On March 20, 2025, the IRS updated its frequently asked questions (FAQs) on the employee retention credit (ERC). The new FAQs address timing of reporting wage expenses on a taxpayer's tax return and how to deal with overstated and understated wage expenses. This is important because it addresses the interaction between the credit and income tax returns by offering another approach for taxpayers to comply with the credit.

Background

The ERC is a refundable federal employment tax credit that was first enacted as part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) in 2020 and repeatedly modified and extended. The ERC is available for qualified wages paid by eligible employers during the COVID-19 pandemic from March 13, 2020, through September 30, 2021. The ERC is generally claimed by filing a refund claim for the relevant quarter.

The IRS has issued various guidance while trying to handle the large number of ERC claims (see Tax Alerts 2023-1790, 2024-1507, and 2024-1539). In January 2025, a news release on the National Taxpayer Advocate's annual report said that a backlog of approximately 1.2 million ERC claims existed as of October 26, 2024, with many claims pending for more than a year. The IRS announced in mid-December 2024 that approximately 500,000 additional claims will be processed in 2025.

New ERC FAQs

On March 20, 2025, the IRS added four new FAQs on ERC claims.

In FAQ 7, under Claiming the ERC, and FAQ 1, under Income tax and the ERC, the IRS said the ERC reduces the amount that can be reported as wage expense on a taxpayer's income tax return for the tax year in which the qualified wages were paid or incurred.

In FAQ 2, under Income tax and the ERC, the IRS addressed what to do if a taxpayer did not reduce its wage expense on its income tax return when it filed for the ERC and the claim was paid in a subsequent year.

The FAQ says that the taxpayer is not required to file an amended return (or administrative adjustment request (AAR), if applicable) to address the overstated wage expenses. Instead, the taxpayer can include the overstated wage expense as gross income on its income tax return for the tax year in which it received the ERC. If a taxpayer received an ERC and did not reduce its wage expense for the year the wage expense was paid or incurred, the FAQ explains, the ERC claim and income tax return would be inconsistent, and the taxpayer may be claiming an unwarranted double benefit contrary to the tax benefit rule.

In FAQ 3, under Income tax and the ERC, the question addresses what to do if a taxpayer's ERC claim was disallowed and the taxpayer already reduced its wage expense by the expected amount of the ERC.

The FAQ says that a taxpayer may, in the year the claim disallowance is final (i.e., the disallowance is not being contested, or the taxpayer has exhausted its remedies), increase its wage expense on its income tax return by the same amount that it was reduced when the taxpayer made the claim. Alternatively, the taxpayer may file an amended return, AAR, or protective claim for refund to deduct the wage expense for the year in which the ERC was claimed.

Implications

Employers that have not reduced their wage deduction should consider the revised approach of adding the credit to gross income in the year the ERC refund is received, especially if the statute of limitations on the income tax return has expired. For many taxpayers, this is welcome news as it gives a path forward with the delayed processing of ERC claims.

For employers that have already reduced their salary and wage deduction, no additional steps are necessary when the refund is processed. Should the claim be disallowed in the future, employers can increase their wage deduction in the year of disallowance.

The new FAQs do raise questions as they are contrary to previous guidance indicating that the reduction of the wage deduction should occur in the year for which the credit is determined. Further, although online FAQs generally are not considered authoritative, they do provide taxpayers with insight into the enforcement positions the IRS can be expected to take. In particular, it is notable that the IRS's interpretation in the FAQs relies on the interaction between general tax principles and the ERC's specific statutory rules. Employers must carefully consider their options based on their facts and circumstances, anticipated wait time for refund processing and if the option to amend the income tax return is still possible.