February 27, 2024

Is the Employee Retention Credit Taxable Income?

In an effort to prevent widespread unemployment, the U.S. government created the Employee Retention Credit program as a refundable payroll tax credit. While millions of employers qualify for the ERC, some have not yet claimed the credit.

Many employers share the same questions and concerns. What is employee retention credit and how do I apply? Is the employee retention credit taxable income? And how will the credit impact taxes?

What Is the Employee Retention Credit?

Before answering the question of the employee retention credit taxable income, it is important to understand how the ERC works.

ERC is a refundable tax credit for eligible wages and some health benefits paid to employees during the period between March 12th, 2020 and October 1st, 2021. It was one of many employee retention strategies put forward by Congress to protect the economy during the height of the COVID pandemic.

Employers who qualified for the ERC could claim back up to $26,000 per employee. If the credits exceed payroll tax liability, the remainder is sent to the employer as a refund.

It is this refundable portion that employers worry may be employee retention credit taxable income.

Is the Employee Retention Credit Taxable Income?

The simple answer to the question is ERC taxable income is no. The ERC is a tax credit that transforms into a refund if the credit is larger than payroll tax liabilities.

So, even employers who receive a refund from the IRS due to the ERC will not have to pay tax.

How is ERC Reported on Tax Returns?

Another reason an eligible employer may not claim ERC is that they don’t know how to report ERC on their income tax return.

The ERC should be reported on form 941. Employers have until April 15th, 2024 to claim credits for the 2020 tax year. 2021 credits can be claimed retroactively until April 15th, 2025. In these cases, the employer can amend form 941 from their previous return.

How Does ERC Impact Tax Return?

For most businesses, the result of employee retention credit reporting on income tax return is a lower employment tax liability. In some cases, the ERC can reduce some small business taxes to zero, or even result in a refund.

If ERC credits exceed tax liabilities, employers with fewer than 500 full-time workers could file form 7200 to ask for advanced credits on their quarterly filings. However, the deadline for form 7200 filings passed on January 31st, 2022.

Qualifying for the Employee Retention Credit

While the qualifications for the ERC are broad, what qualifies as eligible expenses depends on many factors.

Eligible Employers

Under the ERC, any company with at least one employee notably impacted by COVID can file a claim.

The IRS defines impact as businesses that experienced at least one of the following scenarios:

  • Partial or full disruption in operations due to COVID-related government orders

  • A minimum 50% decrease in gross receipts in 2020 when compared to the same quarter in 2019

  • A minimum 20% decrease in gross receipts in 2021 when compared to the same quarter in 2019

Qualified Wages Per Employee

Employers can claim the ERC against wages liable for Social Security, Medicare, and other federal payroll taxes.

Businesses categorized by the IRS as small businesses could claim all employee hours. Large businesses could only apply ERC to wages paid for hours not worked by the employee.

In 2020, the definition of a small business was an employer with 100 or fewer full-time employees. The threshold was raised to 500 or fewer full-time employees for the 2021 tax year.

Maximum Credit Amounts Per Employee

When the ERC was first introduced in 2020, employers could claim up to 50% of qualifying wages, for an annual maximum of $10,000 per employee. In practice, this meant a maximum credit of $5,000 per worker.

In 2021, the credit was significantly expanded. Up to 70% of wages paid from January 1st, 2021 to October 1st, 2021 qualify for the ERC. The cap per employee was also increased to $10,000 per quarter. This raised the total maximum credit per employee to $21,000 for 2021.

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The ERC is a tax refund. Like any other tax write-offs for small business, it does not need to be paid back.

Businesses that want to claim the ERC retroactively should amend their form 941 from the respective tax year.

According to current processing times, ERC refunds may take up to 12 months.

No. The IRS does not require employers to report ERC credits or refunds as gross income for employees.

ERC credits lower the wage deduction for the applicable tax year. This is to prevent employers from receiving credits for the same expense. This change must be reflected in the federal tax return. This could potentially increase a business’s taxable income.

The answer to is the employee retention credit taxable income is not so clear for state taxes. While the ERC is tax-exempt at the federal level, some states may impose a state tax on refunds.

Employers have until April 15th, 2024 to apply for 2020 ERC credits. Credits for the 2021 tax year are available until April 15th, 2025.

The ERC is not an automatic credit. If you do not apply before the deadline, you will not be able to claim the credit or receive a refund.

Employers can claim the ERC by entering qualifying wages on part 3, line 30 of form 941-X.