The Employee Retention Credit (ERC) provided relief for businesses all over the United States when the impact of COVID-19 left small and medium businesses struggling. The credit rewards businesses for keeping employees on the payroll. 

This program continues to benefit businesses, but the newness of the credit comes with questions. How will it impact filing taxes? Does the Internal Revenue Service (IRS) pay interest on ERC refunds? 

The Impact of the ERC on a Business Tax Return

The IRS does pay interest on ERC refunds. Here are more essentials to understand how the ERC will impact a business tax return. 

ERC Wage Disallowance

When a business files for the ERC, it is claiming employee wages that previously would have been a deductible expense. Because the ERC now covers that expense, it will no longer be deductible. 

It can take a while for the ERC to process and for a business to actually collect the refund. The employee wages must be disallowed for the year they were paid — not when the business acquires the refund. 

ERC and Taxable Income

According to the IRS, ERC refunds are not part of the gross income and therefore aren’t directly taxable. However, depending on the business circumstances, wage disallowance could result in loss due to an increase in federal income tax.

ERC and Amending Tax Returns

If a business took the ERC for 2020 and 2021, the tax return can be amended. A business should account for the disallowance of wages in the year they were. So, If a business filed for the ERC in 2020 but didn’t collect the refund until 2021, a business still needs to amend the 2020 tax return. 

Many businesses couldn’t pay for the impact of their increased taxable income in the year they filed for the ERC because they hadn’t collected tax refunds yet. One might wonder how the IRS accounts for this and if penalties are involved. 

This is where interest comes in.

IRS-Paid Interest and a Business ERC Refund

To account for the time value of the money, the IRS pays interest to the total value of a business refund. While the ERC itself is not taxable income, the interest is. When a business collects an ERC refund, it will get a receipt that includes the portion of the refund that is IRS-paid interest. 

A business must include this interest in the taxable income for the year it is collected. 

Let’s say a business filed for the ERC in 2020, and the refund came in as $204,000 in 2022. The receipt lists $4,000 of that amount as interest. A business would include that $4,000 in taxable income for 2022.

A business would then amend income tax for 2020 to reflect the wage disallowance based on the $200,000 refund. Some businesses face penalties if this change increases their tax liability for that year, since the IRS may consider the payment late.

However, the IRS has announced they may waive penalties in part if a business was previously in good standing — meaning it incurred no penalties for the last three years, all required forms and extensions were filed, and all taxes paid.

Have More Questions? Contact Experienced Tax Attorneys at Dayes Law Firm

If you’re an eligible employer, your business ERC refund can have significant implications for your taxes. Instead of taking on this task yourself, you can simplify matters by hiring a tax attorney. 

The tax lawyers and tax professionals here at Dayes Law Firm have ample experience with ERC refund recovery and IRS tax collection. Contact our team today at (800) 503-2000 for a free consultation.