INSIGHT

New ERC guidance from the IRS: Adjusting wages in the year ERC refund received

April 1, 2025

Services: Corporate Tax, National Tax

---

The Employee Retention Credit (ERC) has provided significant financial relief to qualifying businesses affected by the COVID-19 pandemic. The Internal Revenue Service (IRS) clarified in a 2021 IRS Notice that a business must reduce its wage deduction by the amount of the ERC claimed, in the year in which the wage amounts were originally deducted. A recent update from the IRS now allows businesses to make these adjustments in the year the business receives the refund, rather than amending prior-year tax returns.

This guidance provides an alternative approach that simplifies compliance, reduces the administrative burden for many businesses and resolves taxpayer questions regarding the expiration of the Statute of Limitations (SOL) relative to the year for which the credit was claimed.

Understanding the wage deduction adjustment requirement 

The IRS considers the ERC as a refund of payroll taxes, which means a business cannot deduct as wages on its income tax returns, the amount of the credit. As stated above, traditionally, businesses were required to file an amended income tax return to reduce the wage deductions for the tax year in which it originally claimed the ERC. This presented problems for certain taxpayers which had filed ERC credit claims, but did not amend its income tax returns for the 2020 or 2021 tax years while waiting for the ERC credit refund. The IRS has provided that the requirement to amend the income tax returns is not contingent on the receipt of the ERC cash refund. Certain taxpayers that waited for the ERC refund to amend returns have begun to experience the expiration of the SOL of the income tax returns.

Example: Corporate taxpayer A filed for an ERC credit refund claim for the 2020 tax year. The refund claim was $50,000. The taxpayer did not amend its income tax return for the 2020 year to reduce its wages by $50,000. The taxpayer’s 2020 Form 1120 was filed on April 15, 2021 (the original due date of the tax return filing). The ERC refund was not paid until 6/30/2024. The regular SOL for this 2020 income tax return is 3 years from the date of filing, as no extension was requested and the tax return was filed on its original due date. That means the SOL closed for the 2020 tax year on April 15, 2024, and is not able to be amended by the taxpayer.

The new IRS guidance, issued as additional Frequently Asked Questions (FAQs) on March 20, 2025, addresses two common taxpayer situations to provide relief by allowing a business to adjust its wage deductions in a year different from the year for which the ERC refund claim was filed.

Taxpayer filed a claim for the ERC refund, but did not amend its income tax return to reduce its wage deduction. Taxpayer did receive the ERC refund.

The IRS FAQ provides that the taxpayer is not required to file an amended return (or an administrative adjustment request (AAR) in the case of a partnership) to address the overstated wage deductions. Instead, the taxpayer can include the overstated wage deduction amount as gross income on the income tax return for the tax year when the ERC refund is received.

Therefore, in the above example, Taxpayer A must include its ERC refund of $50,000 in income on its 2024 income tax return. There is no ability to amend the 2020 income tax return. However, if the SOL for the 2020 tax year was still open at the time of the receipt of the refund, the taxpayer has the option to include the income in the 2024 year or amend the prior year.

Taxpayer filed a claim for the ERC refund, which was denied by the IRS, but had already filed an amended its income tax return to reduce its wage deduction.

In this case, the FAQ provides that the taxpayer may increase its wage deduction on its income tax return by the same amount that wages were reduced when the amended return was filed. This increase can be done in the tax year in which the claim disallowance is final. This is, generally, the tax year the taxpayer determines it will agree to the disallowance or has exhausted all remedies to fight the disallowance. Alternatively, the taxpayer may file an amended return, AAR, or a protective claim for refund to deduct the wage amount for the year in which the ERC was claimed if the SOL has not yet closed.

Conclusion

The IRS’s new guidance provides much-needed flexibility for businesses adjusting their ERC-related wage deductions. By adjusting wages as described above in the two outlined situations, a business can streamline their tax filings while ensuring compliance with IRS rules. We recommend that you consult with your BPM tax professional to maximize the benefits while adhering to IRS guidance.