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Freelance Businesses Claiming the Employer Retention Credit Now Face an Increase in Taxable Income

The Employer Retention Credit (ERC) was first introduced in 2020 as part of the U.S. government’s relief for small businesses who were adversely affected by the pandemic and was also made available in 2021 to employers who kept employees on their payroll during Covid-19.

The bad news: if you applied for the ERC in 2020 or 2021 even if you have not received the money yet, you will now face a tax bill payable for funds you either received or may receive. Even if the ERC payments that you applied for is still pending based on your payroll, they are considered taxable income in the tax same year as the application was made. 

Here is an expert take on the tax impact of the ERC on small businesses from CPA for Freelancers® founder, Jonathan Medows, CPA:  

“While the original intent of the ERC was to ease the burden for businesses who kept employees on payroll during the pandemic, the bottom line now is that you could owe tax on money that you have not received yet.,” said Medows. “If your freelance business had two employees and applied for the ERC for three quarters in 2021, even if you did not receive the money, you could have a tax bill related to the pending ERC payouts.”

Here is a practical example of a small business with two employees receiving ERC payouts and the potential tax obligation which may occur as a result: 

2 employees x $7,000 ERC x 3 quarters = $42,000 in taxable income.

“An unexpected tax bill of any amount is stressful enough, but this one could be particularly so, given the potential size of pending ERC payouts,” said Medows. 

Filed your taxes and claimed the ERC? Here is what to do next…

“If freelancers and small business owners have already filed their returns, the IRS guidance is to amend your tax return to reduce expenses for the ERC amount claimed.  In addition, freelance business owners should look at local and state tax guidance for the ERC to make sure they are paying all necessary taxes,” Medows remarked. “If you have already filed, consider amending your 2020 or 2021 returns. If filing is pending, please factor the 2021 ERC into your estimated tax payments.”

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Jonathan Medows, CPA

Jonathan Medows is a certified public accountant licensed in New York, New Jersey, Maryland, and Pennsylvania. He is also a recognized expert in taxation for freelancers and the self-employed—often tapped for his expert knowledge and perspective on self-employment taxation by national and regional publications such as The New York Post, BusinessWeek, Forbes taxation blog, WebCPA, CPA Practice Advisor, and others. You can read some of Jonathan’s press coverage here.

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