IMPORTANT: Congress is considering legislation that, if enacted, would make several changes to the employee retention credit (ERC). Most notably, the legislation would retroactively bar the filing of any new/additional ERC claims after January 31, 2024. Please consult a professional tax advisor with any ERC-related questions or concerns.
The Employee Retention Tax Credit, also known as the Employee Retention Credit (ERC), is a government initiative designed to encourage businesses to retain their employees during the COVID-19 pandemic. It provides eligible employers with a refundable tax credit based on qualified wages paid to their employees. This credit helps businesses offset some of their labor costs, promoting employee retention.
Here's everything you need to know about the ERC and how it may benefit your business.
What is the Employee Retention Tax Credit?
The ERC is a tax credit designed to help businesses and tax-exempt organizations impacted by COVID-19. To claim the ERC, eligible employers can file an amended employment tax return.
Employers who qualify for the ERC must have experienced either a suspension of operations due to a government order or a significant decline in gross receipts in 2020 or the first three quarters of 2021. There's also a provision for companies that meet the specific criteria for a recovery startup business.
The ERC has seen significant modifications since its inception in the Coronavirus Aid, Relief, and Economic Security (CARES) Act of March 2020. These adjustments came through subsequent legislation, including the Relief Act, the American Rescue Plan Act (ARPA) of 2021, and the Infrastructure Investment and Jobs Act (IIJA). As of 2023, in most cases, ERC eligibility for wages paid after September 30, 2021 has expired.
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What companies qualify for the ERC?
The ERC was designed to help small businesses that lost revenue due to the pandemic, but only some companies are eligible. To qualify, private companies (including nonprofits) must meet one of the following criteria:
- Your business was ordered by a local government to fully or partially shut down in 2020 or 2021.
- Your gross receipts for a single quarter of 2020 fell by 50% versus the same quarter of 2019 (for the 2020 tax credit).
- Your gross receipts for a single quarter of 2021 decreased by 20% versus the same quarter of 2019 (for the 2021 tax credit).
If your company was not in business in 2019, you could use a corresponding quarter in 2020 to show you had a revenue reduction between 2020 and 2021 and qualify for the ERC.
The IIJA led to significant changes in the ERC. The changes brought forth with the IIJA marked the conclusion of the ERC program.
Recovery startup businesses can still claim credit for the third and fourth quarters of 2021. For other employers, however, it’s crucial to stop applying ERC amounts to payroll after September 2021 and reverse any such credits, which should be paid to the IRS.
Which employees count toward eligibility?
For companies with 100 or fewer full-time employees, all of those employees — regardless of whether they are providing service during the designated period — count toward eligibility. For companies with over 100 employees, only full-time employees are being paid but not providing service due to shutdowns and/or a reduction in gross receipts count.
Employers may not claim the same employee for the ERC credit and the Work Opportunity Tax Credit for the same period, nor may they claim the same wages under ERC and the employer credit in section 45S for the Family and Medical Leave Act (FMLA).
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Who does not qualify for the ERC?
According to the IRS website, some taxpayers and organizations are not eligible to claim the Employee Retention Credit, including:
- Employers who experienced supply chain disruptions but did not experience a full or partial suspension of operations by a qualifying order.
- Employers that didn't pay wages to employees during the qualifying time periods.
- Individual taxpayers who are not business owners.
- People who do not have employees.
- Household employers.
- Government agencies.
- Employees.
- Retirees.
These groups generally do not meet the specific eligibility requirements for claiming the ERC, and attempting to claim it improperly could result in penalties and interest. Specific circumstances and requirements should be carefully reviewed to determine eligibility.
How to calculate the size of your ERC
Eligible companies can claim a refundable credit against what they typically pay in Social Security tax on up to 70% of the “qualified wages” paid out to employees. As of January 2021, qualified wages for employers with fewer than 500 employees are those paid to all full-time employees during which there was a full or partial shutdown or a quarter that had a decline in gross receipts. For employers with more than 500 employees, qualified wages only refer to those paid to employees who were not providing services during that same time period. These qualified wages are limited to $10,000 per employee per quarter in 2021; therefore, the maximum ERC available is 70% of $10,000, or $7,000 per employee per quarter.
