Tax Credits

Accounting for ERC (2023)

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The Employee Retention Credit or ERC is a form of financial aid available for businesses affected by the COVID-19 pandemic. However, accounting for the ERC can be difficult. 

For one thing, there’s no guidance in the U.S. Generally Accepted Accounting Principles or GAAP for certain entities when applying for the ERC. Moreover, there are timing issues that businesses will have to take into account to make sure everything goes smoothly.

What is the ERC?

The ERC is part of the Coronavirus Aid, Relief and Economic Security or CARES Act, a $2.2 trillion assistance package that was passed by the 116th U.S. Congress in 2020. It’s designed to provide economic support during the COVID-19 crisis. 

This tax credit is accessible to small- and medium-sized businesses that opted to keep their workforce during the pandemic and incurred a significant decline in gross receipts owing to limited operations caused by shutdowns and suspensions the government mandated in 2020 and 2021. Read our post about ERC qualifications and eligibility to determine whether your business can apply or not.

ERC Accounting Methods

First and foremost, you have to figure out if your business is eligible for the ERC. If it is, and you’ve applied and received the credit, the next step is to make adjustments to your financial statements accordingly. This depends on the type of your account. In other words, you’ll have to identify the corresponding accounting standard to follow.

There are three methods you can apply to adhere to the U.S. GAAP for ERC accounting:

  • Accounting Standard Codification (ASC) Subtopic 958-605, Not-For-Profit Entities — Revenue Recognition
  • International Accounting Standards (IAS) 20, Accounting for Government Grants and Disclosure of Government Assistance
  • ASC Subtopic 450-30, Contingencies

For-profit entities can refer to any one of the aforementioned methods, as there’s no specific guidance that exists in the U.S. GAAP for ERC application for them. On the other hand, not-for-profit entities can turn to the ASC 958.

ASC 958 ERC Accounting

According to ASC 958, the ERC should be treated as a conditional contribution. This means that recognition of the credit on the income statement is appropriate only when the conditions necessary to earn the credit have been “substantially met.”

To qualify for the ERC, you must meet the requirements related to revenue decline or service suspension and fulfill eligible payroll cost payments. For not-for-profit organizations, the ERC should be recorded as revenue, while business entities have the flexibility to classify it as either grant revenue or other income. However, it’s important to note that both types of entities are prohibited from offsetting the credit against their qualifying costs.

When recording the ERC in the journal entry, you will either create a payroll tax receivable or debit to reduce the tax liability. Conversely, if you have received an advance ERC without substantially meeting the earning conditions, any unearned portion should be presented as a liability until the requirements are fulfilled.

IAS 20 ERC Accounting

Accounting for the ERC under IAS 20 involves recognizing the credit over the periods in which it offsets the associated expenses, provided there is “reasonable assurance” of receiving the credit.

“Reasonable assurance” signifies a high likelihood of the event occurring, which is typically met when a business meets the eligibility requirements and fulfills the necessary payroll costs to qualify for the ERC.

IAS 20 offers two methods for recording the ERC on the income statement. It can be presented as a separate credit, such as under the category of “other income,” or it can be offset against the corresponding payroll costs. In the latter case, it is important to disclose the chosen presentation approach for transparency.

To record the ERC, the journal entry involves a debit to decrease the payroll tax liability. If the reduction exceeds the liability, the excess amount is presented as a receivable on the balance sheet.

ASC 450 ERC Accounting

When it comes to accounting for the ERC under ASC 450, it is treated as a gain contingency. This means that recognition on the income statement is deferred until uncertainties regarding the receipt of the credit are resolved, and the income is considered “realizable.”

Out of the three ERC accounting approaches, this method is the most restrictive. It typically involves deferring recognition of the credit until funds are received from the IRS or upon receiving a formal letter approving the claim.

Regardless of the timing of recognition, it is important to record the credit as a separate account on the income statement. This means that the credit should not be offset against the related payroll expenses.

ERC Accounting Potential Issues

Accounting for the ERC involves various timing considerations. One key timing issue is the application and receipt of the credit. Companies may be eligible for the ERC but have not yet received them, leading to the need to record receivables. Meanwhile, there are instances where companies receive the ERC in advance before incurring the related payroll costs, resulting in the recording of liabilities. These timing complexities require careful attention to ensure accurate and appropriate recognition of the ERC in financial statements.

For-profit entities face a challenge when accounting for the ERC, as they do not have specific guidance in the U.S. GAAP tailored for this purpose, as noted earlier. Unlike not-for-profit organizations, which can follow ASC 958, for-profit entities lack a dedicated accounting standard for the ERC. As a result, these entities must exercise judgment and consider the principles of relevance, faithful representation and the overall framework of the U.S. GAAP.

This absence of specific guidance highlights the importance of professional judgment and consultation with accounting experts to ensure accurate and compliant accounting treatment of the ERC for for-profit entities.

How to Retroactively Apply for ERC

No need to worry if you haven’t applied for the ERC yet. Despite the initial expiration date of October 1, 2021, eligible businesses can still take advantage of this tax relief opportunity.

Basically, you need Form 941-X from the IRS to amend tax returns to apply for the ERC. Put differently, employers who missed out on claiming the ERC can use it to revise their quarterly tax returns, allowing them to apply for the credit retroactively—thus giving them the opportunity to claim the credit that they may have overlooked.

For a more comprehensive guide, read our posts on Form 941-X examples and ERC retroactive claims.

Business Eligibility for ERC

The ERC is available to a wide range of business entities, including nonprofit and for-profit organizations such as corporations and sole proprietors. However, they need to meet specific criteria to be eligible.

Businesses that faced full or partial suspension due to government orders, which limited their operations, are eligible to apply for the ERC. This is commonly applicable to establishments like restaurants and gyms.

In addition, businesses that experienced a significant decline in gross receipts qualify for the credit. To be considered, their gross receipts for a calendar quarter in 2020 must be less than 50 percent compared to the same quarter in 2019. This decline in revenue demonstrates the substantial impact the pandemic had on their operations. In 2021 and 2022, the qualifying threshold was reduced to 20 percent, making it easier for a broader range of businesses to claim this money-saving credit.

For more information, read our post about ERC qualifications and eligibility, as well as our guide on how to calculate gross receipts for the ERC.

ERC Deadlines

To facilitate the process of filing ERC claims, the IRS has established specific deadlines. Fortunately, businesses have been given ample time to gather, prepare and submit the required documentation. Nonetheless, it is advisable to complete this process promptly to ensure timely receipt of the credit.

The deadlines for ERC claims are as follows:

  • All quarters for ERC claims in 2020: Deadline of April 15, 2024
  • All quarters for ERC claims in 2021: Deadline of April 15, 2025

By adhering to these deadlines, businesses can maximize their chances of receiving the ERC in a timely manner and take full advantage of this tax relief opportunity.

For more details, check our post about ERC deadlines and audit assessment periods.

Summary

Accounting for the ERC requires careful consideration and adherence to applicable accounting standards. While not-for-profit organizations can follow ASC 958 for guidance, for-profit entities do not have specific guidelines in the U.S. GAAP. Consequently, professional judgment and consultation with accounting experts are more or less crucial. Timing issues related to applying for and receiving the credit also add complexity to the process. Staying updated on regulations and seeking professional expertise can help ensure compliance.