What Is The Employee Retention Tax Credit?

The COVID-19 pandemic struck businesses hard in 2020, and these effects are still being felt in 2021. While we continue to hope that an end is in sight soon, many small business owners are having to take action now to keep their businesses afloat. Fortunately, Congress has passed several bills that have offered some relief to business owners across the nation.

One form of relief offered to small businesses is the Employee Retention Tax Credit. First introduced in the Coronavirus Aid, Relief, and Economic Security (CARES) Act, this tax credit could be claimed by eligible employers on quarterly tax returns. This program was expanded by the Consolidated Appropriations Act signed into law in December 2020, making the credit accessible to more employers.

In this post, we’re going to break down the Employee Retention Tax Credit. We’ll take a look at how to qualify, how to calculate the amount of your credit, and the changes that were implemented for 2021.

As more guidance is provided by the Internal Revenue Service, we will continue to update this post with the latest changes that may affect your business.

What Is The Employee Retention Credit?

The Employee Retention Credit is a refundable tax credit for employers that was put into law through the CARES Act. This credit is used to offset employment taxes paid by an employer to offer relief due to the coronavirus pandemic.

The Employee Retention Credit is an incentive for employers to keep employees on staff. This credit helps offset employer costs while preserving jobs. The credit is claimed on quarterly tax returns and provides immediate relief to employers by reducing employment tax deposits. In some cases, employers may be eligible to request an advance from the IRS. We’ll go into more detail on this in the next section.

The original Employee Retention Credit outlined under the CARES Act applied to qualified wages paid to employees for the period of March 13, 2020, through December 31, 2020. However, the recent passage of the Consolidated Appropriations Act has extended the credit through June 30, 2021, to eligible employers. This bill also made this credit accessible to more employers and also included some retroactive changes.

We’ll explore these changes throughout this post.

How The Employee Retention Credit Works

The Employee Retention Credit is a refundable tax credit applied to an employer’s employment taxes. Under the CARES Act, employers could claim 50% of eligible wages up to $10,000 paid per employee. In other words, a maximum of $5,000 per eligible employee could be claimed for the period of  March 13, 2020, through December 31, 2020. We’ll break these numbers down further later in this post.

The Consolidated Appropriations Act made some changes for 2021. Now, employers can claim 70% of eligible wages up to $10,000 paid per employee, or a maximum of $7,000 per employee. In addition, this credit can be claimed per quarter for the first two quarters of 2021. This means that an employer can claim a maximum of $14,000 per employee for the period of January 1, 2021, through June 30, 2021. Again, we’ll break these numbers down further to make them easily understandable a little later.

Instead of claiming the credit on an annual business tax return, employers claim this credit when filing their quarterly taxes. This credit reduces employment tax deposits made by employers.

If the amount of the credit exceeds the amount of employment tax deposits due, employers may request an advance payment from the IRS by filing Form 7200 Advance Payments of Employer Credits Due to COVID-19.

How do you know if you’re eligible for this credit? Keep reading to learn who qualifies for the Employee Retention Tax Credit.

Who Qualifies For The Employee Retention Tax Credit?

In order to claim the Employee Retention Tax Credit, there are a few qualifications that businesses must meet. In order to qualify, a business or tax-exempt organization must meet one of the following conditions:

• Business operations were fully or partially suspended as a result of a government mandate OR
• A business had a significant decline in gross receipts

Let’s look at the second condition more closely. For 2020, a “significant decline” is defined as a reduction of at least 50% in gross receipts in a quarter in 2020 when compared to the same quarter in 2019. For example, in Q3 of 2020, a business has gross receipts of $25,000. Gross receipts from Q3 of 2019 were $50,000. This is a 50% decline and therefore, the business would qualify for the credit for any eligible employee (more on that in a minute.)

Extension Under The Consolidated Appropriations Act

As previously mentioned, the Consolidated Appropriations Act extended the Employee Retention Tax Credit through the first two quarters of 2021. Businesses that had to fully or partially suspend operations as a result of a government order are eligible for the ERTC. However, there has been a change in the definition of “significant decline in gross receipts.” For 2021, businesses must reflect a decline of at least 20% when compared to the same quarter in 2019.

