Understanding the Basics
The Employee Retention Credit (ERC) has been a crucial financial aid for many businesses during challenging economic times. However, once you’ve obtained this benefit, it’s essential to know how to report it correctly on both federal and state tax returns. This article aims to simplify these procedures and highlight the distinctions between federal and California state requirements.
Federal Reporting as per IRS Notice 2021-20
When it comes to federal tax filings, the impact of the ERC is significant. Per IRS Notice 2021-20, if your business has received an ERC refund, it is mandatory to adjust your wage expenses. Specifically, you should reduce your wage expense by the amount of the ERC refund when filing your income tax returns for the year you received the refund. This adjustment is crucial as it accurately reflects your taxable income after receiving the credit. This means you’ll be amending you business taxes for the applicable ERC year and your individual returns if your business is a pass-through entity.
Updates at the State Level: California’s Approach
California offers a more lenient approach to ERC refunds. According to the California Franchise Tax Board (FTB), businesses claiming the ERC aren’t required to include the refundable portion of the credit in their state income tax return. Additionally, there’s no need to reduce the amount of deductible wages for state tax purposes. However, remember that these rules are specific to California, and other states may have different regulations. Always consult with a tax professional for state-specific guidance.
Requesting Penalty Relief
Adjusting your wage deduction to account for the ERC can lead to an increase in taxable income, potentially resulting in penalties or interest charges. The IRS may not automatically provide relief for these penalties, but they’re open to considering abatement for underpayments if there’s a “reasonable cause.” Notably, the IRS grants interest on ERC refunds related to the claimed credit periods. This interest is typically set to offset any interest charges due on the additional income tax resulting from the credit.
Moreover, adjustments in tax obligations due to amended returns can trigger late payment penalties. However, under specific conditions outlined in IRS News Release IR-2022-89, these penalties may be waived. Understanding these conditions is vital to avoid unnecessary charges.
Key Takeaways
1. Federal Reporting**: Reduce wage expense by the ERC refund amount on federal tax returns.
2. California State Reporting**: No need to include the ERC refund or adjust wage deductions on state returns.
3. Penalty Relief**: Possible abatement of penalties and interest for reasonable cause; understand IRS conditions for waiver.
Final Thoughts
Navigating the complexities of Employee Retention Credit refunds can be challenging. It’s imperative for businesses and their pass-through members or shareholders to understand these nuances both at the federal and state levels, especially in California. Staying informed and consulting with tax professionals can ensure compliance and minimize financial surprises during tax season.
