Is the Employee Retention Credit Taxable Income?

August 10, 2023
Dayes Law Firm

The Employee Retention Credit, or ERC, has been a great opportunity for businesses and employers who suffered from the impact of COVID-19. The credit incentivizes keeping employees on the payroll. 

But is the ERC taxable income? If you claimed the ERC, how does that impact your taxes?

Business taxes aren’t as straightforward as individual income tax — you must abide by certain rules and specifications that influence your tax liability. Learn about how the ERC impacts your taxes and how Dayes Law Firm can help with your business tax return.

The ERC Does Not Count As Taxable Income

The short answer: no, the ERC is not part of your taxable income. You don’t need to claim it in your gross income when you pay taxes. However, that doesn’t mean it doesn’t impact your taxes at all. 

The ERC does still impact your taxes because you must reduce your payroll expense deduction by the amount of the ERC you claimed.

Relevant Tax Rules to Know About the ERC

When you’re claiming your ERC on your taxes, be aware of these two rules: 

  • IRC Section 280C requires you to reduce your deductible expenses (like payroll expense deductions) by the amount of Research & Development (R&D) credit you took. Note that R&D and the ERC are separate categories — you cannot claim the same costs under both.
  • Section 2301(e) of the CARES Act states that you cannot deduct a portion of payroll expenses equal to your ERC credit. Therefore, your deductions won’t include the amount of ERC you took for that taxable year.

What does this mean for your taxes? Even though your ERC isn’t part of your business income, it will impact your tax deductions. Ultimately, because you need to account for the ERC and R&D credits separately, you’ll have fewer tax deductions available to you. 

The ERC and Tax Returns 

The ERC doesn’t impact all businesses in the same way. Three major factors will determine how your ERC influences your tax returns: 

  • How much you claim from the ERC: The more ERC you claim, the fewer deductions you can make.
  • How much you deduct from payroll expenses throughout the tax year: The amount you usually deduct from payroll expenses determines how much this change will impact your business. 
  • How you define your business entity: Corporations file Form 1120-S, and partnerships file Form 1065. 

Next Steps After Collecting the ERC

When you collect the ERC, you might feel tempted to spend it right away. Avoid taking immediate action before talking to your accountant or tax preparer, so you’ll know the exact impact the ERC will have on your taxes before you begin spending.

One way to counteract the negative impact of the ERC on your taxes is to claim any expenses that aren’t qualified research expenses under your ERC. This reduces the impact on your R&D credit, softening to blow to your deductions. 

Reporting the ERC on Your Tax Return

In addition to Form 1120-S or Form 1065, you must also file two additional forms with your tax return.

Both S-corporations and partnerships need to fill out an accompanying Schedule K-1 to record amounts passed to shareholders or other participants. 

You must also include form 5884-A for all employee retention claims.

Have More Questions? Contact a Professional Tax Lawyer

Hiring a professional tax lawyer can simplify this complex process. Taxes require knowledge of business expenses, cash flow, deductions, retirement plans, credits, and more. You don’t have to navigate it alone. 

Contact Dayes Law Firm at (800) 503-2000 today for a free consultation about how the ERC impacts your business’s taxable income.