On March 21, 2025, the IRS announced a new procedure on how to report Employee Retention Credit (ERC) refunds related to wages from prior tax years. This announcement affects thousands of taxpayers and practitioners who have received or are expecting ERC refunds.
What’s New: IRS Procedure for Unamended ERC Refunds
The IRS has created a new reporting procedure for taxpayers who received ERC refunds but have not amended their original income tax returns to reduce overstated wages from tax years 2020 and/or 2021.
There was originally confusion from taxpayers about how to treat these refunds—especially when the statute of limitations had closed for the original tax year. Now, the IRS confirms:
- If the original tax year is closed (e.g., 2020 or 2021), and an ERC refund is received in a later year (e.g., 2024), the taxpayer must include the amount of overstated wage expense as income in the year the refund is received.
- Example: A taxpayer receives an ERC refund in 2024 related to wages paid in 2021. Because the 2021 tax year is closed, they should report the equivalent wage amount as gross income on their 2024 return.
This method ensures the government recaptures the tax benefit from the initial wage deduction without requiring amendments to closed-year tax returns.
Penalty Relief Still Available
Importantly, the IRS announced that taxpayers who fall under this new requirement may still qualify for penalty relief, originally outlined in IR-2022-89, provided they make a good-faith effort to comply with the tax law.
Open Tax Years: More Flexibility
If the tax year in which the wages were paid is still open, taxpayers have two options:
- File an amended return, administrative adjustment request (AAR), or a protective claim for refund to properly reduce the wage expense in that year; OR
- Elect to report the refund as gross income in the year it is received—similar to the treatment for closed years.
This gives taxpayers and advisors flexibility depending on the situation and strategic tax positioning.
What About Taxpayers Who Already Sent Payments for Closed Years?
Many taxpayers attempted to do the right thing by filing amended returns and sending tax payments for closed years—only to have the IRS return those payments because the statute had expired.
Now clarified: These taxpayers can cash any returned refund checks and use those funds to pay any tax liabilities that result from reporting the ERC refund as income in the current year. This removes uncertainty for those who have been stuck in limbo.
ERC Claims That Were Disallowed
The IRS also addressed situations in which an ERC claim was disallowed after a taxpayer had already reduced their wage expense in the original return. In these cases:
- Taxpayers may now increase their wage expense on their tax return in the year the ERC disallowance becomes final, restoring the deduction that was previously reduced due to the ERC claim.
This guidance ensures that taxpayers are not penalized by losing out on the deduction when their ERC claim is ultimately rejected.
Bottom Line
The new IRS guidance clears up any longstanding confusion around ERC refund reporting and provides fair procedures for both open and closed tax years.
🔗 Full IRS FAQ: Employee Retention Credit – Income Tax Reporting