Critical Risk Analysis: Employee Retention Credit Compliance and Foreign Currency Exposure Mitigation

The Employee Retention Credit (ERC) operates under its own distinct rules, completely separate from foreign currency tax treatment. IRS guidance for the ERC focuses solely on eligibility based on business operations during specific periods and procedures for claiming the credit. It contains no provisions addressing foreign currency gains, losses, or translation effects associated with ERC claims or related payroll expenses. This means the ERC framework itself ignores currency fluctuations entirely.

Conversely, foreign currency transactions involving the ERC are governed by entirely different tax rules under Section 988 of the U.S. tax code. These rules mandate that gains or losses arising from currency exchange rate changes between the time a liability (like payroll taxes) is incurred and when it's paid must be calculated and reported as ordinary income or loss. Taxpayers can sometimes elect capital gain treatment for certain contracts, but the default is ordinary income treatment. This currency impact applies regardless of whether the ERC credit is claimed.

The practical implication is clear: companies must process ERC claims and foreign currency translation entirely independently. Applying ERC rules to handle currency effects, or expecting Section 988 rules to adjust the ERC credit amount, constitutes regulatory misapplication. Failure to recognize this separation exposes businesses to significant risk. Incorrectly treating foreign currency gains or losses in relation to the ERC could lead to substantial tax penalties, interest charges, and potentially trigger compliance scrutiny from the IRS. Accurate calculation of Section 988 impacts on payroll liabilities is crucial before claiming the ERC to avoid these financial and regulatory consequences.

Operational Compliance Risks and Litigation Exposure

The Employee Retention Credit (ERC) program presents immediate cash-flow risks tied to strict regulatory deadlines. Taxpayers must file any claims for Q3 and Q4 2021 by January 31, 2024, per the One Big Beautiful Bill Act (OBBBA). While those who received refunds before July 4, 2025, can initially keep the funds, the IRS may demand repayment if those claims are later disallowed during compliance actions. This creates significant liquidity pressure; businesses might face sudden, large tax bills requiring immediate cash settlement.

IRS enforcement prioritizes eligibility disputes over other issues. Its litigation resources focus solely on whether businesses met the ERC's qualifying criteria, like experiencing significant revenue decline or full/partial operational suspension. Critically, the IRS does not consider foreign currency fluctuations in its ERC determinations. This narrow focus means companies with complex international operations won't get relief for FX impacts but also won't face unexpected penalties from unrelated currency translation adjustments. The repayment obligation remains a hard cash drain, however, demanding careful reserve planning.