Do You Have to Amend Income Tax Returns for ERC?
Unpack the tax implications of the Employee Retention Credit. Get clear guidance on when and how to amend your income tax returns.
The Employee Retention Credit (ERC) was established as a refundable payroll tax credit to support businesses that retained employees during the COVID-19 pandemic. While the ERC directly impacts payroll taxes, its connection to deductible wages often raises questions about the need to amend previously filed income tax returns. Understanding this relationship is important for businesses to ensure tax compliance.
ERC’s Effect on Taxable Income
The fundamental principle governing the Employee Retention Credit’s impact on income tax is that wages used to calculate the credit are not deductible for income tax purposes. This rule prevents businesses from receiving a “double benefit,” where they would both claim a tax credit for wages and deduct those same wages as a business expense. The Internal Revenue Code (IRC) Section 280C outlines this requirement, ensuring that the economic benefit of the credit is properly accounted for on income tax returns.
This adjustment applies to the income tax year in which the qualified wages were paid or incurred, regardless of when the ERC was actually received. For instance, if a business paid qualified wages in 2020 that generated an ERC, the income tax adjustment relates to the 2020 income tax year, even if the ERC refund was received in 2022 or later. The amount of the ERC directly reduces the amount of wage expense that can be deducted, potentially increasing taxable income for that year.
Businesses that initially filed their income tax returns without anticipating an ERC claim might have deducted the full amount of their payroll expenses. When they later claim and receive the ERC, this prior full deduction becomes overstated because a portion of those wages is now effectively reimbursed by the credit. This necessitates an adjustment to reflect the reduced deductible wage expense. The IRS has provided updated guidance allowing flexibility, where taxpayers who did not reduce wage expenses in the original year may report the ERC as gross income in the year the credit is received, instead of amending the prior year’s return.
Determining the Need to Amend
A business generally needed to amend its income tax return if it claimed a deduction for wages on its original return and subsequently received an Employee Retention Credit (ERC) for those same wages. This is because the ERC reduces the amount of deductible wage expense, meaning the original income tax return would have overstated the deduction.
For example, if a business claimed an ERC for qualified wages paid in 2020 or 2021, and its income tax return for that year had already been filed, an amendment was historically required to reduce the wage expense deduction for that specific year. This applied to various business structures. Sole proprietorships, for instance, would typically adjust their Schedule C (Form 1040). Partnerships would amend Form 1065, U.S. Return of Partnership Income, and S corporations would amend Form 1120-S, U.S. Income Tax Return for an S Corporation. C corporations would amend Form 1120, U.S. Corporation Income Tax Return.
Process for Amending Income Tax Returns
When a business determines an income tax return amendment is necessary, the process involves specific IRS forms tailored to the entity type. Individuals and sole proprietors typically use Form 1040-X, Amended U.S. Individual Income Tax Return, to make corrections. Corporations generally file Form 1120-X, Amended U.S. Corporation Income Tax Return, while partnerships utilize Form 1065-X, Amended Return or Administrative Adjustment Request (AAR). These forms are available for download directly from the IRS website.
To complete the amendment, businesses must identify the specific lines on the form where the wage expense deduction needs to be adjusted. The amount of the adjustment will correspond to the qualified wages that were used to calculate the Employee Retention Credit. This reduction in the wage deduction may increase the business’s taxable income for the year, potentially resulting in additional tax due.
Once the appropriate form is completed, it must be signed and dated by an authorized individual. The amended return, along with any supporting documentation, should then be mailed to the designated IRS address. It is advisable to retain a complete copy of the submitted amendment and all related records for future reference. The IRS typically takes approximately 16 weeks to process amended returns, although processing times can vary and may extend longer depending on the complexity of the return and current IRS workloads.