The Employee Retention Credit was created as a response to the COVID-19 pandemic and has mutated almost as much as the coronavirus itself. It even has been retroactively terminated by Congress. If only they could do that to the coronavirus and all its variants. Here’s a look at the Employee Retention Credit and how businesses can make the most of it.
What is the Employee Retention Credit?
The federal government created the ERC to help employers keep workers on their payrolls during the coronavirus pandemic. The law gave employers a payroll tax credit equal to a percentage of eligible wages. In other words, it gives employers a dollar-for-dollar cut in what they pay in Social Security taxes. If the credit amounts to more than an employer’s Social Security tax liability, the employer gets a refund from the IRS.
The ERC was created in March 2020 as part of the $1.8 trillion Coronavirus Aid, Relief, and Economic Security (CARES) Act.
It was changed and expanded in December 2020 through the Taxpayer Certainty and Disaster Tax Relief Act, which was part of the $2.3 trillion Consolidated Appropriations Act. The ERC was updated and extended in March 2021 through the $1.9 trillion American Rescue Plan Act. It was changed again in November 2021 through the $1 trillion Infrastructure Investment and Jobs Act.
That last update retroactively ended the ERC as of Sept. 30. Employers who had planned to make use of the tax credit up to Dec. 31, 2021, when it had previously been set to expire, had to adjust accordingly.
A look at Employee Retention Credit basics
The ERC remains a tax credit that employers can claim quarterly to allow a dollar-for-dollar reduction in payroll taxes, which could result in cash refunds. It’s also referred to as the Employee Retention Tax Credit, or ERTC.
In general, this refundable tax credit is more generous to small companies. For 2020, that was defined as an employer with up to 100 workers, and for 2021 the definition of a small company changed to mean up to 500 workers. Employers above those thresholds can take the tax credit, for the appropriate quarters, only for workers who were furloughed but still received pay. Small employers can take the credit for all workers, whether they were furloughed or continued to work.
The tax credit is open to businesses, hospitals, universities, and nonprofit organizations.
To qualify, an employer must have experienced a partial or complete shutdown due to government orders or have seen a certain level of decline in revenue. The decline in gross receipts for a quarter must be more than 50% from 2019 to the same quarter in 2020 or more than 20% from 2019 to the same quarter in 2021.
In general, wages that are subject to FICA taxes, as well as qualified health plan expenses, are eligible.
For these qualified wages, and some health insurance costs, paid from March 13, 2020, to Dec. 31, 2020, the credit can be as high as $5,000 per employee. (The ERC can be applied to 50% of each employee’s wages up to $10,000.)
The credit rose to 70% of qualified wages paid from Jan. 1, 2021, to Sept. 30, 2021. But the $10,000 wage maximum per employee can be applied for each quarter, so the maximum credit is $7,000 a quarter and $21,000 for three quarters.
Who qualifies for the ERC?
Employers might need professional help to determine whether they qualify for ERC, and to what extent, because of the complex regulations. For one example, a business must use a particular formula to show its number of full-time equivalent employees, but the formula is not the same one used to determine FTEs for the Paycheck Protection Program, another federal program to help businesses keep workers on the payroll during the pandemic. (We’ll touch on the PPP loans later in this article.)
Here’s how to get a feel for whether an employer might qualify for ERC.
- From March 13 to Dec. 31, 2020, the employer saw a significant decline in gross receipts, which means they dropped by more than 50% compared with quarterly revenue from 2019.
- From Jan. 1, 2021, to Sept. 30, 2021, revenue dropped by more than 20% compared with the same calendar quarter in 2019. Or, in 2021 revenue dropped in the previous quarter by more than 20% compared with the same quarter in 2019. (For example, if the 20% reduction test applies for the first quarter of 2021, the business can use the ERTC for the second quarter of 2021 even if business had picked up by then.)
- The employer’s activities were suspended or partially suspended by the government at any time between March 13, 2020, and Sept. 30, 2021.
- Also, an employer can qualify as a Recovery Startup Business for the third and fourth quarters of 2021 if it was up and running by Feb. 15, 2020, and maintained an average revenue of $1 million or less. It does not need to meet the standards for mandated shutdowns or revenue drops to apply for the tax credit.
How do I claim the Employee Retention Credit?
Eligible Employers can claim the tax credit on their federal employment tax returns by determining the ERC amount for a pay period and reducing the payroll deposit by that amount. Most of them would do this on Form 941, Employer’s Quarterly Federal Tax Return.
If the credit exceeds the required payroll deposit, the employer files for a refund.
The Internal Revenue Code states that:
“… to claim the new Employee Retention Credit, eligible employers will report their total qualified wages and the related health insurance costs for each quarter on their quarterly employment tax returns, which will be Form 941 for most employers … The credit is taken against the employer’s share of Social Security tax but the excess is refundable under normal procedures.
“In anticipation of claiming the credit, employers can retain a corresponding amount of the employment taxes that otherwise would have been deposited, including federal income tax withholding, the employees’ share of Social Security and Medicare taxes, and the employer’s share of Social Security and Medicare taxes for all employees, up to the amount of the credit, without penalty, taking into account any reduction for deposits in anticipation of the paid sick and family leave credit provided in the Families First Coronavirus Response Act.”
Employers who received Paycheck Protection Program (PPP) loans can claim the ERC for qualified wages as long as the employer did not use those wages as payroll costs in obtaining forgiveness of the PPP loan.
Can I claim the ERC retroactively?
The IRS provides a form that employers can use to file for the tax credit retroactively.
To claim the credit for past calendar quarters, employers must file Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund, for each Form 941 that is being amended.
The IRS issued Notice 2021-20 in March 1, 2021, to give instructions on how to claim the employee retention credit retroactively. It includes guidance on how employers who received a PPP loan can retroactively claim the ERC, too.
Form 941-X would have to be filed before the statute of limitations expires for filing an amended return, which generally is the later of these two occurrences: three years from the original filing date or two years from when the employer paid the tax reported on the Form 941.
The Bottom Line
No matter the size of the company, significant amounts of money are available through the Employee Retention Credit – too much to be put off by the complexities of compiling all the information for the tax forms, filling them out properly and filing them.
The professional wealth advisors at GovCon Wealth, a division of Cope Corrales, can help you navigate those murky waters and reap the benefits.