The IRS recently released Notice 2021-49, providing long awaited guidance on many aspects of the Employee Retention Credit (ERC). One aspect relates to the timing of the wage disallowance for ERC claims.
In FAQs issued by the IRS in 2020 and reiterated earlier this year in Notice 2021-20, employers that claim an ERC must reduce their wage expense and health plan expenses (if appliable) on their income tax returns by the employee retention credit amount. However, the timing of this reduction was uncertain – is it in the year the amounts were paid or the year which the ERC claim is filed? Often, this results in two different tax years.
The IRS answered this question in Notice 2021-49. Employers must reduce their wage expense in the year which the wages were paid or incurred.
Employers Who Already Filed a 2020 Tax Return
If your 2020 income tax return was already filed but did not include the wage disallowance for 2020 ERC claims, an amended income tax return may be required. The IRS is applying a tracing requirement for the wages. Any wages and health care expenses utilized for the ERC must be traced back to the year which a deduction was claimed on an income tax return. This is the year which the wage disallowance applies.
An alternative option for filing an amended income tax return is filing an Administrative Adjustment Request. This option is only available for partnership tax return filers and is a way to avoid having each underlying partner or member file an amended tax return.
Employers Who Have Not Yet Filed a 2020 Tax Return
If your 2020 income tax return has not been filed yet, you are in luck. Finalize any 2020 employee retention credit calculations before the tax return is due. For calendar year end partnerships and S-corporations, the extended due date is September 15, 2021. For calendar year C-corporations, the extended due date is October 15, 2021. The wage expense and health insurance costs on the income tax return must be reduced by the amount of the ERC.
A Note for Tax-Exempt Organizations
Tax-exempt organizations generally follow the method of accounting used on their books and records. For tax-exempt organizations that follow generally accepted accounting principles (GAAP), the ERC is typically reported as contribution revenue rather than a reduction to wage expense. The IRS has provided no guidance on how a tax-exempt organization should report the ERC on its annual Form 990 or Form 990-PF filing.
If a tax-exempt organization claimed the ERC for wages paid on an unrelated business activity (UBI), it will be subject to the amended return requirement if it filed its Form 990-T without including the wage reduction for the ERC. ERC wages attributable to an unrelated business activity should be reported like for-profit organizations – a reduction to wage and/or health insurance expenses on the Form 990-T.
It is unclear whether a tax-exempt organization must file an amended return if the ERC wages claimed are not associated with a UBI activity. The Form 990 instructions indicate the organization should generally follow the accounting principles utilized on its books. Until we receive additional information from the IRS, tax-exempt organizations should wait on filing 2020 amended returns for any ERC relating to 2020 non-UBI wages.
If you have questions on whether an amended return may be required for your circumstances, please contact your advisor at Clark Nuber for further assistance.
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