Question: Larry is a long-time tax professional who, after hearing all the advertising hype regarding employee retention credit (ERC) refunds, has determined that one of his clients qualified for the ERC in both 2020 and 2021. The client is an S corporation, which kept its employees on the payroll during the qualifying time frame and met the other requirements for claiming the credit. Therefore, Larry plans to claim the ERC for his client. His question is: When is the ERC claimed? Is it when the money is received or is it claimed on the amended returns for the tax periods in which the ERC credit applies?
Answer: Larry will claim the ERC on amended tax returns for the tax periods in which the ERC applies and the client qualifies. ERC claims are made via filing Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund. The entity’s tax returns for the period being claimed must be amended to reflect the ERC as a reduction in payroll expense [Notice 2021-20; Notice 2021-49].
Claiming the ERC for 2020 and/or 2021 requires the filing of amended Forms 1120-S U.S. Income Tax Return for an S Corporation, which will decrease the payroll expense by the amount of the calculated ERC. The amended Forms 1120-S will then report an increase in the net profit (or a reduction in an originally reported net loss), causing amendments to the Schedules K-1, Shareholder’s Share of Income, Deductions, Credits, provided to each of the shareholders for the years the ERC is claimed.
Issuing amended Schedules K-1 will also require each of the shareholders to amend their personal Forms 1040, U.S. Individual Income Tax Return, for both 2020 and 2021. Filing these amended Forms 1040 will likely result in additional tax due since the originally reported net profit will be increased or an originally reported loss will have been reduced. It’s likely the IRS will assess interest to these same shareholders for the increased tax owed. While we recommend filing an appeal of these assessments, it’s unclear whether the IRS will consider these explanations as reasonable cause.
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Information included in this article is accurate as of the publish date. This post is not reflective of tax law changes or IRS guidance that may have occurred after the date of publishing. All taxpayer circumstances are different, and NATP recommends contacting research services if you have specific questions about your clients’ tax situations.