How To Qualify For The Employee Retention Tax Credit

Your small business is (hopefully) finally starting to recover from the losses the COVID-19 pandemic and the strain the years 2020/2021 have caused, and you have begun collecting all of your information as 2022 comes to an end. While you are preparing for tax season, you may find yourself asking, who qualifies for employee retention credit?

If you fought to keep your employees on your payroll during 2020 and 2021, there’s a good chance that you qualify for the refundable payroll tax credit, the Employee Retention Credit (ERC)!

This article will explain what the ERC is, who is eligible to claim the ERC, what qualified wages are, who doesn’t qualify for the ERC, and what your next steps are after qualifying for the ERC.

What Is The Employee Retention Tax Credit? The Quick Answer

The employee retention credit (ERC) program was created under the Coronavirus Aid, Relief, and Economic Security (CARES) Act in 2020. The ERC was designed to incentivize small businesses with a refundable tax credit for keeping their staff on payroll during the economic shutdown. This program has since ended, but you can still claim the 2020 ERC until April 15th, 2024, and the 2021 ERC until April 15th, 2025.

The ERC that can be claimed is for wages paid. In 2020, that can be as high as $5,000 per employee; wages paid in 2021 can be as high as $21,000 per employee.

Businesses that qualify for the ERC can look back at wages paid after March 12th, 2020 through September 30th, 2021 (or December 31st, 2021 for certain businesses) to see if they would be considered eligible.

Who Qualifies For The Employee Retention Credit?

Any eligible business that paid qualified wages to their employees in 2020 or 2021 can claim the ERC. But there are different rules for 2020 and specific parts of 2021.

If you did not qualify in 2020 or even the first calendar quarter of 2021, there’s still a chance you could qualify under the changes made by three different acts in 2021.

If your business was fully or partially shut down due to a governmental order during any part of 2020 and/or the business’s gross receipts in any quarter of 2020 declined 50% or more relative to the same quarter of 2019, AND you kept 80% of your employees on your payroll, you may qualify for the ERC according to the IRS and U.S. Department of The Treasury.

What Are Qualified Wages?

Qualified wages have to have been paid or incurred from March 12th, 2020 through September 30th, 2021 (or December 31st, 2021 if you are considered a recovery startup business).

This includes:

• Cash wages (salaries, hourly wages)
• Vacation pay
• Tips that total over $20 in a calendar month
• Other wages taxable under FICA
• Certain health insurance expenses 

Wages that are not considered qualified include (but are not limited to)

• Payments to former employees
• Wages paid to relatives
• Worker Opportunity Tax Credit employee wages
• Employer wages/salaries
• Tips amount to less than $20 in a calendar month
• Wages forgiven or expected to be forgiven by a Paycheck Protection Program (PPP) loan

Learn more about how ERC and PPP interact in our complete guide.

Qualifying For The ERC For Wages Paid In 2020

In order to retroactively apply to receive ERC for the year 2020, there are several specific requirements your small business must have met.

Keep in mind that there was only one iteration of the ERC in 2020 while there were three different acts that changed the qualifications for the ERC in 2021.

• Qualified wages must have been paid to employees:
  • Between March 13 – December 31, 2020.
• Eligible employers are:
  • An employer operating a trade, business, or tax-exempt organization and NOT governments, their agencies, and instrumentalities.
• In order to meet eligibility requirements:
  • Your business has to have experienced full or partial suspension of operations due to a government order due to COVID-19 during any quarter, or a significant decline in gross receipts.
• The percent of qualified wages eligible for credit is:
  • 50% of qualified wages of $10,000 per employee ($5,000) for the year including certain healthcare expenses are eligible for credit.
• If you had 100 or fewer average full-time employees in 2019:
  • All wages paid to employees both providing services and not providing services are qualified wages.
• If you had more than 100 average full-time employees in 2019:
  • Wages paid to employees not providing services are qualified wages.

Qualifying For The ERC For Wages Paid In 2021

We’ll break down the following section by each of the three acts that altered the ERC in 2021. Note that the qualifications were the same from 2020 to 2021 unless noted otherwise.

The Relief Act of 2021

• Qualified wages must have been paid to employees:
  • Between January 1 – June 30, 2021.
• Eligible employers:
  • Meet the 2020 requirements
  • Can now be certain governmental employers that are Organizations described in section 501(c)(1) and exempt from tax under section 501(a), and colleges or universities or whose principal purpose is to provide medical or hospital care.
• In order to meet the eligibility requirements:
  • Your business was eligible according to the 2020 requirements.
  • Your business had to see a decline in gross receipts defined as a quarter where gross receipts are less than 80% of the same quarter in 2019.

