24 Mar 2025

New IRS Guidance on ERTC Refunds

Roger Rossmeisl, CPA
Automotive, Current Events, Small Business Tax Briefs
New IRS Guidance on ERTC Refunds
On March 21, 2025, the IRS released updated FAQs and guidance that introduce a new process for taxpayers dealing with Employee Retention Tax Credit (ERTC) refunds, particularly when those refunds relate to wages paid in prior tax years like 2020 or 2021. This update aims to simplify reporting requirements and provide clarity for taxpayers who either received ERTC refunds or had their claims disallowed. Here’s a breakdown of what this means for you and how to handle your tax filings moving forward.
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Background on ERTC and Wage Expenses
The Employee Retention Credit, introduced as part of COVID-19 relief measures, allowed eligible businesses to claim a credit for qualified wages paid to employees. However, claiming the ERTC comes with a catch: taxpayers are generally required to reduce their wage expense deduction on their income tax return for the year the wages were paid. This adjustment reflects the fact that the ERTC acts as a reimbursement, and you can’t deduct expenses you expect to be reimbursed for, as outlined in IRS Notice 2021-20.
But what happens if you didn’t adjust your wage expense when you claimed the ERTC—or if your ERTC claim was denied after you already reduced your deduction? The IRS’s latest guidance addresses these scenarios with practical solutions.
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New Rules for ERTC Refunds Received
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If you received an ERTC refund in a later year (say, 2024) for wages paid in a prior year (like 2021), and you didn’t file an amended return to reduce your wage expense for that prior year, the IRS now offers a streamlined approach:
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  • For Closed Tax Years: If the tax year in question (e.g., 2021) is closed—meaning the statute of limitations for amending it has expired—you don’t need to go back and amend that return. Instead, you must include the overstated wage expense (the amount you didn’t reduce) as gross income on your tax return for the year you received the refund (e.g., 2024). For example, if your business claimed a $700 ERTC based on $1,000 in 2021 wages but didn’t adjust your 2021 return, and you received the refund in 2024, you’d report that $700 as income on your 2024 return. This approach leverages the tax benefit rule to correct the double benefit you might have received.
  • For Open Tax Years: If the prior year is still open, you have options. You can file an amended return, administrative adjustment request (AAR), or protective claim for refund to properly deduct the wage expense for the year the ERTC was claimed. Alternatively, you can simply report the refund as income in the year you received it, avoiding the need to amend prior returns.
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This guidance is a game-changer for taxpayers who previously filed amended returns for closed years and paid additional taxes, only to have the IRS refund those payments because the year was no longer adjustable. Now, you can cash those refund checks without worry and use the funds to offset taxes owed when you report the ERTC refund as income.
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Relief for Disallowed ERTC Claims
On the flip side, if you reduced your wage expense expecting an ERTC payout that was later disallowed, the IRS has you covered too. Once the disallowance is final (i.e., you’re not contesting it or have exhausted appeals), you can:
  • Increase your wage expense on your income tax return for the year the disallowance becomes final (e.g., 2024 for a 2021 claim). For instance, if your business cut its 2021 wage expense by $1,000 expecting an ERTC that was denied in 2024, you can add that $1,000 back as a deduction on your 2024 return.
  • Alternatively, file an amended return or AAR for the original year (if still possible) to reclaim the deduction.
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This flexibility eliminates the pressure to file protective claims for years nearing the amendment deadline and provides relief for closed years where the statute of limitations has expired.

Penalty Relief Still Available
The IRS continues to emphasize that penalty relief remains available for taxpayers navigating these ERC-related adjustments, as noted in news release IR-2022-89. This is welcome news for businesses working to comply with these evolving rules in good faith.

Why This Matters
These updates reflect a practical approach to a complex issue. The ERTC’s “special statutory rules” (like Section 2301(e) of the CARES Act and Section 3134(e) of the Internal Revenue Code) treat the credit as a reasonable expectation of reimbursement, which impacts how and when wage expenses can be deducted. By allowing adjustments in the year of refund or disallowance, the IRS is reducing the administrative burden and offering taxpayers more flexibility—especially for closed tax years.

What Should You Do Next?
  • Check Your Records: Review your ERTC claims and tax returns to see if you adjusted your wage expenses correctly when you filed for the credit.
  • Assess Your Situation: Did you receive a refund for a closed year without amending? Or was your claim disallowed after reducing your deduction? Identify which scenario applies to you.
  • Plan Your Filing: For 2024 returns (or beyond), ensure you report ERTC refunds as income or adjust disallowed claims per the new guidance. Consult your tax professional to confirm the best approach, especially if capitalized wages or other adjustments are involved.
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The IRS’s updated FAQs (available at www.irs.gov/coronavirus/frequently-asked-questions-about-the-employee-retention-credit#incometax) provide detailed examples and further clarification. With these new procedures, taxpayers can resolve ERTC-related tax issues more efficiently—and with less stress.
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(This is Blog Post # 1719)
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