State Taxability of the Employee Retention Credit (ERC)

Companies are starting to receive ERC funds for which eligible employers were granted credits due to COVID-19 closures. The question arises regarding how to report or treat these credits from an income tax perspective.

Federal law prohibits a deduction for wages or salaries for which a Taxpayer is claiming an employment credit (IRC Section 280C). When claiming federal employment credits, Taxpayers must reduce the wage deduction used to claim the credit in an amount equal to the credits received.

The ERC is effectively taxable by the federal government since reducing an expense by the ERC amount has the same effect as recognizing the ERC amount as additional income.

NY and CA have special subtraction adjustments for federal wages that are not deductible under IRC Section 280C. Thus, for NY and CA tax purposes, the ERC is not taxable. The NYS subtraction adjustment is reported as a Code S-205 adjustment on NYS Form IT-225. CA will likely have this as a subtraction adjustment on the respective form depending on the taxpayer claiming the credit.

Currently, NJ does not have such an adjustment. The computation of NJ taxable income starts with federal taxable income and since there is no specific modification for federal tax credits, the ERC remains taxable for NJ purposes.

The full effects of the ERC and its treatment on a jurisdictional basis are still developing. We urge you to stay tuned as we strive to keep you informed regarding tax news.