Business Finance

Is the Employee Retention Credit Taxable Income?

Nov 30, 2022 • 5 min read
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      If you were in business when COVID-19 began, you may be eligible for the Employee Retention Credit (ERC). Introduced in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), the ERC offers a payroll tax credit for wages and health insurance that were paid to employees during that time. 

      Despite the fact that the Infrastructure Investment and Jobs Act of 2021 ended this program, qualifying businesses can still claim the ERC for up to five years retroactively. One of the most common questions about the ERC is whether it’s considered taxable income. Keep reading to find out.

      What is the ERC?

      First and foremost, let’s dive deeper into what the ERC actually is. Put simply, the ERC is a refundable payroll tax credit. It was designed to incentivize employers to keep their employees on payroll during the pandemic. As long as you’re an eligible business, you can receive as much as 50% up to $10,000 in qualified wages per employee or up to $5,000 per employee for 2020 and 70% of up to $10,000 in qualified wages per employee for each qualifying quarter (Q1-Q3) or up to $21,000 per employee total for 2021.

      Is the ERC Taxable Income?

      Now it’s time to discuss one of the most common ERC questions: Is the tax credit taxable income? The answer is yes and no. 

      As a business who acts as an employer, the credit you receive from the government through the ERC is not included as gross income in your federal income taxes.

      It does, however, reduce the amount of wages or salaries expenses you can claim as a deduction in your income tax return by the amount you qualified for through the ERC. This increases your taxable income by the amount of the credit for the time period you qualified for the ERC. Any changes made to your income tax return will be done retroactively. 

      For example, if an employer paid $100,000 in wages in 2020 and received an ERC of $40,000, the employer would report an expense of $60,000 in wages on their business tax return rather than the full $100,000.

      Difference Between a Tax and Refund

      It’s important to understand that the ERC is not considered a tax. Instead, it’s a refundable tax credit for qualifying employee wages. For 2020, your business can lock in up to $5,000 per employee. The maximum credit per employee in 2021 is $21,000.

      Since the ERC is a payroll tax credit not an income tax credit, you can still receive an ERC credit even if you paid no income tax in the year you qualified. Additionally, because the credit is refundable, you can receive a refund above and beyond what you originally paid in payroll taxes for the time periods you qualify for.

      For example, if you qualify for a $30,000 ERC credit, but only paid $10,000 in payroll taxes, you would still receive the full amount of $30,000.

      How much money you can qualify for each year from the ERC

      Am I Eligible for the ERC?

      If your business faced partial or full shutdowns as a result of government orders during COVID-19, you may qualify for the ERC. 

      To calculate the ERC, you’ll need to use the qualifying wages you pay your employees during their eligible employer status. Keep in mind that since ERC is a refundable tax credit you may receive a refund in excess of your original tax liability.

      What Happens If I Never Applied for ERC?

      You might be wondering what your options are if you never applied for the ERC. Since the ERC filing period has passed, you must file an amended return using Form 941-X to claim any credits you may be eligible for.

       Expiration dates for filing amended payroll tax forms for ERC are as follows: April 2024 for 2020 941 payroll tax filings and April 2025 for 2021 941 payroll tax filings. Rest assured, if you didn’t apply for the ERC, you can still do so. Simply amend the return for every quarter in 2020 and 2021 where you meet the criteria for ERC. It’s in your best interest to reach out to a tax professional to help you out. They can help you avoid a denial or delay.

      Bottom Line

      The ERC is a valuable tax credit you may claim for keeping your employees on your payroll during the COVID-19 pandemic. While it’s not included in gross income for employees, it is subject to expense disallowance rules. Therefore, your wage deduction as an employer will be reduced by your ERC amount which could result in taxable income. If the business wasn’t profitable even after the change it would not cause an increased tax burden.

      About the author
      Anna Baluch

      Anna Baluch is a freelance personal finance writer from Cleveland, Ohio. You can find her work on sites like The Balance, Freedom Debt Relief, LendingTree and RateGenius. Anna has an MBA in marketing from Roosevelt University.

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