no A/R entry needed.