On March 20, 2025, the IRS released updated guidance on the Employee Retention Credit (ERC), clarifying how taxpayers should handle the wage expense reduction associated with the credit. These updates are critical for corporate tax advisors navigating ERC claims, amended returns, and potential tax consequences for their clients.

Key Takeaways from the IRS FAQ Update

The IRS reaffirmed that taxpayers who claimed the ERC must adjust their wage expense on their income tax return for the year in which the qualified wages were incurred. This means:

• Taxpayers were required to reduce wage expenses in the year wages were incurred, not in the year the ERC was received.
• If a taxpayer did not adjust wage expenses accordingly, they must now recognize the ERC as income in the year of receipt.
• For taxpayers whose ERC claims were disallowed, they may restore the originally reduced wage expense in the year the disallowance is final.

These clarifications provide guidance on how to correct past filings without requiring extensive amendments in certain cases.

Implications for Taxpayers and Advisors

1. Addressing Overstated Wage Expenses – Many taxpayers have received their ERC refunds in years after the qualified wages were originally incurred. The IRS now explicitly allows these taxpayers to report the ERC amount as gross income in the year received instead of amending prior-year tax returns. This approach simplifies compliance and prevents potential penalties for failing to properly reduce wage expenses.
2. Handling ERC Denials and Wage Adjustments – For taxpayers who preemptively reduced their wage expenses on tax returns in anticipation of an ERC approval—but later had their ERC claim denied—the IRS now allows an adjustment in the year the disallowance is final. This eliminates the need to amend prior-year tax returns to reclaim the wage deduction.

Final Thoughts

The IRS’s new guidance provides much-needed clarity but also imposes obligations on taxpayers to correctly account for ERC-related wage adjustments. Advisors should proactively assist clients in navigating these updates to minimize risk and ensure compliance.

Please see the following link for the IRS FAQ update:  https://www.irs.gov/coronavirus/frequently-asked-questions-about-the-employee-retention-credit – the updated guidance is located under the header “Income tax and ERC”