IRS Rules on ERC and Amending Tax Returns
C. Timing of Qualified Wages Deduction Disallowance
Section 2301(e) of the CARES Act, as explained in section III.L. of Notice 2021-20, and section 3134(e) of the Code provide the general rule that an employer’s deduction for qualified wages, including qualified health plan expenses, is reduced by the amount of the employee retention credit. The Treasury Department and the IRS have been asked about the timing of the reduction, specifically in the circumstance in which a taxpayer files an adjusted employment tax return to claim the employee retention credit for prior calendar quarters and has already filed a federal income tax return for the tax year in which the credit is claimed on the adjusted return.
Under section III.L. of Notice 2021-20, a reduction in the amount of the deduction allowed for qualified wages, including qualified health plan expenses, caused by receipt of the employee retention credit occurs for the tax year in which the qualified wages were paid or incurred. When a taxpayer claims the employee retention credit because of the retroactive amendment of section 2301 of the CARES Act by section 206(c) of the Relief Act (relating to eligibility of PPP borrowers to claim the employee retention credit) or otherwise files an adjusted employment tax return to claim the employee retention credit, the taxpayer should file an amended federal income tax return or administrative adjustment request (AAR), if applicable, for the taxable year in which the qualified wages were paid or incurred to correct any overstated deduction taken with respect to those same wages on the original federal tax return. Section 2301(e) generally provides, in relevant part, that rules similar to the rules of section 280C(a) of the Code shall apply. Section 280C(a) requires tracing to the specific wages generating the applicable credit. See, generally, Treas. Reg. § 1.280C-1. To satisfy this tracing requirement, the taxpayer must file an amended return or AAR, as applicable.