How to Report ERC Interest Income on Your Tax Return

The Employee Retention Credit (ERC) provides financial relief to businesses, but many recipients are surprised to learn they must report interest income from delayed ERC payments. The IRS includes interest when issuing refunds, and this amount is taxable. Failing to report it correctly can lead to penalties or additional tax liability.

Understanding how to account for this interest on your tax return ensures compliance and prevents issues with the IRS.

Source of the Interest

When the IRS processes an ERC refund, it often takes months or even years before businesses receive payment. To compensate for the delay, the IRS adds interest, accruing from the date the refund should have been issued until the actual payment date. The interest rate fluctuates quarterly and is based on the federal short-term rate plus 3% for individuals and 5% for corporations as of 2024.

This interest is calculated using a daily compounding method, meaning longer delays result in higher amounts. For example, if a business was owed $100,000 in ERC and the refund was delayed by 18 months, the interest could add thousands of dollars to the total payment. This interest is separate from the ERC itself and must be reported as taxable income.

Identifying Taxable Income

Interest from an ERC refund must be reported as taxable income in the year it is received, regardless of when the original credit was claimed. The IRS categorizes this as “interest income,” subject to federal and, in some cases, state taxation.

The IRS issues Form 1099-INT for interest payments of $10 or more, which businesses must include in their tax filings. Even if the total interest is below this threshold and no 1099-INT is issued, the income remains taxable and must be reported. The IRS cross-references reported interest payments with tax returns, so omitting it may trigger scrutiny.

For pass-through entities like S corporations or partnerships, the interest income flows through to individual owners based on their ownership percentage. Each owner reports their share on their personal tax return, typically on Schedule B of Form 1040. C corporations report the income directly on their corporate tax return, Form 1120.

Reconciling Previous Filings

If a business failed to report ERC-related interest income, it may need to amend prior tax filings. Since interest is taxable in the year it is received, discrepancies between reported income and IRS records can lead to audits or penalties. Businesses should file an amended return using Form 1120-X for corporations, Form 1065-X for partnerships, or Form 1040-X for individual filers of pass-through income.

Timing differences between when the ERC was claimed and when the interest was received can complicate financial reporting. If a business recorded the ERC refund as income or reduced payroll expenses in one year but received the interest in another, adjustments must be made to avoid misstating financial statements. Under Generally Accepted Accounting Principles (GAAP), interest income should be recognized in the period it is earned, which may differ from tax reporting requirements. Businesses using accrual accounting should ensure their financial statements align with IRS rules to avoid inconsistencies.

Documentation Requirements

Accurate records of ERC-related interest income are necessary for tax compliance and potential audits. Businesses should retain all IRS correspondence, including Notice CP210, which details the refund amount and any interest paid. If a 1099-INT is issued, it must be matched with internal records to confirm the reported interest aligns with IRS data.

Bank statements reflecting the deposit of ERC refunds serve as additional verification, particularly if a 1099-INT was not received. Businesses should document the breakdown of principal and interest, ensuring proper classification in accounting records. For those using accrual accounting, journal entries should reflect interest income separately from the ERC refund, with supporting schedules reconciling amounts reported on tax returns and financial statements.

Potential Effects on Estimated Taxes

Interest income from an ERC refund can impact a business’s estimated tax obligations, particularly for those required to make quarterly payments. Since this interest is taxable, it may increase overall tax liability, potentially leading to underpayment penalties if not accounted for in advance.

For corporations, the IRS generally requires estimated tax payments if total tax liability exceeds $500 for the year. Pass-through entities, such as sole proprietorships and partnerships, follow individual estimated tax payment rules, which apply if total tax due exceeds $1,000. If ERC interest significantly increases taxable income, adjusting estimated payments using Form 1040-ES or Form 1120-W can help avoid penalties. Businesses should also consider state tax implications, as some states require separate estimated tax calculations that may differ from federal rules.