A common question recipients of employee retention credits (ERCs) ask is “When can the credits be recognized in the income statement?” In some circumstances, the answer can be as simple as when payment is received or even when the claim for credit is made with the Internal Revenue Service (IRS). However, for many claimants, the answer is more complicated and requires an understanding of not only the relevant accounting guidance, but also the nuances of the ERC, the payroll tax audit process, and the various avenues at the IRS’ disposal when it believes ERC claims may not be valid.
A refresher on the employee retention credit
Before moving too deeply into the question of when ERCs can be recognized, a quick refresher on the basics of the ERC may be helpful. The credit was initially allowed by the federal CARES Act as part of the response to the potential economic fallout from the COVID-19 pandemic. The ERC is a refundable credit against certain employment taxes, with the ability for amounts in excess of employment tax liabilities to be refunded. There are many facets to ERC eligibility, with the most notable being that an eligible entity must either have a demonstrated reduction in gross receipts during specified quarters or a suspension of operations to comply with a COVID-19-related government order. ERCs were permitted to be claimed on a quarterly basis beginning in March 2020 and continuing through June 2021, with subsequent laws providing additional claims to be made for all quarters of 2021. The credits were claimed on initially filed or amended Forms 941 with the IRS.
Unlike many other tax provisions, guidance on the ERC wasn’t provided through Treasury regulations. There’s a lack of published guidance on eligibility for the ERC which makes such determinations challenging and potentially subject to judgment.
Accounting guidance for the employee retention credit
The first step in determining when ERCs can be recognized in the income statement is to identify the appropriate accounting guidance. (Note that this article focuses on the accounting by for-profit entities that follow U.S. GAAP. The accounting for ERC by not-for-profit entities that follow U.S. GAAP or entities that follow other accounting frameworks could differ.) Because the ERC is based on employment taxes, the credit isn’t subject to the income tax guidance found in U.S. GAAP in Financial Accounting Standards Board (FASB) ASC 740. Rather, the rules for accounting for government grants should be applied. Current U.S. GAAP doesn’t provide specific guidance on the recognition and measurement of government grants, and most recipients analogize to the guidance provided in the International Financial Reporting Standards (IFRS). In June 2025, the FASB approved the development of new U.S. GAAP guidance to account for government grants by for-profit entities. That guidance, which is expected to be based on IAS 20, is slated to be published in the fourth quarter of 2025. This guidance provides a relatively straightforward framework for recognizing government grants, specifying that amounts should be recognized when it’s probable — in other words, likely to occur — that the entity will comply with the grant’s conditions and the amounts will be received.
For early claimants, ERC claims were generally reported on initial returns and refund requests were generally processed and paid timely by the IRS. As a result, the analysis focused solely on compliance with the ERC’s conditions (i.e., eligibility for the credit). For entities that filed ERC claims on amended returns before payment, those amended returns were submitted to examiners to screen and, in some cases, examine. Complicating matters and creating delays, the IRS instituted a moratorium on the processing of amended returns seeking ERC credits due to fraud concerns, and the recently enacted One, Big, Beautiful Bill specified that claims for refunds will only be permitted for those returns filed on or before Jan. 31, 2024. As such, it’s possible that some entities will need to address the probability of payment being received, along with eligibility considerations.
Assessing eligibility for the employee retention credit and likelihood of payment
The second, and perhaps more challenging step in the process, is to determine whether it’s probable that the conditions of the ERC will be complied with, and whether it’s probable that payment will be received. To make these assessments, it’s important to understand how ERC claims on original or amended Forms 941 are handled by the IRS, and the process followed to audit employment tax filings and the methods that may be used to reclaim amounts if the IRS challenges the eligibility of an ERC claim.
Let’s look first at the issue of whether it’s probable the ERC payment will be received. When ERC claims were filed with the IRS on initial returns, eligibility for the ERC wasn’t evaluated, the return with the claim was processed, and the credit was paid. Consistent with other employment tax filings, the IRS relies on its normal audit and assessment process to address the possibility of excess or ineligible payments. This is the reason why many early claimants received ERC payments shortly after filing requests with the IRS. For those ERC claims that haven’t yet been paid, the requesting entity needs to consider all available information when determining whether payment is probable, particularly in light of the claim processing moratorium and the disallowance of claims made after Jan. 31, 2024. Should an entity conclude that payment of an ERC claim isn’t probable, further consideration of the eligibility requirements isn’t necessary.
As indicated above, eligibility for the ERC wasn’t evaluated by the IRS when the credit was paid on an originally filed return (or in some amended returns when an examiner didn’t review the claim). As such, contrary to popular belief, receipt of an ERC payment doesn’t provide evidence as to whether the recipient was eligible for the credit, and all entities need to consider the ERC’s eligibility requirements.
