Is the Employee Retention Credit Refund Taxable?

The Employee Retention Credit (ERC) is a refundable tax credit for the salaries of qualifying employees. It is not included in gross income for federal income tax purposes, but it is subject to expense dismissal rules, which in practice make it taxable. Employers that receive a tax credit for qualified wages, including allocable qualifying health plan expenses, do not include the credit in gross income for federal income tax purposes. Neither the part of the credit that reduces employment taxes applicable to the employer nor the refundable part of the credit are included in the employer's gross income. The ERC is not a tax, but rather a refundable tax credit.

When it is received, it is not taxable; however, salaries equal to the ERC amount are subject to expense dismissal rules. A taxpayer's wage deduction for a tax year must be reduced by the amount of the ERC related to that tax year. Any eligible employer can choose not to apply the ERC for any calendar quarter by not requesting it on the employer's payroll tax return. The client employer is responsible for avoiding a “double benefit” with respect to the employee retention credit and the credit under section 45S of the Internal Revenue Code. The client employer cannot use the salaries that were used to apply for the employee retention credit and declared by the third-party payer on behalf of the client employer to apply for the 45S credit on their income tax return. Notably absent in Article 51 (i) of the Internal Revenue Code (IRC) or in the first IRS guidelines was the direct prohibition of claiming to the ERC for salaries paid to the majority owner of a corporation or to the spouse of the owner.

However, the rules do not directly disqualify the owner of the ERC, unless the building property rules are analyzed broadly. The notice did exactly that and concluded that the owner cannot be included in the ERC if that person has a living brother, spouse, ancestor or direct descendant (because that living member of the family will be the constructive owner of more than 50% of the company and the legal owner will be related to the building owner).At the end of a tax year, taxpayers have already paid or incurred salaries that will be used to apply for any applicable ERC and, presumably, have sufficient information to determine its amount with reasonable accuracy. See instructions on Form 941-X, Employer's Adjusted Quarterly Federal Tax Return, or Request for Refund. When it was originally implemented, employers were not eligible for ERC if they received a loan from Check Protection Program (PPP). No part of ERC reduces an employer's deduction for their participation in Social Security and Medicare taxes. Taxpayers should also note that denial of expenses related to ERC may affect their wage limit for purposes of qualified business income (QBI) deduction under section 199A.

If you have any questions about ERC or its impact on you or your company, please contact GHJ's tax advisors.

Zachary Kadner
Zachary Kadner

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