*Note: A new rule stated that if your business was not in existence in 2019, you could use the corresponding calendar quarter in 2020 to determine whether there was a decline in gross receipts.

• The percent of qualified wages eligible for credit is:
  • 70% of qualified wages of $10,000 per employee ($7,000) per calendar quarter including certain health care expenses.
• If you had 500 or fewer average full-time employees in 2019:
  • All wages paid to employees both providing services and no providing services are qualified wages.
• If you had more than 100 average full-time employees in 2019:
  • Wages paid to employees not providing services are qualified wages.

The American Rescue Plan Act of 2021

• Qualified wages must have been paid to employees:
  • Between July 1, 2021 – December 31, 2021.
• Eligible employers:
  • Meet the 2o20 and 2021 first calendar quarter requirements.
• In order to meet eligibility requirements:
  • Your business had to see a decline in gross receipts defined as a quarter where gross receipts are less than 80% of the same quarter in 2019. (If your business was not in existence in 2019, you could use the corresponding calendar quarter in 2020 to determine whether there was a decline in gross receipts.)
  • Your business is considered a “recovery startup business,” employers who didn’t meet the eligibility criteria of full or partial suspension or decline in gross receipts. These are businesses that began carrying on any trade or business after February 15, 2020, had average annual gross receipts under $1,000,000 for the 3-taxable-year-period ending with the taxable year that precedes the calendar quarter for which the credit is determined, and do not meet the other eligibility criteria.
• The percent of qualified wages eligible for credit is:
  • Unchanged.
• For the third and fourth calendar quarters of 2021:
  • “Severely financially distressed employers” may treat all wages as qualified wages during the calendar quarter in which the employer is severely financially distressed.
• Severely financially distressed employers are:
  • Eligible employers due to a decline in gross receipts, but with gross receipts that are less than 10% of the gross receipts in a calendar quarter as compared to the same calendar quarter in 2019.
• If employers were not in existence in 2019:
  • They may use the average number of full-time employees in 2020 to determine whether the employer had greater than 500 average full-time employees.

Infrastructure Investment and Jobs Act (IIJA)

• Qualified wages must have been paid to employees:
  • Between October 1 – December 31, 2021 only by a recovery start-up business.
• Eligible employers:
  • Meet all previous requirements.
• In order to meet eligibility requirements:
  • You must be considered a recovery startup business.

Note: A new rule removed the requirement for fourth calendar quarter that a recovery startup business not otherwise be an eligible employer due to a full or partial suspension of operations or a decline in gross receipts.

• The percent of qualified wages eligible for credit is:
  • Unchanged.
• For the fourth calendar quarter of 2021:
  • Rules relating to severely financially distressed employers no longer apply.

Qualifying For The ERC In 2020 VS 2021

As you can see from the section above, there are a lot of differences in qualifications for the ERC between 2020 and 2021. All in all, the differences made the credit more widely available to different businesses impacted by the economic shutdown in 2020 and the resulting hardships in 2021.

Who Doesn’t Qualify For The Employee Retention Tax Credit?

The businesses that don’t qualify for the ERC by one of the many, many eligibility requirements available include (but are not limited to) government entities, self-employed individuals who have no employees to pay wages to, any business that wasn’t impacted by COVID-19 related economic shutdowns, essential businesses that had to remain open, any business who didn’t lose major profits in 2020 or 2021.

Next Steps After Qualifying For The Employee Retention Credit

Now that you have a better idea of whether or not your business qualifies for the ERC, you may be wondering what your next steps are.

The most important step is to apply for the ERC!

Before you are able to do this, you will need to collect your payroll information from 2020 and/or 2021 for each quarter you will be claiming the ERC. You can collect this information from your own hard copies or from the tax information in your accounting software. It may also be helpful to have physical copies of the taxes you filed in 2020 and 2021 if you are preparing to work with a new service or accountant this tax season. Need help filing your taxes? We have you covered with our article The Complete Tax Guide For Small Businesses.

The IRS has created Form 941-X exactly for the purpose of amending your 2020/2021 tax returns to claim the ERC.

Once you have completed the Adjusted Employer’s QUARTERLY Federal Tax Return or Claim for Refund form, you can file it with the IRS on your own or use the paid preparer you prefer for your taxes.

Companies like Lendio have begun offering services to help streamline the process of applying for the ERC. Find out the best options for ERC funding before you take the next step. (You can check with these services, too, if you have also received PPP loans.)

The majority of these companies partner with ERC experts who can determine if you qualify, help you navigate the tax laws, help you calculate your refund, and then ensure that your ERC application is processed and that you receive your credits within 2-8 months!

FAQs About Who Qualifies For Employee Retention Credit