ERC reported as income.

Technical topics regarding tax preparation.
#1
philly  
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Cash basis taxpayer (schedule C) has not received yet from IRS $ 25,000 of Employer retention Credit applicable to 2021 941 wages.
Do I have to go back and amend the 2021 1040 to reflect the taxable income of $25,000.
 

#2
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Did you reduce payroll expenses for the amount of the credit when you filed the 2021 return?
 

#3
philly  
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No. How would the taxpayer have known at that point? The taxpayer applied for the ERC at the end of 2022.

If we have to go back and amend the return, I would think the taxpayer would be subjected to interest and penalties.
 

#4
JR1  
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Yes, they get penalty and interest, oddly enough. You do have to amend.
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#5
JAD  
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Don't forget to consider state tax implications. CA just came out with something saying that the ERC might be state taxable income. People seem surprised, but why wouldn't the $$ be taxable for state purposes if the full deduction was claimed on the state return?
 

#6
philly  
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The IRS will be receiving a few million amended tax returns to process in the next several months. I guess the interest and penalties will help to substantially reduce the federal debt.
I do not know what other people in the group are thinking but I think having to amend prior year returns and subjecting a business to penalties and interest is crazy. I thought the ERC was implemented to help small business during the COVID.
 

#7
JR1  
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It's an income opportunity for you. Client is happy, getting lots of free money, so they don't mind paying you for this.
Go Blackhawks! Go Pack Go!
Remembering our son, Ben Jan 22, 1992 to Aug 26, 2011.
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#8
dsocpa  
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I had a client get very angry about the ERC amount added back as income. At the time they didn't qualify for PPP2. I advised them of ERC, which they did qualify for. Come time to file and they were upset the credit was added back as income. My response was they could return the money. Silence. Now before I even begin the process, I tell them the tax consequence and the cost benefit. In some situations, it's net positive, others negative.
 

#9
JR1  
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People. I'm loving them less and less all the time. Esp. while driving this morning.
Go Blackhawks! Go Pack Go!
Remembering our son, Ben Jan 22, 1992 to Aug 26, 2011.
For FB'ers: https://www.facebook.com/groups/BenRoberts/
 

#10
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I do not know what other people in the group are thinking


I’ll tell you what I’m thinking: The implementing legislation (the Cares Act) said this:

(e) Certain Rules to Apply.--For purposes of this section, rules similar to the rules of sections 51(i)(1) and 280C(a) of the Internal Revenue Code of 1986 shall apply.

Well, that rule involve claiming a credit on the same tax return where the wages are shown. To your point, seems very unreasonable to apply the “same” rule to the ERC situation, where we have an income tax return (with the wages) and a Form 941X (with the credit claim). Two different tax returns. Yet, IRS guidance (which was in a Notice only) didn’t directly address the Congressional mandate. Rather, the IRS Notice applied the SAME rule to the ERC situation, which is an entirely different animal. An animal that involves two tax returns and not one. An animal that kept changing – initially, we were told you didn’t even qualify for the ERC if you received a PPP Loan. I could go on. Anyway, it seems to me that reporting the refund in the year received is “similar” to disallowing a deduction.

Also, amended returns are not required, as we all know.

And finally, how is the IRS going to police this? Do they even have the capability? Are they expecting an amended return from your client? How do they know that your client didn’t already reduce wages on his original filing? Some people, you know, actually booked up a Receivable and credited wages before getting an answer on the ERC claim. Will the IRS match filed and amended 941’s to the wage number on the original income tax return? What would happen if you report the refund as income in the year of receipt, but a prior return gets audited (the one with the relevant wages)…and you tell the IRS, “I reported the refund in 2022. I’ll sign a closing letter saying I won’t amend the 2022 return (to remove said refund income) if you let this go without having me file an amended return for the prior year. I offer this up because we’ll end up in the same place. If we do it your way, I owe tax for the prior year, plus interest. Then I’ll get a refund for 2022 when I amend that return, plus interest. If we do it my way, we don’t have to go through this exercise amending returns and wasting valuable IRS resources.” Maybe they’ll say, “Fine.” If they don’t say fine, then it seems we have a bona fide dispute about what “similar” means, whether or not the Congressional mandate was followed, and the real authority of the IRS Notice.

I also wonder this: What if you don’t amend a prior year return (to reduce wages), but you don’t report the refund as income either? I have a sneaking suspicion that if SOL has run on the prior income tax return, the IRS will come back with something like, “Well, you’re on the cash basis of accounting. Amending the prior year income tax return wasn’t the only way to fix the situation. Since you didn’t amend and reduce wages, the refund is taxable in the year of receipt.” And note: This SOL issue is highly relevant. You could file an ERC claim at the very last minute. But by the time it gets processed, the SOL on the income tax filing has expired. Did the IRS even think about this possibility? I know there’s a special SOL with certain ERC claims, but I’m pretty sure that doesn’t apply to the related income tax return.
 

#11
JAD  
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Spidell is just now reporting that the FTB now says that the ERC is not taxable income. Good news for taxpayers. I don't understand the logic.
 