Let’s look at an example. A business had gross receipts of $8,000 for Q1 in 2021. In 2019’s Q1, the business had gross receipts of $10,000. This business would qualify for the ERTC.

If you’re a new business and don’t have gross receipts dating back to 2019, you can use gross receipts from the quarter when your business started to compare to Q1 or Q2 of 2021.

Qualifying Wages

In order to receive the ERTC, your business must have paid qualified wages to employees. What counts as qualified wages depends on how many employees your business has.

If your business has more than 100 full-time employees, qualified wages are wages and certain health care costs that were paid to employees that were not providing services during the quarter when operations were suspended or gross receipts had declined. For example, let’s say that your business has 200 employees. Your business was shut down by government order. Of these employees, 50 continued to work from home, 50 were paid a salary but did not work from home, and 100 were laid off without pay. Assuming you meet all other requirements, you could claim a credit for the 50 employees that continued to receive a salary but did not perform work or services for your business.

If your business has 100 or fewer full-time employees, the rules are different. Wages (including certain health care costs) paid to any employee regardless of whether or not they perform work or services for your business may be claimed under the ERTC. Let’s look at another example. Your business has 100 employees. Of those employees, 25 continued to work at the business’ physical location, 25 were allowed to work from home, and 50 were laid off without pay. Assuming your business meets all other requirements, you could claim the ERTC credit for the qualifying wages for the employees that worked at the physical location and that worked from home.

Under the Consolidated Appropriations Act, how qualified wages are calculated will change. Under this new law, businesses with 500 or fewer employees may be able to claim qualified wages even for those employees that continued to work or perform services, provided the business meets all other criteria.

Additional guidance from the IRS regarding this change is expected in the near future, and this article will be updated to reflect any additional changes or information.

ERTC & Paycheck Protection Program Loans

Under the CARES Act, employers that received a loan under the Paycheck Protection Program (PPP) were ineligible to claim the Employee Retention Tax Credit.

A new rule under the Consolidated Appropriations Act now allows employers that received a PPP loan to also claim the ERTC assuming that there is no “double dipping.” Quite simply, this means that you can’t claim the tax credit for wages that were paid with your PPP funds.

For example, let’s say you have 10 employees. Funds from your PPP loan were used to pay utilities and eight of your employees. Your remaining two employees were paid out-of-pocket. The ERTC could be claimed for these two employees.

As previously mentioned, the IRS has yet to release updated guidance on the changes made through the Consolidated Appropriations Act. We will continue to monitor and update this post as needed to reflect any changes or further clarifications.

Additional Requirements

Here are a few last things to keep in mind before applying for the ERTC. If you are self-employed, you can not claim the ERTC for yourself. However, if you have paid qualified wages to your employees, you may be eligible to claim the credit.

Government employers are also ineligible for the ERTC.

You may also not claim the ERTC for any employee for whom you’ve claimed a credit under the Paid Family and Medical Leave Act.

How To Calculate The Employee Retention Credit

Once you’ve determined you’re qualified to receive the Employee Retention Tax Credit, it’s time to calculate the exact amount of your credit. We’ll determine how to do this for 2020, as well as under the new rules for 2021.

Calculating The ERTC For 2020

The ERTC can be claimed for qualifying wages paid to employees during the period of March 13, 2020, through December 31, 2020. To calculate your credit, take the following steps:

1. Determine the time period when your business qualified for the ERTC. This would be when your business was partially or fully closed due to a government mandate or the period when gross receipts declined by at least 50% when compared to the same quarter in 2019.
2. Determine how many full-time employees were paid qualified wages during this time period. Remember, the rules are different depending on the total number of employees in your business.
3. Calculate the wages paid (including eligible health care costs) to each qualified full-time employee during this time period.
4. You can claim 50% of qualified wages for each employee. Qualifying wages are capped at $10,000. In 2020, this means that you can claim a maximum credit of $5,000 per employee for the entire year.
5. Add the total credits of all employees to determine the total amount of your ERTC. This may be claimed on your Form 941 Employer’s Quarterly Federal Tax Return to reduce the amount of your employment tax deposit.
6. If the amount of your credit exceeds the amount of your employment tax deposit, you can request an advance from the IRS by filing Form 7200.

