Employee Retention Credit in 2026: Audits and Clawbacks
Where the pandemic-era credit stands now: claims still pending, denials and audits, the extended assessment period, and the income tax consequences of a credit that is paid, denied, or repaid.
Reviewed by the Fairlight Accounting cross-border tax team — U.S. & Canadian Tax Desks
The employee retention credit was a refundable payroll tax credit for wages paid in 2020 and 2021 by businesses hit by the pandemic. The filing deadlines have passed. What remains in 2026 is processing of backlogged claims, denial letters, audits of paid claims (within six years for late-2021 quarters), and the income tax adjustments that follow either way.
On this page
Where do claims stand?
| Claim status | What happens now |
|---|---|
| Paid | Subject to audit; for the third and fourth quarters of 2021, the 2025 law extended the assessment period to six years after the latest of the original return's filing, its deemed filing date, or the date of the claim |
| Pending | IRS continues to process; claims for the third and fourth quarters of 2021 filed after January 31, 2024 are barred and will not be paid |
| Denied (Letter 105-C or partial disallowance) | Appeal rights apply; once the disallowance is final, the business can restore the wage deduction it reduced |
| Withdrawn or repaid under earlier programs | Closed; no further penalty |
| Promoter-prepared with doubtful eligibility | Highest audit risk; an unpaid claim (or an uncashed refund check) can still be withdrawn, and an overstated claim can be reduced on an adjusted return |
The voluntary disclosure programs that allowed repayment at a discount have closed — the second one on November 22, 2024.
What are the income tax consequences?
- Credit received. Wages for the credit year are reduced by the credit amount on the income tax return for that year — not the year the money arrived. A business that did not reduce its wage deduction can amend that year or, under IRS guidance, report the overstated amount as gross income in the year the credit was received.
- Credit denied or repaid. Once a disallowance is final, the business can add back the previously reduced wages as a deduction on its return for that later year instead of amending (amending the original year remains an option); a withdrawn claim may still call for an amended return.
- Interest paid by the IRS on a delayed refund is taxable income in the year received.
What does an audit look at?
Whether the business actually met the gross receipts decline test or the government-order suspension test for each quarter claimed; whether the wages were qualified wages (not paid to majority owners' relatives, not double-counted with forgiven paycheck protection loans); whether the business was a large employer for the year, which limits qualifying wages; and whether the claim was built on a supply-chain disruption theory the IRS rejects.
What should a business with a paid claim do?
Keep the eligibility file — orders, revenue by quarter, payroll detail, the loan forgiveness application — at least until the assessment period ends, six years for late-2021 quarters; confirm the wage deduction was adjusted; and if the claim does not hold up on review, consider an adjusted return (Form 941-X) reducing it before the IRS makes contact.
Frequently asked questions
Can I still file a new claim for 2020 or 2021?
No. The deadlines passed in April 2024 for 2020 quarters and April 2025 for 2021 quarters, and the 2025 law bars any credit or refund for the third and fourth quarters of 2021 unless the claim was filed by January 31, 2024.
My promoter took a percentage of the credit. Is their fee deductible?
Generally yes, as a business expense, in the year paid.
What are the penalties if a claim is disallowed after payment?
Repayment with interest, and possibly penalties. The 2025 law added a $1,000-per-failure due diligence penalty for ERC promoters and extended the 20 percent penalty for excessive refund claims to employment tax — but only for claims made after July 4, 2025, after the ERC filing deadlines.
Does a denial letter mean an audit?
Not necessarily. Letter 105-C is a claim disallowance: the IRS asks for a response within 30 days, an appeal can be requested within two years of the letter, and a refund suit must be filed within two years unless extended on Form 907. An audit of a paid claim comes by separate examination notice.
Official sources
The IRS explains: “If the IRS disallowed your ERC claim with Letter 105-C and you disagree, you may request an administrative appeal, review by the IRS Independent Office of Appeals, or file suit.” — Internal Revenue Service, Employee Retention Credit, https://www.irs.gov/coronavirus/employee-retention-credit
The IRS explains: “The amount of your ERC reduces the amount that you are allowed to report as wage expense on your income tax return for the tax year in which the qualified wages were paid or incurred.” — Internal Revenue Service, Frequently asked questions about the Employee Retention Credit, https://www.irs.gov/coronavirus/frequently-asked-questions-about-the-employee-retention-credit
Next step
Fairlight Accounting handles U.S. domestic, cross-border (U.S.–Canada), and international tax returns, plus bookkeeping, payroll, and CFO advisory. Our U.S. Tax Desk reviews paid claims against the eligibility tests and files the wage-deduction amendments both ways. See pricing or book a free fit call.
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