As amended ERC claims continue to be processed, S corporations are grappling with how to accurately handle the credit’s impact on their federal tax returns. The situation has created confusion—and given the amounts involved, the stakes are high.
Understanding ERC’s dual effect on Form 1120S
The Employee Retention Credit (ERC), established under the CARES Act, is a fully refundable payroll tax credit designed to encourage employers to keep staff on payroll during the COVID-19 crisis. If your S corporation received this credit—most often by amending prior year Forms 941 via Form 941-X—it impacts your corporate income tax return in two distinct ways: one on wages reported as deductions, the other on credits passed through to shareholders.
1. Adjusting wage deductions
According to IRS guidance (irs.gov), businesses must reduce their wage expense deductions on Form 1120S by the amount of ERC they received. That means the lines 7 and 8, which together report compensation of officers and other salaries/wages, must reflect net amounts after ERC adjustments.
For example, if your payroll record shows $150,000 in eligible wages during Q4 2020 and you received a $30,000 ERC, only $120,000 should be deducted as wages on the return.
“I thought the W-3 needed to match the Form 1120-S wage lines exactly,” said Marty Lin, CPA for a manufacturing S-corp in Ohio. “But after cross-verifying with IRS publications, we realized the deduction must exclude the ERC—even though W-3 still shows gross. It’s a tricky balance.”
2. Reporting the credit correctly
The ERC is reported as a separate line item on Line 13g of Form 1120S under “Other Credits” using Code P. This reflects the IRS final instructions in Draft Form 1120S documents, and is supported by guidance from both Thomson Reuters and Brotman Law’s analysis (Brotman Law).
The credit listed on Line 13g is then automatically transferred to each shareholder’s Schedule K-1, where it appears on Line 13, again with Code P.
Steps to file correctly
Here is the breakdown for incorporating ERC into Form 1120S:
- Step 1: Reduce total wages reported on lines 7 and 8 by the total ERC amount claimed in the year.
- Step 2: Report the ERC amount on Line 13g (Other Credits) using Code P.
- Step 3: Transfer the credit through to each shareholder’s Schedule K-1, Line 13 (Code P).
- Step 4: If the return was previously filed before claiming ERC, file Form 1120-X to amend.
This dual treatment—adjusting deductions and recording credit—ensures your S-corp doesn’t claim tax deductions for expenses already offset by the ERC benefit.
If an amendment is needed
If you filed your 1120S return before you claimed the ERC (which is often the case when ERC is filed retroactively via Form 941-X), the IRS expects you to amend the return to reflect these changes. That means submitting Form 1120-X and providing a detailed statement explaining:
- The amount of ERC claimed
- The updated wage deductions
- The new credit reported on Line 13g
Deadlines are strict: for 2020 ERC claims, the amended return must be submitted by April 15, 2024. For 2021 credits, the deadline is April 15, 2025 (IRS).
ERC is not taxable—but watch the deduction
While the ERC isn’t taxable per se—it doesn’t count as income—it still reduces your deductions. That’s a subtle but crucial distinction. Brotman Law confirms: “The credit lowers deductible wages, meaning your taxable income increases accordingly, even though you didn’t receive taxable income from the credit itself.”
Ignoring this can result in underreported income—and costly notices down the line.
Common mistakes to avoid
| Mistake | Why it’s wrong | Correct approach |
|---|---|---|
| Reporting full wages and ERC | Double benefit: deducting wages already subsidized | Reduce wage expense by ERC amount |
| Omitting ERC from Line 13g | Fails to report credit as required | Include on Line 13g with Code P |
| Leaving K-1 unchanged | Shareholders miss their credit | Update K-1 Line 13 accordingly |
FAQ
What are the specific steps to reduce wage deductions by the ERC amount on Form 1120S?
Subtract the total ERC received during the tax year from the wage expenses reported on Lines 7 and 8 of Form 1120S. Make sure your internal payroll records clearly show this adjustment. Do not change the W-3 or payroll tax filings already submitted to IRS or SSA.
How do I update Schedule K-1 when reporting the ERC on Form 1120S?
On each shareholder’s Schedule K-1, report their proportionate share of the ERC credit on Line 13, using Code P for “Other Credits.” This ensures the credit passes through for individual reporting on Form 1040.
What is the deadline for filing an amended return to claim the ERC on Form 1120S?
The statute of limitations follows typical refund timelines: three years from the original return. For the 2020 tax year, the deadline is April 15, 2024. For 2021, it’s April 15, 2025.
Who can sign an ERC claim for a corporation or LLC treated as a corporation?
The person authorized to sign is typically an officer of the corporation listed with the IRS. This person must have authority to bind the entity, and in case of Form 1120-X, that signature must also accompany the explanation for the changes made due to ERC.
How do I calculate the qualified wages for the ERC on Form 1120S?
ERC-qualified wages depend on the number of full-time employees and the period being claimed. For 2020, up to $10,000 in wages per employee for all quarters may qualify. For 2021, it’s $10,000 per employee per quarter (first 3 quarters). You must include only wages not used for other credits (e.g., PPP forgiveness). Documentation must be maintained supporting these calculations.
