Tax Credits

Employee Retention Credit California Tax Treatment (2023)

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In today’s competitive business landscape, retaining top talent has become a crucial priority for organizations of all sizes.

To incentivize employers and support their efforts in retaining employees during challenging times, the Employee Retention Credit (ERC) has emerged as a significant tax incentive at the federal level. However, as with many tax-related matters, the treatment of this credit can vary from state to state.

In this article, we will focus on the California tax treatment of the Employee Retention Credit, shedding light on how it impacts businesses operating in the Golden State. By understanding the nuances of the ERC in the state, employers can make informed decisions and maximize their tax benefits while ensuring compliance with the state’s tax laws.

What is the Employee Retention Credit (ERC)?

The Employee Retention Credit (ERC) is a tax incentive designed to encourage businesses to retain their employees during challenging times. Originally introduced as part of the CARES Act in response to the COVID-19 pandemic, the ERC has undergone several changes and expansions since its inception.

The ERC offers a valuable tax credit to eligible employers who meet specific criteria. Initially, the credit was available only to businesses that experienced significant revenue declines or had operations fully or partially suspended. However, subsequent legislation has expanded eligibility to include recovery startup businesses that started trade or business after February 15, 2020.

With the ERC, eligible employers are able to offset their tax liabilities and free up valuable resources. The credit can also help businesses maintain their workforce, sustain operations, and navigate through economic uncertainty.

Importantly, even if you missed out on claiming the ERC in previous quarters, you can still retroactively apply for it by using Form 941-X. This offers businesses the opportunity to recoup missed credits and optimize their tax savings.

ERC for Businesses in California

The qualifications and maximum credits for ERC in California mirror those at the federal level. This means that if you continued to pay wages to eligible employees during the COVID-19 pandemic, you may be eligible to claim the ERC.

Similar to the federal level, California businesses are eligible even if they received Paycheck Protection Program (PPP) loans. Previously, using PPP loans disqualified employers from claiming the ERC. However, this restriction has been lifted, allowing businesses to benefit from both programs.

While many businesses in California can take advantage of the ERC, there are a few exceptions. Ineligible candidates include those who took out a Small Business Interruption Loan, employers in the government sector, and self-employed individuals.

For start-ups launched after February 15, 2020, there is even more good news. Such businesses are eligible for up to $100,000 of credits on wages paid from July 1, 2021, through December 31, 2021, under the ERC provisions for recovery start-up businesses.

ERC Tax Treatment for Businesses in California

In the realm of tax treatment for the ERC in California, there has been a recent change in the stance of the Franchise Tax Board (FTB). Initially, the FTB indicated that an ERC refund would be taxable for California income tax purposes, while the wages used to claim the credit would remain deductible. This meant that the refundable portion of the ERC would be considered income for state tax purposes.

However, the FTB has since reversed its position after reviewing federal rules and guidelines. The new position from the FTB states that businesses claiming the ERC are not required to include the refundable portion of the credit as taxable income on their state income tax return. Furthermore, they are not required to reduce the amount of deductible wages.

For businesses that have already filed original or amended returns, reporting an ERC refund as taxable income, it is advisable to review the tax impact of that position. If the tax impact was significant, businesses may consider filing an amended return to report less income and claim a refund for taxes that were previously paid.

This change in tax treatment provides relief to businesses in California, allowing them to retain the full benefit of the ERC without an additional tax burden at the state level.

Verdict

In California, businesses benefit from the tax treatment of the Employee Retention Credit (ERC). While the Franchise Tax Board (FTB) previously considered the ERC refund taxable for state income tax purposes, there is a new position that brings great news for businesses in the Golden State.

The FTB now states that businesses claiming the ERC are not obligated to include the refundable portion of the credit as taxable income on their state income tax return. Moreover, they are not required to reduce the amount of deductible wages. This change in position aligns the implementation of the ERC in California with the federal level.

This means that businesses in California can fully enjoy the benefits of the ERC without facing an additional tax burden at the state level. The reversal by the FTB provides welcome relief for businesses, allowing them to retain the full extent of what the ERC affords them in terms of tax savings and financial support during challenging times.