Running a business means balancing operations, employee satisfaction, and tax compliance. During the COVID-19 pandemic, one key relief measure was the Employee Retention Credit (ERC), designed to help businesses retain employees during shutdowns or revenue declines.
Now that the pandemic is over and the ERC program has officially ended, many businesses are asking: “Is the Employee Retention Credit taxable for businesses?” Understanding this is crucial because while the ERC itself isn’t taxable income, it does affect how businesses calculate their deductions and taxable income.
What Was the Employee Retention Credit (ERC)?
The ERC was introduced under the CARES Act of 2020 to incentivize businesses to keep employees on payroll during the pandemic. Its main features included:
- Refundable Tax Credit: Applied against certain payroll taxes.
- Eligible Wages: Covered qualified wages and health insurance costs.
- Credit Amount: Could reach up to $26,000 per employee across 2020 and 2021.
- Non-repayable: Unlike loans, the ERC did not require repayment, making it a valuable relief tool.
What Happened to the ERC After COVID?
The ERC was temporary and applied to wages paid in 2020 and the first three quarters of 2021 (Q1–Q3). The program ended after Q3 2021, but businesses could initially claim the credit retroactively by filing amended payroll tax returns (Form 941-X) within the statute of limitations.
Important Update for 2025:
- The deadline to claim ERC for 2021 wages was April 15, 2025.
- As of now, that filing window has passed. Businesses can no longer submit retroactive ERC claims for 2021 wages.
This makes the ERC a historical program, but understanding its tax treatment remains important for proper reporting and compliance.
Is the ERC Taxable?
The Employee Retention Credit is not taxable income at the federal level. However, there’s an important nuance: businesses that claim the ERC must reduce their wage expense deductions by the amount of the credit.
This prevents a “double benefit” where a business would deduct wages and also claim a credit for the same wages. In effect, this can increase your taxable income, even though the credit itself isn’t taxed.
Example:
- A company paid $100,000 in wages in 2021 and received a $20,000 ERC.
- Without ERC: The company deducts the full $100,000.
- With ERC: Deduction must be reduced by $20,000, leaving $80,000 deductible.
So, while the $20,000 credit isn’t taxed directly, taxable income is effectively higher due to the reduced deduction.
To know more about whether Third-Party Sick Pay Taxable in PA, do read our in-depth blog.
Other Important Considerations
- Timing of Wage Deductions: If the ERC was claimed, wage deductions must be adjusted for the year the wages were originally paid, even if the credit was received later.
- Interaction with Other Relief Programs: Wages used to claim the ERC cannot also be used for PPP loan forgiveness or other payroll-based credits. Documentation is critical to avoid overlap.
- State Tax Treatment: Most states follow federal rules, but some may treat ERC deductions differently. Employers should check state-specific guidance.
- IRS Scrutiny and Scams: The IRS monitors ERC claims closely. Many unqualified “ERC consulting” services have targeted businesses. Submitting ineligible claims could result in audits, penalties, and repayment obligations.
Pros and Cons of the ERC (Looking Back)
Even though the program has ended, reviewing its benefits and limitations is useful:
Pros:
- Provided significant financial relief (up to $26,000 per employee)
- Refundable credit, not a loan
- Encouraged businesses to retain employees during a crisis
Cons:
- Reduced wage deductions, potentially increasing taxable income
- Complex eligibility rules
- Required careful documentation
- Subject to IRS review/audit if claimed improperly
Conclusion
The Employee Retention Credit was a critical tool that helped businesses navigate the uncertainty of the COVID-19 pandemic. While the program officially ended and the deadline for retroactive claims has now passed, understanding how it affects taxable income remains important for proper reporting.
To summarize: the ERC itself is not taxable, but it reduces deductible wages, which can increase taxable income. Employers must account for this when filing returns and ensure historical claims are accurately reported.
Even though businesses can no longer claim the ERC for 2021 wages, proper documentation and awareness of its tax effects are essential for compliance and for avoiding future IRS adjustments.To stay updated on such workforce strategies, HR professionals can explore Compliance Prime’s expert human resources webinars for practical insights and guidance.
