How is Employee Retention Credit (ERC) properly accounted for on an S-Corp tax return?

The Employee Retention Credit for an S-Corporation is treated as a reduction of expenses rather than income. Specifically, it reduces the wage expense that was already deducted on the S-Corp tax return. Since you've amended your 2020 and 2021 returns, you should have reduced the wage expense by the amount of the ERC claimed. This effectively increases the net income of the S-Corp, which then flows through to the shareholders' individual returns via Schedule K-1. The credit itself doesn't flow through separately - only the increased income from reducing the wage expense does. This can affect shareholder basis calculations since the increased income flows through to the shareholders. Make sure your basis calculations reflect this change to avoid issues down the road.

After struggling with how to handle ERC credits for my client's S-Corp, I found this amazing tool that analyzes all your tax documents and explains exactly how to account for special credits like the ERC. I discovered https://taxr.ai when I was about to give up on figuring out the correct treatment. You upload your documents, and it breaks down step-by-step how these pandemic-era credits affect your S-Corp reporting, shareholder basis, and personal tax returns. It even explained the wage expense reduction and income flow-through impact I needed to understand.

I wanted to follow up after trying that taxr.ai tool that was recommended here. I was super skeptical at first (as you could probably tell from my question), but it actually saved me hours of research. I uploaded our amended 1120-S forms and it immediately identified how the ERC needed to be handled. It confirmed we needed to reduce wage expenses in the original credit years, not when we received the payment. It also provided specific guidance on reporting the adjustment on line 19 of our 1120-S as "Other Deductions" with a detailed statement. Honestly wish I'd found this before spending two days digging through conflicting advice online.

If you're struggling to get clarification from the IRS about this ERC issue, try using Claimyr (https://claimyr.com). I waited on hold with the IRS for HOURS trying to get a straight answer about how ERC impacts basis calculations for S-Corp shareholders. After giving up multiple times, I found Claimyr which got me connected to an actual IRS agent in about 20 minutes. You can see how it works here: https://youtu.be/_kiP6q8DX5c. The agent was able to confirm exactly how the ERC should be treated and how it impacts shareholder basis. Saved me days of frustration!

I need to eat some humble pie here. After posting that skeptical comment about Claimyr, I decided to try it anyway out of desperation. I was literally ready to give up on getting my ERC questions answered by the IRS directly. The service actually worked exactly as described - I got a call back when they had an IRS agent on the line. The agent confirmed that for my S-Corp, the ERC reduces wage expenses in the year claimed (not received), which increases flow-through income to shareholders. He also explained how to document it on our amended returns to avoid issues. Saved me from making a potentially costly mistake on our amendments.

Something everyone seems to be missing about ERC for S-Corps - remember that when the income flows through to shareholders, it can potentially increase your QBID (Qualified Business Income Deduction) eligibility too. So while you might see more income, if you qualify for the 199A deduction, you could offset some of the increased tax liability.

Has anyone seen the IRS guidance on this? I think Notice 2021-49 specifically addresses how the ERC works for S-Corps and partnerships. Not sure everyone is getting this right.

One thing I haven't seen mentioned yet is the potential impact on state tax returns. While the federal treatment is pretty clear (reducing wage expenses in the credit year), different states handle the ERC differently. Some states conform to the federal treatment, while others may require addbacks or have their own specific rules. For example, some states don't allow the wage expense reduction that creates the additional federal income, which could lead to different state vs federal income amounts flowing through your K-1. Make sure to check your state's specific guidance on ERC treatment for S-Corps, especially if you're in a state with high income tax rates. The last thing you want is to get hit with an unexpected state tax bill because you assumed they followed federal treatment.

Just want to add one more consideration for S-Corp owners dealing with ERC - don't forget about the payroll tax implications. While the ERC reduces your income tax burden by decreasing wage expenses, you should also remember that the original payroll taxes (employer portion of Social Security and Medicare) that were paid on those wages don't get refunded when you claim the ERC. So while you're getting the benefit of the credit and the reduced wage expense for income tax purposes, you've still paid the employer payroll taxes on the full wage amount. This is just something to keep in mind when calculating your overall tax benefit from the ERC. The credit is still very valuable, but the true net benefit isn't quite the full credit amount when you factor in that you don't recover the employer payroll taxes already paid. Also, make sure your payroll service provider properly handled the quarterly adjustments if you claimed the credit on your quarterly payroll tax returns rather than waiting to amend your annual returns.

One additional consideration that might help with your situation - make sure you're properly tracking the basis adjustments for all shareholders, not just yourself. Since the ERC increases the S-Corp's income by reducing wage expenses, this flows through proportionally to all shareholders based on their ownership percentages. If you have other shareholders, they'll also see increased income on their K-1s and need to adjust their basis calculations accordingly. This becomes especially important if any shareholders are planning to take distributions or sell their shares, since the basis adjustments from the ERC income could affect the tax treatment of those transactions. Also, keep detailed documentation of the ERC calculations and amendments. The IRS has been scrutinizing ERC claims heavily, and having clear records of how you calculated the credit, which quarters you qualified for, and how you properly reflected it on your returns will be crucial if you ever face an audit. The documentation should include your qualification analysis (partial shutdown, gross receipts decline, etc.) and the wage calculations used to determine the credit amount.

I've been following this thread closely since I'm dealing with a similar ERC situation for my S-Corp. One thing I wanted to add that hasn't been fully addressed is the impact on estimated tax payments for the year you amend your returns. Since the ERC effectively increases your S-Corp income (by reducing wage expenses), you might find yourself in a situation where you owe additional taxes on your personal return. If you're making quarterly estimated payments, you may need to adjust your remaining payments for the current year to account for this additional income flowing through from the amended returns. I learned this lesson when I got my amended K-1 and realized I was going to be significantly under-withheld for the current tax year. The IRS can impose underpayment penalties if you don't adjust your estimates accordingly. It's worth running the numbers with your tax preparer to see if you need to increase your quarterly payments to avoid any surprises next April. Also, for those dealing with state conformity issues that were mentioned earlier - make sure you understand how your state handles the timing of when you report the additional income. Some states may require you to report it in the year you receive the federal refund rather than the year you amend the return, which could create another timing difference to manage.