IRS Changes Course: What You Need to Know Now About the Income Tax Treatment of ERC Refund Claims

On March 20, 2025, the IRS released new guidance that marks a sharp departure from the position it has maintained since the Employee Retention Credit (ERC) program launched five years ago. The IRS has updated the ERC FAQs found on its website. Here’s what you should know about these changes.

Before this latest guidance, taxpayers were required to report the ERC refund claim as a reduction in wage expense in the year the ERC was earned — either 2020 or 2021. This adjustment could be made on either the original return or an amended return for those years, as outlined in previous IRS guidance. As a result, taxpayers had to include the ERC refund amount in their taxable income (through a reduced wage deduction), even if the refund had not yet been received.

In updated IRS FAQs released on March 20, 2025, the IRS introduced an additional option. Taxpayers who have not yet adjusted their wage expense for an ERC claim now can make that adjustment and include in taxable income in the tax year the ERC refund is actually received. The updated guidance states: “Instead, you can include the overstated wage expense amount as gross income on your income tax return for the tax year when you received the ERC.”

This is a welcome change — one that many taxpayers and practitioners had hoped for sooner, as it would have eliminated the need to amend prior tax returns and deal with the resulting IRS notices.

Another notable change in the updated IRS FAQs addresses ERC refunds disallowed by the IRS. Typically, after filing an ERC claim, taxpayers would adjust wages on their originally filed or amended 2020 or 2021 returns and then wait for the refund. However, if the IRS later disallowed the claim, sometimes one to two years after filing, taxpayers were forced to amend those prior returns. Under the new guidance, taxpayers now have a choice:

“If the ERC was disallowed and you reduced the wage expense on your income tax return for the year the ERC was claimed, you may, in the year your claim disallowance is final (meaning you are not contesting the disallowance or you have exhausted your remedies to argue against the disallowance), increase your wage expense on your income tax return by the same amount that it was reduced when you made your claim. Alternatively, you may, but are not required to, file an amended return, AAR, or protective claim for refund to deduct your wage expense for the year in which the ERC was claimed.”

We’ve provided an ERC chart summarizing the latest changes outlined in the updated FAQs.

ERC Refund Claim Status

Notes:

1. Source – IRS Website. FAQs on Employee Retention Credit (ERC): https://www.irs.gov/coronavirus/frequently-asked-questions-about-the-employee-retention-credit
2. Situations Highlighted Above in Yellow, were Addressed by IRS in Revisions on IRS Website on March 20, 2025
3. The Updated Tax Treatment With ERC Made by the IRS on March 20, 2025, on its Website, Differs Significantly from What the IRS Stated in IRS Notice 2021-20 and Notice 2021-49.
4. The above ERC chart does not reflect the impact of amending a prior tax return and generating interest on an overpayment. Taxpayers should consider the impact of interest with an amended return in situations: (1) where they have not yet received an ERC payment, and/or (2) filed/amended a prior year return for ERC that was subsequently disallowed by the IRS. Given the new IRS guidance that allows for taxpayers to report the impact of ERC disallowance in the year of occurrence, amending a prior year’s tax return may be the more prudent option in some cases.

Here are a few additional considerations based on the IRS’s new guidance regarding the income tax treatment of ERC:

• As mentioned above, if an ERC filer’s refund claim is disallowed, they now have the flexibility to choose when to claim the deduction for the disallowed amount they must repay. While it may be more straightforward to take the deduction in the year the repayment is made, filing an amended return for the prior year could result in the taxpayer receiving interest on the overpaid tax tied to the disallowed ERC for several years.
• If there have been ownership changes in the business since 2020 or 2021, determining when to recognize adjustments due to receipt or disallowance of an ERC claim requires careful evaluation. This is something that should be discussed between the owners and their advisors.
• In cases where a business has been sold and ERC refund claims were either still pending with the IRS at the time of sale or not yet reported for income tax purposes, complex tax and legal issues arise. It is essential to consult both tax and legal professionals to navigate these situations.

These points address the most recent IRS changes regarding the tax treatment of ERC claims. However, plenty of nuances and timing issues remain around ERC claims and statutory deadlines that still require careful attention.

Sikich’s ERC professionals are available to discuss your situation and can assist as necessary.

About Our Authors

Tom Bayer, CPA, CExP, has specialized expertise in the areas of business succession planning, tax planning and compliance, and business advisory. He has deep experience providing a range of accounting, tax, and business advisory services to commercial clients across industries.

Jim Brandenburg, CPA, MST, possesses extensive experience and knowledge in corporate and partnership tax law, mergers and acquisitions, and tax legislation. His expertise includes working with owners of closely held businesses to identify tax planning opportunities and assist them in implementing these strategies.