The Current Situation
A significant number of Employee Retention Credit (ERC) claims filed in 2022 and 2023 are only now being processed, following extended IRS review periods. For businesses receiving these refunds in 2026, the arrival of the check does not close the matter. It opens a separate income tax question: how should the refund be reported, and is any further filing required?
This is a procedural question with a defined answer, not a planning opportunity. The IRS has issued specific guidance addressing exactly this scenario, and the correct treatment depends on decisions made (or not made) when the ERC claim was originally filed.
A Brief Recap
Start with the basics: The ERC is a payroll tax credit which is claimed on Form 941-X, not an income tax credit. That one distinction is where most of the confusion starts. Because the credit relates to wages, the Internal Revenue Code requires you to reduce the wage deduction on your income tax return by the same amount, for the same period those wages were paid. In plain terms: you can’t deduct the full cost of wages and collect a tax credit for those same wages; you have to pick one side of the equation and adjust it.
The IRS stated this position early on, in Notice 2021-49: a taxpayer’s deduction for qualified wages must be reduced by the amount of the ERC, and this reduction applies to the tax year in which the qualified wages were paid or incurred, not the year the refund check arrives.
Why That Original Guidance Became Difficult to Follow
The original guidance assumed a reasonably prompt turnaround between filing an ERC claim and receiving the refund. That assumption did not hold. Processing delays stretched into years, and for many businesses, the three-year statute limitations for amending the original income tax return closed before the refund ever arrived. A business that filed a 2020 ERC claim, for example, generally had until roughly three years after its original 2020 return was filed to amend that return. Many ERC refunds for 2020 wages were not paid until 2023, 2024, or later — well past that window.
This created a genuine compliance gap: taxpayers were technically required to correct a return they no longer had the ability to amend.
The IRS’ 2025 Relief: Reporting the Refund as Income in the Year Received
In March 2025, the IRS issued updated FAQ guidance addressing this exact gap. For businesses that received an ERC refund but never reduced the wage deduction on the original return, the IRS now permits a simpler path: report the ERC refund as gross income on the tax return for the year the refund is received, rather than amending the original wage year.
This rests on something called the tax benefit rule: if you deducted an amount in the past and it later turns out that deduction was too high, you must include the difference in income once that becomes clear. Here, that’s exactly what happened; the wage deduction on your original return turns out to have been overstated by the ERC amount. Since amending that old return may no longer be possible, the fix shows up instead as income on the return for the year you actually received the refund.
For a business receiving an ERC refund in 2026 that never adjusted its original wage deduction, this means the refund amount is generally reported as gross income on the 2026 federal income tax return.
Confirming Which Scenario Applies
Before applying this treatment, it is worth confirming, which of the following situations actually describes the business’s history:
- The wage expense was never reduced on the original return, and the statute of limitations for amending that original return has closed. This is the scenario the 2025 FAQ relief was designed for. The ERC refund is generally reported as income in the year received.
- The wage expense was never reduced, but the statute of limitations for amending the original return is still open. In this case, amending the original return remains an available option, and the choice between amending versus reporting the refund as current-year income should be evaluated based on specific facts, including any difference in tax rates or other items on the original return that amending might affect.
- The wage expense was already reduced on the original return in anticipation of the ERC, and the claim has since been paid as expected. No further correction is generally needed; the original return already reflects the proper treatment.
- The wage expense was reduced on the original return, but the ERC claim was later disallowed. The IRS’s 2025 guidance also addresses this scenario in the opposite direction: the business may generally restore the wage deduction on the return for the year the disallowance becomes final, rather than amending the original year.
Why a Protective Refund Claim May Still Be Worth Considering
Even with this simplified path, a protective refund claim retains a role in certain circumstances, and it is worth understanding why before assuming it is unnecessary.
First, the IRS has been explicit that its FAQ guidance, while helpful, is not the same as a formal revenue ruling or regulation and is not legally binding in the way statutory or regulatory guidance is. Tax professionals have raised open questions about how this newer position interacts with the earlier Notice 2021-49 framework, particularly for businesses that already amended returns under the original guidance and would be in a different position had they waited. A protective claim preserves the ability to pursue an alternative position if the IRS’s stance shifts again or is challenged.
Second, a protective refund claim remains relevant for a business whose ERC claim is still under IRS review, in appeal, or otherwise unresolved. The general guidance in this situation is to wait rather than adjust income proactively — but where a statute of limitations on a related tax year is approaching expiration while the ERC claim itself remains outstanding, filing a protective claim preserves the right to a refund on that year without requiring the business to take a final position before the ERC matter is settled.
Third, for businesses weighing whether to amend an original year that remains open (the second scenario above) versus waiting to report income in the year of receipt, a protective claim can serve as a placeholder while that analysis is completed, particularly as a filing deadline nears.
A Procedural Checklist for 2026
For a business that received an ERC refund in 2026, the following sequence reflects the cautious, procedural approach this situation calls for:
- Verify Applicable Scenario: Confirm which of the four scenarios above actually applies, based on the business’s own filing history, not an assumption about what “most businesses” did.
- Check Statute Status: Confirm whether the statute of limitations on the original wage year is open or closed, since this determines which options are available.
- Closed Year Reporting: If the original year is closed and no adjustment was previously made, report the ERC refund as gross income on the 2026 return, consistent with the March 2025 FAQ guidance.
- Open Year Evaluation: If the original year remains open, evaluate amending that year against reporting the refund as 2026 income before filing anything.
- Pending IRS Claims: If any related ERC claim remains under IRS review or appeal, hold off on income adjustments tied to that claim until it is resolved.
- Protective Refund Claims: Where a statute of limitations is approaching on a related year and matters remain unresolved, evaluate whether a protective refund claim should be filed before that window closes.
- Retain Full Documentation: Retain full documentation of the original ERC filing, the wage calculations used, and the refund correspondence, since this determines which of the above scenarios applies and will support the position taken.
The Takeaway
Getting your ERC refund in 2026 isn’t the finish line. It’s the moment a tax question you put off finally comes due. The IRS has made this easier for most people: report the refund as income in the year you got it. But that only works if you’ve correctly figured out which situation applies to you. And because this newer guidance is still just FAQ-level guidance, not a formal rule, and nobody’s fully sure yet how it lines up with the older rules, this isn’t the moment to guess and move fast.
Before you put this refund on your 2026 return, it’s worth checking three things: which scenario actually fits your case, whether the statute of limitations on the original year is still open, and whether a protective filing makes sense given your facts. At Manay CPA, this is exactly the kind of question we sit down and work through with clients before anything gets filed.
