The IRS requires employers to adjust their wage deductions for the year in which they claimed the Employee Retention Credit (ERC) to reflect the reduction in deductible wages. This adjustment is necessary because the ERC is a credit against employment taxes, and the wages used to calculate the credit cannot be deducted as business expenses.
Most employers who received tax refunds for calendar years 2020 and 2021 would have been required to file amended tax returns within 3 years from the date of the original filing. Accordingly, employers with calendar years must determine the original filing date, including extensions, in the succeeding calendar year. For example, a timely filed 2020 C corporation tax return for 2020 should have been filed by March 15, 2021, and a timely filed 2021 C Corporation tax return for 2021 should have been filed by March 15, 2022. Therefore, Amended C Corporation tax returns would be required to be filed no later than 3 years under the statute of limitations, or March 15, 2024 and March 15, 2025, respectively.
Here is a detailed guidance on how employers should adjust their wage deductions:
Legal Basis
Under Section 280C(a) of the Internal Revenue Code, no deduction is allowed for that portion of the wages or salaries paid or incurred for the taxable year which is equal to the sum of the credits determined for the taxable year under sections 45A(a), 45P(a), 45S(a), 51(a), and 1396(a).
Steps to Adjust Wage Deductions
- Identify the Qualified Wages:
- Determine the total amount of qualified wages for which the ERC was claimed. Qualified wages are generally defined as wages paid to employees during periods when the business operations were fully or partially suspended due to a governmental order or during a calendar quarter in which the business experienced a significant decline in gross receipts [2].
- Calculate the ERC:
- The ERC is equal to 50% of qualified wages paid after March 12, 2020, and before January 1, 2021, up to $10,000 per employee for all calendar quarters in 2020. Therefore, the maximum credit per employee is $5,000 [2].
- Reduce Wage Deductions:
- Reduce the wage deductions on your income tax return by the amount of the ERC claimed. For example, if you claimed an ERC of $5,000 for an employee, you must reduce your wage expense deduction by $5,000.
- File the Correct Forms:
- Form 941-X: If you need to correct previously filed Forms 941 to reflect the ERC, use Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund. This form is used to correct errors on a previously filed Form 941, including adjustments for the ERC [3].
- Form 943-X: For agricultural employers, use Form 943-X, Adjusted Employer’s Annual Federal Tax Return for Agricultural Employees or Claim for Refund, to correct errors on Form 943 [4].
- Form 944-X: For employers who file annual employment tax returns, use Form 944-X, Adjusted Employer’s Annual Federal Tax Return or Claim for Refund, to correct errors on Form 944 [5].
- Documentation:
- Maintain detailed records of the qualified wages and the calculation of the ERC. This includes documentation of the governmental orders that led to the suspension of operations or the decline in gross receipts, as well as records of the wages paid and the health plan expenses included in the ERC calculation [2].
- Amend Income Tax Return:
- If the ERC was claimed for a prior year, you may need to file an amended income tax return (Form 1040-X for individuals, Form 1120-X for corporations, etc.) to adjust the wage deductions for that year. The reduction in wage deductions should be reflected in the amended return.
Example
If an employer claimed an ERC of $20,000 for the year 2020, they must reduce their wage expense deduction by $20,000 on their 2020 income tax return. If the original return has already been filed, the employer must file an amended return to reflect this adjustment no later than 3 years after the original tax return filing.
Conclusion
Employers must ensure that their wage deductions are properly adjusted to account for the ERC claimed. This involves reducing the wage expense by the amount of the credit and filing the appropriate forms to correct any previously filed returns. Proper documentation and record-keeping are essential to substantiate the adjustments made.
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