For example, if you are a restaurant that had a 20% reduction in gross receipts in Q1 2021 versus Q1 2019, you can then request a tax credit of up to $7,000 per employee for the first quarter of the year. If that trend continued through the rest of the year and you have lower gross receipts, you could potentially claim the ERC for Q1 through Q3 of 2021. For a restaurant with 30 employees, for example, the credit could be worth as much as $630,000 in 2021.
Guidelines for new businesses
The ERC now includes recovery startup businesses, which are newly established businesses that began operations after February 15, 2020, and have less than $1 million in average revenue over the last three years. Unlike other businesses, recovery startups do not need to show a decline in revenue or a suspension of operations to qualify for the credit. Recovery startups can claim the credit for the last quarter of 2021, and they are the only businesses eligible for this quarter.
Newly established recovery startup businesses operational after the aforementioned date that meet all guidelines can still claim the ERC for up to $50,000 and exclusively for Q4 2021. No revenue decline or operation suspension is required in such cases.
ERC and PPP can be applied to the same payroll
One of the most significant changes Congress made to the ERC in late 2020 was allowing employers who took first- and second-draw Paycheck Protection Program (PPP) loans to also use the ERC. The PPP provided forgivable loans to small businesses impacted by COVID-19, primarily to cover payroll and other qualifying expenses. The ERC was initially not available to businesses that received a PPP loan, but this rule was later changed.
Today, businesses are no longer eligible for PPP loans, and they are not retroactive (unlike the ERC). However, businesses can still qualify for the ERC even if they received a PPP loan, but they cannot claim the credit against wages paid with PPP loan funds.
How to claim the ERC
Companies looking to claim the ERC must report their total qualified wages, as well as the related health insurance costs, on their quarterly tax returns (Form 941 for most employers). This refundable credit will be taken against the employer’s share of Social Security tax.
Ahead of receiving the credit, employers may opt to retain the value of employment taxes up to the amount of the ERC, rather than depositing it, without penalty. Eligible employers that have fewer than 500 full-time employees can also request advance payment of the ERC using IRS Form 7200. Employers with more than 500 employees are not able to receive an advanceable ERC.
Though the ERC ended on October 1, 2021, businesses can still file for a retroactive ERC refund by Form 941-X. This form can be used to adjust employment taxes filed within three years of the original return or two years from the date the employer paid the tax. Therefore, eligible companies that did not initially claim their ERC could potentially do so through 2024, depending on when they originally filed or paid their business taxes. Employers should keep in mind that this retroactive refund is only available for the 2020 tax year as well as the first three quarters of the 2021 tax year; the eligibility criteria does not apply for Q4 of 2021 nor the 2022 tax year and beyond.
How to avoid ERC scams
As the ERC gained prominence as a valuable COVID-era tax credit, disreputable scammers continue to attempt to exploit businesses and tax-exempt organizations. Falling for such scams can lead to dire consequences, including the obligation to repay the ERC with potential penalties and interest.
The IRS warns against the following signs of a potential ERC scam:
- Misleading statements about “having nothing to lose,” ignoring potential repayment, interest, and penalties.
- Unsolicited calls or ads promoting an "easy application process."
- Claims of determining ERC eligibility within minutes, despite its complexity.
- Advice that goes against your trusted tax professional's guidance.
- Fees based on a percentage of your ERC refund.
- Large upfront fees.
Scammers often distort ERC eligibility requirements, putting businesses at risk of identity theft or a share of improperly claimed credits. To safeguard against ERC scams, educate yourself about the credit's specifics and seek guidance from reputable tax professionals. By remaining vigilant and informed, you can protect your business from falling victim to unscrupulous ERC schemes.
Talk with your accountant or payroll preparer about ERC
While the ERC is a great tool to help struggling businesses reduce their tax burden, it is still a tad complicated to take advantage of it. If you believe your company is eligible, you should immediately speak with your accountant and potentially your payroll preparer. Because the credit size depends on how much you normally pay in Social Security taxes, both your accountant and payroll company can help you determine how much your credit is worth and how much tax should not be paid to the federal government. A financial professional can also help make sure you don’t apply the same payroll for both PPP loan forgiveness and the ERC.
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