How ERTC Affects Your Business Taxes: What You Need to Know

The Employee Retention Tax Credit (ERTC) has been a lifeline for thousands of businesses navigating financial challenges during the COVID-19 pandemic. While many businesses have already claimed or plan to claim the ERTC, one critical question remains — how does ERTC impact your business taxes?

Understanding the tax implications of the ERTC is essential to ensure your business stays compliant with IRS rules, avoids penalties, and accurately reflects credits on your tax returns. In this article, we’ll explain how the ERTC affects your taxes, what adjustments you need to make, and how to stay ahead of IRS requirements.

1. Is the ERTC Taxable Income?

Technically, the ERTC is not classified as taxable income, but it does impact your business’s taxable income indirectly.

✅ Here’s how it works:

• ERTC reduces the amount of deductible wages you can claim on your business tax return.

• Since the ERTC provides a payroll tax credit, you must reduce your payroll expense deduction by the amount of the credit.

• This reduction increases your taxable income, leading to a potential increase in your income tax liability.

💡 Important: Many businesses mistakenly think ERTC is a “tax-free bonus” — but because it reduces deductible expenses, it indirectly increases taxable profits.

2. Reporting the ERTC on Your Tax Return

The ERTC does not directly show up on your income tax return, but its impact is felt through reduced payroll expenses on forms like:

• Form 1120 (for corporations)

• Form 1065 (for partnerships)

• Schedule C (for sole proprietors)

The IRS requires you to reduce your wage deduction by the amount of ERTC claimed when preparing your income tax return.

Example:

If your total wages were $500,000 but you received $80,000 in ERTC, you must report $420,000 as deductible wages on your tax return.

3. Timing Matters: When to Reflect ERTC on Taxes

The ERTC must be applied in the same tax year in which you qualified for the credit, even if you received the refund in a later year.

For example:

• If you claimed the ERTC for wages paid in 2020, you must adjust your 2020 tax return (even if you received the refund in 2022 or later).

• This may require you to amend past income tax returns if you didn’t originally reduce your wage deduction.

✅ Amended Payroll Tax Filings vs. Income Tax Filings

• ERTC is claimed by filing or amending Form 941 (quarterly payroll tax return).

• Income tax returns (Form 1120, 1065, Schedule C) must be adjusted separately.

4. How ERTC Affects Taxable Income

Since you are reducing deductible wages:

• Your net taxable income may be higher.

• This could result in increased income taxes for the year(s) affected.

💡 Key Insight: The cash refund from ERTC often far exceeds the extra income tax generated by reducing wage deductions — but you should plan for the added tax liability.

5. What If You Already Filed Your Income Tax Return Without Adjusting for ERTC?

If you received the ERTC after filing your income tax return for the applicable year, you may need to:

1. File an amended income tax return (Form 1120-X, 1065-X, or an amended Schedule C).

2. Correct your wage deduction.

3. Adjust your tax liability accordingly.

✅ Don’t Ignore This Step:

Failing to adjust your wage deduction could trigger IRS penalties or additional taxes during an audit.

6. ERTC and Estimated Taxes

If you expect to receive a large ERTC refund:

• Consider adjusting your estimated tax payments for the current year.

• The additional taxable income from reduced wage deductions could affect your quarterly estimated taxes.

Working with a tax professional can help you avoid surprises and plan for any cash flow impact from increased tax liabilities.

7. Best Practices to Stay Compliant

✅ Keep Thorough Records

Maintain documentation of:

• ERTC calculations

• Qualified wage reports

• Amended payroll tax filings (Form 941-X)

• Corresponding adjustments to income tax returns

✅ Work with a Tax Professional

Due to the complexity of coordinating:

• Payroll tax returns

• Income tax returns

• ERTC adjustments

It’s highly recommended to work with a CPA or enrolled agent to avoid compliance risks.

✅ Don’t Overlook Amended Returns

Even if you received your ERTC refund without adjusting your prior-year tax return, you are still obligated to file an amended return and correct your wage deduction.

ERTC’s Impact on Business Taxes is Manageable — If Handled Properly

While the ERTC has provided valuable relief, its impact on taxable income is often misunderstood. By understanding how it interacts with your business’s wage deductions, you can ensure:

• Accurate tax filings

• Avoidance of penalties or audits

• Proper planning for future tax liabilities

💡 Key Takeaways:

• ERTC is not taxable but does reduce deductible wages.

• You must adjust past or current tax returns if you received the ERTC.

• Missing adjustments could lead to penalties or IRS scrutiny.

• Professional guidance is recommended for compliance.

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