Understanding the Tax Implications of the Employee Retention Credit

Learn about employee retention credit (ERC) refundable tax credit for qualified wages paid by employers to their employees during COVID-19 pandemic.

Understanding the Tax Implications of the Employee Retention Credit

The employee retention credit (ERC) is a refundable tax credit for qualified wages that employers pay to their employees. The credit was created to incentivize companies to keep their employees on the payroll during the COVID-19 pandemic, even if they weren't working. The ERC is not taxable when it is received, but salaries equal to the ERC amount are subject to expense dismissal rules. The ERC is not included in gross revenues, but it is subject to expense relief rules, which in practice make it taxable.

The IRS concluded that Section 3121 (q) of the Internal Revenue Code (IRC) results in the employer considering those amounts paid for the purposes of Section 2301 of the CARES Act and Section 3134 of the Code (and presumably the employee retention credit in cases of qualified disaster that is requested on Form 5884-A). A taxpayer can file a modified payroll tax return in a later tax year, but they will have to apply the wage expense exemption in the year to which the ERC application relates, and not when the ERC application is filed or when the funds are received. No part of the ERC reduces the employer's deduction for their participation in Social Security and Medicare taxes. You can apply for both the Families First Coronavirus Response Act (FFCRA) credit and the ERC credit if your company qualifies.

The notice provides examples of companies that qualify as “qualified salaries” and establishes a process for those companies to treat all salaries paid to employees during that quarter as “qualified wages” for the purposes of calculating the ERC. Section 280C of the IRC states that “no deduction shall be allowed for the part of wages or salaries paid or incurred during the tax year that is equal to the sum of the credits determined for the tax year.” This is done so that a taxpayer cannot “pay twice” and receive a wage deduction and a credit for the same wage expense. If you have any questions about how this affects you or your company, please contact GHJ's tax advisors. Marianna Dyson works in areas such as payroll tax, additional benefits and reporting, with a specific focus on requirements given to employees and managers, worker classification, tip reporting, cross-border compensation, additional withholding, reporting, and penalty reduction.

She has also advised large insurance companies and employers on reporting requirements under sections 6055 and 6056 of the Affordable Care Act, as well as on section 6050W (reporting form 1099-K), including its application to third-party payment networks.

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