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Employee Retention Credit: Can Your Small Business Benefit?

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The Employee Retention Credit is one of the most important new tax credits to help small businesses suffering in the wake of the coronavirus pandemic. It provides a dollar-for-dollar reduction in an eligible company’s payroll tax liability that owners can take advantage of immediately. However, there are limitations on who qualifies for the tax credit and how much you can receive.

What is the Employee Retention Credit?

The Employee Retention Credit (ERC) is a refundable tax credit established as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act as an incentive for employers to maintain their payroll while their operations were partially or fully suspended due to COVID-19 restrictions. The ERC is one of three new credits created by the CARES Act and an earlier relief measure known as the Families First Coronavirus Response Act.

Background

Initially, the ERC could be claimed against 50% of up to $10,000 of qualified wages (including qualified health plan expenses) paid between Mar. 13, 2020, and Dec. 31, 2020. That made the maximum credit $5,000 per employee in 2020. Small business owners also had to decide between claiming the tax credit or accepting a Paycheck Protection Program (PPP) loan.

In December 2020, Congress expanded the ERC, allowing employers who qualify to claim a credit against 70% of qualified wages paid. That limit applies to $10,000 of wages per employee per quarter for the first two quarters of 2021. This initial expansion made the maximum credit worth $14,000 per employee in 2021.

Employers who received a PPP loan were also allowed to claim the ERC, as long as the same wages aren’t used for claiming the ERC and requesting forgiveness of the PPP loan. This change was retroactive to March 27, 2020.

What’s new

The American Rescue Plan (ARP) Act of 2021 expanded the ERC once again. The credit remains at 70% of up to $10,000 in qualified wages per quarter but Congress extended the credit to apply to all four quarters of 2021. So, an eligible employer can claim $28,000 per employee for 2021.

How the ERC works

The ERC is refundable, so employers may get a cash refund if the credit amount exceeds the amount of employment taxes owed. The credit does not only limit the business’s tax liability but can also provide an immediate reimbursement of funds, said Linda Farinola, president of Princeton Financial Group in New Jersey.

“To some extent, it’s reducing your taxes, and to some extent they’re giving the business money to put toward salaries,” she said.

EXAMPLE

In the fourth quarter of 2020, ABC Supply had 10 employees who earned a total of $500,000. ABC Supply would typically be required to pay the federal government 6.2% of that, or $31,000 in Social Security payroll taxes. ABC is eligible for an ERC of $50,000 (10 employees x $10,000 in wages x 50%). So ABC Supply’s fourth-quarter Social Security tax liability would be zero, and ABC could get the remaining $19,000 as a refundable credit.

In the first quarter of 2021, ABC Supply still had 10 employees earning a total of $500,000 and met all of the eligibility requirements to claim the credit. The company would be eligible for an ERC of $70,000 (10 employees x $10,000 in wages x 70%). For Q1 2021, ABC would owe no Social Security taxes and receive the remaining $39,000 as a refundable credit.

How to qualify for the ERC

Private-sector businesses and tax-exempt organizations, such as nonprofits, may qualify for the tax credit, regardless of size. To be eligible for the ERC in 2020, businesses must pass one of two tests:

  • Operations have been fully or partially suspended under government orders related to the COVID-19 pandemic during any quarter of 2020.
  • The business has experienced a significant decrease in revenue during any quarter of 2020. The IRS defines a significant decrease as a 50% or greater drop in gross receipts compared to the same quarter in 2019. The decline would end when gross receipts are at least 80% of what the business earned in the same quarter last year or when the first quarter of 2021 begins.

For 2021, the eligibility rules changed slightly so the two tests are:

  • A full or partial suspension of operations of business operations due to a government order, or
  • A decline in gross receipts during the calendar quarter, where gross receipts for that quarter are less than 80% of gross receipts for the same quarter in 2019 (or less than 50% of gross receipts from the same quarter in 2020 if the business didn’t exist in 2019).

The tests are calculated each calendar quarter because businesses file employment taxes on a quarterly basis, Farinola said. If your business does not qualify during one quarter, you may still qualify in another quarter, should your business circumstances change.

SIZE REQUIREMENTS

The tax credit may only be applied to certain employees’ wages, depending on your workforce’s size. For claiming the ERC in 2020, those size requirements depend on the number of employees in your business.

  • More than 100 full-time employees: Only wages of full-time employees who are earning a paycheck but not providing a service because the business is closed or experiencing a significant drop in revenue would count toward eligibility.
  • 100 or fewer full-time employees: Wages of all employees earning a paycheck would count toward eligibility, regardless of whether they are providing a service.

For 2021, the same rules apply, but the threshold increases to more than 500 full-time employees and 500 or fewer full-time employees.

Businesses with a larger number of full-time employees who earn relatively low wages may be able to get the most out of the tax credit, Farinola said. “This would be an avenue where they would at least be able to pay their employees and at least get some money back from the government in the form of that refundable credit to keep the employees on the payroll,” she said.

HOW TO APPLY

Eligible employers must file IRS Form 7200 to request an offset in advance of their tax credit when reporting their quarterly payroll tax. You would submit the request along with Form 941, the quarterly federal tax return for employers.

Businesses ineligible for the Employee Retention Credit

Household employers and self-employed people are not eligible for the ERC. However, if you are self-employed but you employ others and meet the requirements, you may be eligible based on wages paid to your employees, but not your own earnings.

Another option: Even if you are not eligible for the credit, the CARES Act allows all employers to defer payment of Social Security tax and certain self-employment taxes in 2020. You’d owe 50% of the deferred amount by Dec. 31, 2021, and the remaining 50% by Dec. 31, 2022.

FAQs about the ERC

Can I get the Employee Retention Credit and a PPP loan?

Initially, employers were not eligible for the ERC if they received a Paycheck Protection Program loan.

Congress later lifted the restriction, allowing eligible employers to take advantage of both the ERC and Paycheck Protection Program, as long as the employer didn’t use the same wages to claim both the ERC and PPP loan forgiveness. Legislation made this change retroactive to Mar. 27, 2020.

What are qualified wages?

Qualified wages encompass compensation, including health plan expenses, paid to part-time and full-time employees between Mar. 12, 2020, and Dec. 31, 2021. If you have more than 100 full-time employees, only wages paid while employees were not providing a service qualify for a 2020 ERC. If you have 100 or fewer full-time employees, wages paid to any employee qualify for a 2020 ERC, regardless of whether they provided a service.

In 2021, employers with more than 500 full-time employees can only use wages paid while employees were not providing a service to calculate the ERC. Employers with 500 or fewer full-time employees can use any employee wages, regardless of whether they provided a service.

Do I need to provide documentation to the IRS after receiving the Employee Retention Credit?

The IRS has not indicated business owners need to provide additional documentation after receiving the tax credit. However, you should document your revenues, payroll and employment information from 2019, 2020, and 2021 in the event there is a question. “That could always happen. It’s best practice to keep those records to make sure you qualify,” Farinola said.

Is my business eligible for additional tax credits?

Businesses can claim tax credits to cover qualified leave wages for employees who take paid sick, family or medical leave for reasons related to COVID-19. Employers may receive both the ERC and the paid family and medical leave credit, but not for the same wages. You cannot apply both credits to the same wage payments.

These credits are available in addition to expanded tax credits for net operating losses (NOLs) and donations made by corporations to charitable organizations.

 

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