#12
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good post Jeff. This process will create a lot of work for practitioners which in turn will be an additional expense to small businesses not to mention the IRS getting several million amended returns to process.
I thought the purpose of the ERC was to help small business that suffered during the COVID.
I believe the ERC should be taxable but make it taxable in the year that it was received. Many businesses are still waiting in 2023 for the ERC refund since the IRS is very backed up. So, they did not receive the ERC credit, but they have to amend a prior year return pay the tax with interest & penalties. I contacted my congressional representative via phone and email. There has to be an easier solution to this issue.
 

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Jeff-Ohio wrote:I know there’s a special SOL with certain ERC claims, but I’m pretty sure that doesn’t apply to the related income tax return.


Yes, the payroll tax returns are subject to a 5yr SOL. I expect most of them to be audited...and many should be.

All very interesting stuff.
~Captcook
 

#14
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So, they did not receive the ERC credit, but they have to amend a prior year return pay the tax with interest & penalties.

No penalties.

I contacted my congressional representative via phone and email. There has to be an easier solution to this issue.

Totally agree. You’re a little late to the game, though. Issue has been around for a long while now. FYI, the applicable Cares Act provision is codified in Code Section is 3134(e):

For purposes of this section, rules similar to the rules of sections 51(i)(1) and 280C(a) shall apply.


It’s really the 280C(a) reference that we’re analyzing here. And yup, that’s all it says. And here’s 280C(a):

No deduction shall be allowed for that portion of the wages or salaries paid or incurred for the taxable year which is equal to the sum of the credits determined for the taxable year under sections 45A(a) , 45P(a) , 45S(a) , 51(a) , and 1396(a) . In the case of a corporation which is a member of a controlled group of corporations (within the meaning of section 52(a) ) or a trade or business which is treated as being under common control with other trades or businesses (within the meaning of section 52(b) ), this subsection shall be applied under rules prescribed by the Secretary similar to the rules applicable under subsections (a) and (b) of section 52.

Here’s what somebody might say about that: Take one of these credits, like the Indian Employment Credit in Sec 45A(a). As far as I know, that credit is not refundable. Thus, all it could do is offset (income) tax liability. Makes sense that we’d need to account for detriment (wage reduction) in the same year we claim the credit (the benefit), because the credit operates via offset (of one’s income tax liability), subject to carryover provisions. We don’t know when (or if) the taxpayer will receive the income tax benefit of the credit, but we do know he is immediately entitled to its use. This would be so even if the credit was claimed on an amended income tax return. Further, for a number of reasons, trying to align taxation of the benefit with the detriment, timing wise, would be unworkable. That is, it would be unworkable to tax the benefit (either outright or via wage reduction) in the year the credit was actually used.

ERC is quite different. For one thing, it is a refundable credit. Thus, you don’t get the income tax benefit of it until you receive it in cash. This is so even though a portion of the ERC offsets previously paid taxes (employment taxes, not income taxes). So, given all of this, someone might interpret the “similar” word in Sec 3134(e) like this: Ok. If the credit is non-refundable, we take the detriment into account immediately. A similar approach to a refundable credit (and one which is offsetting employment taxes and not income taxes) is to take the detriment into account when the benefit is received. That is consistent with the cash method of accounting and basic income tax principles.

I find the IRS’ position in the Notice to be lazy and unthoughtful.
 

#15
philly  
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This is the E mail that I sent my congressional representative.

Many small businesses across the country have applied for the Employee Retention Credit by amending payroll tax form 941 for previous years. The purpose of the credit was to help small business during the COVID due to loss of revenue. IRS notice 2021-49 requires a business to go back and amend prior year income tax returns by reducing payroll expenses by the amount of the ERC credit amount. The result is a business received the ERC money in 2022 or they are still waiting for the IRS to process the refund claim in 2023 and they have to go back to 2021 for example and amend the income tax returns, pay the tax with penalties & accrued interest. Amending prior year years will also result in additional professional fees to be paid by a small business.

The purpose of the credit to begin with was to help and not hurt small businesses that suffered during the COVID.

Please contact me concerning this issue.
 

#16
philly  
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Businesses are being approached by 3rd party consulting firms saying that they are eligible for the ERC when in fact the business gross income is higher in 2021 as compared to 2020 and 2019. In addition, they are not subtracting the PPP loan money that was received.
I am sure that all these consulting firms will disappear by next year.
 

#17
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philly wrote:Businesses are being approached by 3rd party consulting firms saying that they are eligible for the ERC when in fact the business gross income is higher in 2021 as compared to 2020 and 2019. In addition, they are not subtracting the PPP loan money that was received.
I am sure that all these consulting firms will disappear by next year.


It's per quarter, not the whole year. So q1 2021 could be lower than 2020 q1, and then would be eligible.
 

#18
JR1  
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Yeah, I have a rep for these outfits who claims there will be no audits...alas. And he still claims that even when revenue increased, they can claim supply chain bs as the reason to get thousands of free dollars and no jail time.

I say BS and I won't have it.
Go Blackhawks! Go Pack Go!
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#19
philly  
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Yes, is it by quarter. However, these are businesses that have gross income higher in every quarter for 2021 as compared to 2020 and 2019. They are being told that are eligible to receive the ERC.
 

#20
philly  
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If a taxpayer goes back and amends a prior year return, will they be subjected to a failure to pay penalty plus interest.

Has anyone in the group filed amended prior year returns yet for the ERC received ?
 

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