In some limited circumstances, determining whether the ERC qualification requirements were met may be easy, and an entity can easily conclude that the benefit of the credit may be recognized in the income statement upon receipt of payment (or filing of the related Form 941 if payment was considered probable). However, in certain situations, evaluating whether the eligibility requirements have been met requires significant judgment, which could result in differences in opinion about whether it’s probable that the conditions have been met. When an entity can’t assert that it’s probable the eligibility requirements have been met, any ERC payments received should generally be deferred on the balance sheet and not recognized in the income statement. In circumstances where an entity believes it’s probable that payment of the credit will be received, but it can’t be asserted that it’s probable the eligibility requirements have been met, recognition of a receivable and offsetting deferred liability in the balance sheet is generally not.
Consideration must then be given to the timing of recognition of amounts currently deferred on the balance sheet in the income statement. This further assessment requires a detailed understanding of the IRS audit process for employment tax filings and the approaches available to reclaim amounts should the government believe that an ERC claim isn’t valid. The two most likely outcomes that could result in previously deferred amounts being recognized in the income statement are as follows:
Subsequent determination that eligibility criteria have been met. This outcome would most likely occur when an IRS audit of the ERC claim concludes that the eligibility requirements have been met. While the results of IRS audits of other entities are sometimes known to other parties, it generally wouldn’t be appropriate to base changes in judgment regarding eligibility on audits of other entities, unless there is specific information provided by the IRS through approved communication methods.
Expiration of statute of limitations. Similar to other federal tax filings, employment tax filings on Form 941 (including related ERC claims) are subject to a statute of limitations, after which the IRS is no longer permitted to request reimbursement for ERC amounts claimed. However, the IRS has multiple avenues to pursue should it believe an ERC claim isn’t valid. Understanding each of these is necessary to conclude whether and when an ERC claim can be recognized in the income statement based on these three considerations:
- Deficiency and assessment procedures. Deficiency and assessment procedures (more commonly referred to as audit procedures) are the most common approach used by the IRS to recover ineligible payments from taxpayers. In general, the deadline for the IRS to assess additional tax (the statute of limitations) is three years from April 15 following the end of the year containing the quarter for with the credit relates for claims in 2020 and the first two quarters of 2021. For the last two quarters of 2021, the statute of limitations for the ERC was extended to the later of April 15, 2028, or six years following the filing of the claim. Following is a summary of these dates:
- ERC claims filed for all quarters in 2020 — assessment deadline is April 15, 2024.
- ERC claims filed for first two quarters of 2021 — assessment deadline is April 15, 2025.
- ERC claims filed for last two quarters of 2021 — assessment deadline is later of April 25, 2028, or six years from the date of filing of the ERC claim.
- However, in circumstances where there is a “false or fraudulent return with the intent to evade tax” or a “willful attempt in any manner to defeat or evade tax,” there’s no statute of limitations. Keep in mind that determining whether an ERC claim is false or fraudulent is based on the specific facts and circumstances and the underlying legal concepts; consultation with a qualified tax or legal expert is recommended in these situations. As such, if there’s reason to believe that an ERC claim is false or fraudulent, recognition of the credit in the income statement may not be appropriate absent of specific approval by the IRS or through a court judgment.
- Recovery of amounts through civil suit. Apart from the deficiency and assessment procedures, the IRS can also reclaim ineligible ERC claims through civil action. Civil suits must generally be brought within two years after issuance of the refund, except that suits may be brought within five years of making the refund if the refund was “induced by fraud or misrepresentation of material fact.” Depending on when the ERC refund claims were received, it’s possible that the statute of limitations for a civil recovery could expire before or after the statute of limitations from an IRS assessment.
- Government offset. The common law right of offset allows a creditor (the government in this instance) to refuse to pay an obligation on the basis that a mutual obligation is owed to it (by a taxpayer). The government may exercise a right of offset when a taxpayer requests a tax refund or application of a tax overpayment or asserts entitlement to payment of any amount from the government, which may be offset against what the IRS believes is an improper prior ERC claim. Thus, while the government doesn’t request repayment of the prior ERC claim, they have the power to avoid payment of future amounts otherwise owed to the taxpayer to the extent of the invalid ERC claim. The government’s ability to exercise the right of offset against a taxpayer is indefinite (that is, there is no statute of limitations). While the government isn’t required to formally assess tax against an entity in order to assert the right of offset, in practice, it’s exceedingly rare that offset would occur without assessment.
In many circumstances, it will be appropriate to follow the statute of limitation expiration dates as outlined above for the deficiency and assessment procedures, i.e., audit procedures. Once the statute of limitations expiration date has passed, it may be appropriate to consider recognition of an ERC claim in the income statements if there are no exceptional circumstances underlying the ERC claim. However, it’s important to remember that significant complexity and judgment underly these assessments and conclusions. The statute of limitations provisions related to ERC claims are based on the laws initially authorizing the ERC, various sections of the Internal Revenue Code and Treasury Regulations, and case law. Because the determination of whether an entity has met the eligibility requirements underlying an ERC claim (including consideration as to whether a claim could be fraudulent or based on misrepresentation) is ultimately a matter of legal interpretation, consultation with appropriate tax or legal experts is recommended.
