IRS Explains Process for Partnerships to Fix Employee Retention Tax Credit Errors

(Parker Tax Publishing October 2025)

The Office of Chief Counsel was asked for advice regarding the procedures partnerships should follow when they fail to file a timely and/or valid administrative adjustment request to correct a failure to reduce the wage expense deduction by the amount of the employee retention tax credit (ERTC) it received in a tax year as required under Code Sec. 3134(e). The Chief Counsel's Office advised that the answer depends on the tax year in which the IRS refunded or credited the ERTC to the partnership. CCA 202538022.

Background

Under Code Sec. 3134(e), if a taxpayer receives an ERTC for a tax year, the taxpayer must reduce its wage expense deduction for the same tax year by a corresponding amount. However, some taxpayers claimed the ERTC without first reducing their wage expense deductions. Some partnerships subsequently attempted to reduce their wage expense deductions by submitting administrative adjustment requests (AARs) that were untimely, lacked required signatures, or lacked a valid designation/appointment of a partnership representative or designated individual.

A partnership may file an AAR to request an adjustment to one or more partnership-related items (PRIs) for a tax year. However, under Code Sec. 6227(c) the partnership cannot file an AAR for a tax year more than three years after the later of: (1) the date on which the partnership return for the tax year was filed, or (2) the partnership return due date for the tax year (determined without regard to extensions). Additionally, the partnership cannot file an AAR after the IRS has mailed a notice of administrative proceeding (NAP) to the partnership.

For a partnership subject to the partnership audit rules under the Bipartisan Budget Act of 2015 (BBA), Code Sec. 6223(a) provides that the "partnership representative" has the "sole authority to act on behalf of the partnership under [the BBA] subchapter." As a result, only the partnership representative can file an AAR.

The BBA regulations also indicate the IRS does not have discretion to accept or process AARs that are not signed by a validly designated/appointed partnership representative or designated individual. Namely, Reg. Sec. 301.6227-1(c)(2) requires an AAR to include certain other information but state that, if some or all the information is missing, the IRS "may, but is not required to, invalidate [the] AAR or readjust any items that were adjusted on the AAR." In contrast, the regulations do not give the IRS discretion over whether to accept an AAR that has not been signed under penalties of perjury by the partnership representative or designated individual. As a result, the IRS cannot accept an AAR that lacks a required signature or a valid designation or appointment.

On the IRS's Employee Retention Credit Frequently Asked Questions (FAQs) webpage, Question 2 in the "Income tax and ERC" section asks, "I claimed the ERC but didn't reduce my wage expenses on my income tax return. The ERTC claim was paid in a subsequent year. What do I do?" The answer states: "Under these facts, you're not required to file an amended return or, if applicable, an administrative adjustment request (AAR) to address the overstated wage expenses. Instead, you can include the overstated wage expense amount as gross income on your income tax return for the tax year when you received the ERC."

The answer also explains that this approach is based on the tax benefit rule, which requires a taxpayer to "include a previously deducted amount in income when a later event occurs that is fundamentally inconsistent with the premise on which the deduction is based." Here, the receipt of the ERTC is fundamentally inconsistent with the uncorrected wage expense deduction.

CCA 202538022

The Office of Chief Counsel was asked for advice regarding the alternative procedures partnerships should follow when they fail to file a timely and/or valid AAR to correct a failure to reduce the wage expense deduction by the amount of the ERTC it received in a tax year. The Chief Counsel's Office advised that the steps that partnerships should take to comply with this requirement depend on when the partnership received the ERTC; that is, the answer depends on the tax year in which the IRS refunded or credited the ERTC to the partnership, not the tax year in which the partnership paid the qualified wages.

The Chief Counsel's Office stated that if a partnership has not yet received the ERTC, then the partnership should report the ERTC as income for the tax year in which the IRS credits or refunds the ERTC to it. For example, if the IRS pays a refundable ERTC to a partnership during tax year 2025, the partnership should include the amount of the ERTC as income on its 2025 partnership return. Additionally, if the IRS credited or refunded an ERTC to a partnership during tax year 2024 and the partnership has not yet filed its 2024 partnership return (because, for example, it received a six-month extension to file), the partnership should include the amount of the ERTC as income on its 2024 partnership return when it files the return.

If the IRS credited or refunded an ERTC to a partnership during a prior tax year (e.g., 2022, 2023, 2024) and the partnership already filed its partnership return for the tax year, then the partnership should file an AAR for that tax year to adjust its income based on the inclusion of the amount of the ERTC. For example, if: (1) a partnership claimed an ERTC based on qualified wages paid during tax year 2020, (2) the partnership failed to reduce its 2020 wage expense deduction by the amount of the ERTC, (3) the IRS paid the ERTC to the partnership during tax year 2023, and (4) the partnership has already filed its 2023 partnership return, then the partnership should file an AAR for tax year 2023 to increase its income by the amount of the ERTC.

The Chief Counsel's Office noted that the inclusion of the ERTC in the partnership's income will be a positive adjustment under Reg. Sec. 301.6225-1(d)(2)(iii), and will result in the partnership owing an imputed underpayment (IU). When the partnership files the AAR, it must either pay the IU reflected on the AAR or elect to have the reviewed year partners take their pro rata shares of the positive adjustment to income into account.

The Chief Counsel's Office further advised that if the IRS credited or refunded an ERTC to a partnership during a prior tax year, the partnership already filed its partnership return for the tax year, and the Code Sec. 6227(c) period for filing an AAR for that tax year has closed, then the partnership does not have a way to include the ERTC in its income. For example, if the IRS paid an ERTC to a partnership during tax year 2021, and the partnership filed its partnership return on April 15, 2022, then under Code Sec. 6227(c), the last date when the partnership can file an AAR for tax year 2021 is April 15, 2025. If the partnership does not file an AAR by April 15, 2025, then the partnership will be unable to include the amount of the ERTC in its income for the tax year when the IRS credited or refunded the ERTC to it. The Chief Counsel's Office noted that this scenario would only arise with respect to partnerships that received the ERTC (as a credit, refund, or offset) during tax year 2021.

For a discussion of the employee retention credit, see Parker Tax ¶106,460.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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