Let’s break this down into an easy example. You have determined that you had two employees on staff that were paid qualifying wages. Each employee was paid $5,000 for the quarter. Since you can claim 50% of qualified wages, you would be able to claim a $2,500 credit for each employee — or a total of $5,000. You then determine that you must pay $6,000 in employment taxes. This credit would reduce the amount owed to just $1,000. This would be recorded on your quarterly tax return, and you would submit it along with your $1,000 payment.

Now, let’s assume the same scenario, but your employment taxes are only $4,000. In addition to using your credit to cover the cost of employment taxes, an advanced payment of $1,000 could be requested by submitting Form 7200 to the IRS.

Calculating The ERTC For 2021

The rules for the ERTC are a little bit different for 2021, but the method for calculation remains generally the same.

1. Determine the time period when your business qualified for the ERTC. For 2021, the quarter must fall within January 1, 2021, and June 30, 2021.
2. Determine how many full-time employees were paid qualified wages during this time period. As mentioned previously, this now allows businesses with 500 or fewer employees to claim a credit for wages paid to full-time employees who continued to work or perform services within the business.
3. Calculate the wages paid (including eligible health care costs) to each qualified full-time employee during this time period.
4. Under the new law, you are now eligible to claim 70% of qualified employee wages. The maximum amount of qualified wages per employee remains $10,000. However, these limits apply per quarter — not for the entire year. This means that you can claim the full credit on qualified wages for Q1 and Q2 if all requirements are met.
5. Add the total credits of all employees to determine the total amount of your ERTC. This may be claimed on your Form 941 Employer’s Quarterly Federal Tax Return to reduce the amount of your employment tax deposit.
6. If the amount of your credit exceeds the amount of your employment tax deposit, you can request an advance from the IRS by filing Form 7200.

Let’s look at the same example under these new rules. You have two employees. Wages of $5,000 per employee were paid in Q1. Since you are able to claim 70% of qualified wages, you could claim a credit of $3,500 per employee — $7,000 total — each quarter.

You determine that you owe $5,000 in employment taxes. In this case, the credit would be applied to your tax liability, and you would be able to request an advance of $2,000.

If the same situation applies in Q2, you can once again claim the credit. Remember, you can claim up to $7,000 per employee per quarter — or a maximum credit of $14,000 per employee for the period of January 1, 2021, through June 30, 2021.

Is The Employee Retention Credit Taxable?

If you claim the ERTC, how will it impact your federal tax return? Per the IRS:

An employer receiving a tax credit for qualified wages, including allocable qualified health plan expenses, does not include the credit in gross income for federal income tax purposes. Neither the portion of the credit that reduces the employer’s applicable employment taxes, nor the refundable portion of the credit, is included in the employer’s gross income.

However, it should be noted that employers that claim the ERTC for an employee cannot claim the Work Opportunity Tax Credit (WOTC) for the same employee. Payroll tax credits claimed under the Families First Coronavirus Response Act (FFCRA) may also be reduced as a result of claiming the ERTC. Learn more about how your specific tax situation will be impacted by speaking with your accountant.

Final Tips On The Employee Retention Tax Credit & Other Coronavirus Relief Options

The coronavirus hit us hard, and many of us are still reeling from the effects. Fortunately, there is some relief that can help ease the burden brought about by this pandemic. The ERTC is just one way to help keep your business on track. Be sure to take advantage of other coronavirus relief options like the Economic Injury Disaster Loan or the Paycheck Protection Program to help keep your business afloat.

In addition to checking out our resources about COVID-19 relief, don’t forget about your taxes. Got a PPP loan or EIDL Advance and don’t know how to proceed with your return? Check out our post, Are PPP Loans & EIDL Grants Taxable?, to learn more about how these relief options affect your tax return.

Before you file, don’t forget to check out the top 30 tax deductions for small business owners. In this crazy world, every penny counts — so make sure to keep more money in your business and in your pocket by maximizing your tax return. Good luck!

Employee Retention Tax Credit FAQs