The IRS issued new guidance on how businesses will be able to handle the Employee Retention Credit (ERC) on income tax returns going forward. The update was released on March 20, 2025, and it offers clarity for businesses that received ERC refunds but have not amended their tax filings. It also addresses what to do if a refund was received and then later disallowed.
Background on ERC
The ERC was created during the pandemic to help employers keep workers on payroll during that time. It applied to qualified wages paid between March 13, 2020, and September 30, 2021, with a longer eligibility period for recovery startup businesses. Since the launch of the program, the IRS has received at least 3.6 million claims. However, enforcement efforts have ramped up as the IRS works through a backlog of submissions and investigates potential fraud and improper claims.
New Guidance, as of March 20, 2025
Businesses That Received ERC Refunds but Haven’t Amended Returns
One of the most common issues addressed in the update involves businesses that claimed the ERC and received the refund in a later year. Those business may not have amended original income tax returns to reduce wage expenses paid in those years. The IRS now says that businesses in this situation do not have to go back and amend a prior-year return.
Instead, they are instructed to report the ERC refund as gross income in the year the check was received. This adjustment corrects the previously overstated wage deduction. For example, if a business claimed the ERC for 2020 but received the refund in 2024 without reducing its 2020 wage expense, the ERC amount should be reported as income on the 2024 return.
This aligns with the tax benefit rule, which generally requires a taxpayer to include in income any previously deducted amount if a later event reveals that the original deduction was overstated. In other words, it gives the taxpayer a more straightforward way to resolve the mismatch without revisiting closed tax years.
When an ERC Refund Is Disallowed After Wage Expense Was Reduced
Another issue covered in the guidance involves businesses that reduced wage expenses on a prior-year return because they expected to receive the ERC, but their claim was later disallowed. The IRS now allows businesses to correct it by increasing the wage expense on the return for the year in which the disallowance becomes final.
For example, if a business filed its 2021 return with a reduced wage deduction with an expectation of receiving the ERC and the IRS later denied the claim in 2024, the business can increase the wage expense on the 2024 return. This is a potential solution for businesses that relied on good-faith expectations but are now facing an adjustment due to the disallowance of the credit.
The IRS also states that businesses may still amend the original return, assuming the deadline has not passed, if they prefer to correct the wage deduction in the year it was originally reported. However, amending is not required under this updated guidance.
Late Refunds and Closed Amendment Periods
Some businesses waited years for their ERC refunds to arrive. In many of those cases, the original credit was based on wages paid in 2020 or 2021, but the refund check didn’t come until 2024. However, the deadline to amend the original return had passed.
The IRS has now clarified how to handle this. If the wage expense wasn’t reduced at the time of filing, and it’s too late to go back and amend the return, the ERC amount can be reported as income in the year the refund is received. For example, a business that received a $700 refund in 2024 based on 2021 wages would include the $700 on its 2024 return. This allows the business to resolve the issue without reopening closed tax years.
Other Considerations
In some situations, businesses may have capitalized wage expenses instead of deducting them. For example, wages included in inventory costs or tied to asset basis may require different treatment. The IRS notes businesses in this position shouldn’t automatically report the ERC as income. Instead, they’ll need to adjust the underlying asset or inventory basis, which may also affect depreciation or cost of goods sold. The right treatment depends on how the wages were originally reported.
It’s also important to keep detailed records. Documentation related to the original ERC claim, wage expense calculations, and any follow-up adjustments should be retained in case of review. Since every situation is different, working with a tax professional can help ensure the reporting method aligns with the new guidance.
Looking Ahead
The IRS’s update provides direction for businesses dealing with ERC compliance issues. Small business owners will want to review the status of ERC claims and determine if additional reporting is required. For more information on applying these IRS updates to your situation, contact PBMares Tax Partner Charles Dean Smith, Jr.
