The Employee Retention Credit: Income Tax Issues
You may recall navigating the PPP loan and how it wound being basically free money in that you did not have to pay income taxes on it to the extent it was used for approved expenses. With the Employee Retention Credit is important to know that the ERC is not tax free money as the PPP loans were. The credits are subject to income tax. But there is a matching component where the income from the credit must be recognized in the same year as the wages were report for which the credit was calculated. It is technically shown on the business tax return as a reduction in wages for that period. For a credit that you received based on qualified wages from 2020 the proceeds from the Employee Retention Credit must be recognized as income on the income tax return for that business in the same year as the qualified wages, 2020 in this example.
If you get the Employee Retention Credit based on 2020 qualified wages and the 2020 income tax return for that business was prepared years ago. Now those business income tax returns need to be amended to show the Credit as an increase in taxable income in for that year. If the business entity is a pass through entity then the members or shareholders of that entity will also need to amend their personal income tax returns for that year as well.
It is complicated and as you may know that is what the CPA Superhero does. But not only is the ERC complicated, but explaining it to business owners is complicated and I have been taken aback by the emotions involved for business owners in processing how this credit works.
I have mentioned the need to amend income tax returns and consider what happens if you amend for example a 2020 income tax return that results in adding income and income taxes. Could there be penalties for underpayment of tax? Of course, but why? That is the way it is but it is not right because you did not receive that money in 2020 in this case. You are receiving the money now perhaps in 2022 and it results in an increase in your taxable income for 2020 and thus the possible penalties for late payment.
Why should someone pay a penalty for underpayment of taxes on the credit that they may not have received yet or if they have they just received it and did not get it in the tax year 2020. I know, I know, this is ridiculous. A year ago when we were working through how this worked it was hoped that it would be changed so that the income from the credits could be reported in the year they were received rather than matching them up with the year the qualified wages were reported like for 2020. That change has not come, must to our frustration. But that is the reality.
Back a year ago when we in the CPA community were trying to figure out strategy for the income tax piece of this, many CPAs were proposing that we wait to amend the income tax return until the credits were actually received. Part of the rational was that would be easier for the taxpayer to swallow rather than paying tax on money they have in many cases not yet received.
Now to throw a fly into the ointment, the IRS has alluded to abating the late payment penalties for receiving the ERC as long as they can show reasonable cause and not willfully neglect to pay the taxes. Here is the exact wording from the IRS release:
This release reminds taxpayers that, consistent with the relief from penalties for failure to timely pay noted in Notice 2021-49, they may be eligible for relief from penalties for failing to pay their taxes if they can show reasonable cause and not willful neglect for the failure to pay.
But not so fast. We will have to see how this plays out. But why CPA Superhero? A couple of reasons. First, the IRS statement refers to penalty relief but in the context for employers. Sure if a business gets the credit they can get penalty relief but most of my clients businesses won't be subject to income tax because their businesses are pass through entities and they will personally be paying the income taxes and not the businesses. I assume the penalty relief will flow through to the partners/shareholders just as the income does, but I can't be 100% certain. Yet.
This gets even more complicated because of reasonable cause and willfulness. Recall, a common idea among CPAs was to wait and file the amended income tax returns after the credits were received. Now is that the best strategy? Could that put reasonable and willfulness into question? It seems that obtaining relief from late payment penalties could be significant. That is the penalties could be significant. Because of the wording of the IRS release now the some in the CPA community are thinking it might be better to file amended income tax returns sooner to avoid being perceived as willfully neglecting to pay the increased income taxes even though you haven't actually received the money for the credit yet. At the very least this is something to be discussed by the taxpayer with his or her CPA.
If the income tax returns are amended before receiving the credit what about the hardship of paying those taxes. I get it and I don't like it. I don't think the intent was for taxpayers to pay taxes on money they have not yet received. But my feelings may not be relevant. Adding to this issue is the IRS's difficulties with processing the amended payroll returns which have to be mailed in and processed to obtain the ERC. I have to think it should be understandable that the payment of the additional taxes on the income from the credits should be born by the taxpayer after they receive the credits. But it may not work that way. Additionally, I understand to receive abatement of the late payment penalties will require a request be sent to IRS after those penalties have been assessed.
Is it worth it?
The answer in most cases is yes. But the business owners need to know how much their credits will be. They need to know what the fees will be for applying for the credits. They need to have an idea of how much income tax they will pay which should basically be their marginal tax rate times the amount of the credits. Then they need to know the IRS will likely assess late payment penalties but they can probably be abated but that will require their CPAs to write to the IRS to request the abatement which will likely mean more fees to be paid to the CPAs. So what could a taxpayer(s) be looking at? Let's assume the Employee Retention Credits for their business will be $500,000. They would receive the $500,000 plus interest. They would pay for the service to apply for the credits. Then they would pay the income taxes on the $500,000 in credits, for example, and let's say the taxpayers have a 30% marginal tax rate. The income taxes on the credits would be $150,000. Assuming the penalties are abated the taxpayers would net about $350,000 less the CPA fees.
Is that worth it? That would be roughly $350,000 that they don't have now and could receive that in a number of months depending on the IRS and then pay the income taxes to get to the net of roughly $350,000. I have my clients pay my fees for preparing the amended payroll tax reports to get the credits before they are mailed in. So they are looking at a small investment that will payoff in five to eight months or so (but I have now had a client receive their credits in four months. So the IRS is getting faster at processing these). The first one I did for a restaurant, the business received a quarter of a million dollars in ERCs within eight months. Now I am amending the income tax returns and handling the accounting issues so the ERCs are not taxed twice. The return on investment for this client was about 1350% on an annualized basis. I don't know, you tell me, is it worth it?
How Did I Get Into This?
My first client that asked me about the ERC insisted I help him because he thought it could mean a lot of money for him and his business and he was right. But at first they did not qualify because they had taken out a PPP loan. But then the legislation changed and the client qualified even though they had PPP loans. I still did not want to do it because I don't do payroll and the ERC is really complicated. His payroll person did not want to do it either so he continued to pester me about it until I relented but I told him he would pay me handsomely. It was complicated but after taking some classes, reading the legislation, and figuring out how to file the amended payroll tax returns by reading the instructions I figured it out. He now has his money, over a quarter of a million dollars, plus interest and he has told others about it. Not surprisingly most CPAs don't want to touch this. I did not want to either, because it is enough just to keep up with the income tax code and the changes recently have been significant. Additionally, the work life balance for CPAs that prepare income tax returns seems to have been changed permanently and not for the better.
Of course this, The Employee Retention Credit, is a government credit for which the requirements and related issues are continuing to evolve. I keep with up changes and stay in the loop with other professionals involved in this area of expertise to make sure I can provide top quality service to my clients.
Now that I have done the legwork to become competent in applying for the ERC I can help you to apply for the credits. I will also work with your CPA to help them understand the issues mentioned above and let them benefit from my experience with these issues.
If you are a CPA with clients that may qualify but you don't want to mess with the ERC then you should use my contact information below to setup an appointment. I am not taking on anymore income tax clients now that I have gotten busy with the ERC. The only work I will take on is work doing the Employee Retention Credit.
This credit can be a substantial game changer for businesses. Restaurants especially need the help this credit can provide. If you would like help in obtaining the credit why not ask someone who both has done it and also understands these various issues. For my assistance to help you claim the Employee Retention Tax Credit use my email address below to contact me and make an appointment to discuss your situation.
jeff.jhtaxes@gmail.com
The Employee Retention Credit Posts:
Be careful when reading about tax law and its application, including my articles, because the wording and definitions are such a challenge and are influenced by writers perspective, specifically his own clients situations that he is mindful of and other situations the writer is not thinking of. The point is talk to your CPA about your situation and circumstances and don't rely on or make conclusions based on articles you read, including articles form irs.gov, because concepts and definitions are not very clear, and of course, they are subject to change. Now is the time to be having discussions about your situation and developing strategies for you and your business. Again, contact me using my information above to discuss your situation. I help business owners all over the U.S. and in foreign countries with their tax returns
