Employee Retention Credit is a tax benefit offered by the US Government to encourage businesses to keep employees on payroll during the COVID-19 pandemic. This credit can be taken as a refundable tax credit of up to 50% of an eligible employer’s qualified wages, including health plan expenses, that are paid in 2020 and 2021 while certain government mandated closures are in effect.
In general, businesses are not taxed on Employee Retention Credit received. However, depending on how the Employer Retention Credit is utilized and the circumstances of the business, taxes may need to be paid in some cases. This guide will provide an overview of:
- When the Employee Retention Credit requires taxes to be paid
- Who is eligible for this credit
- Other pertinent information about applying for and using this credit.
What is the Employee Retention Credit?
The Employee Retention Credit (ERC) is a refundable tax credit that helps businesses keep their employees on payroll while they face economic hardship amid the coronavirus pandemic. The ERC encourages businesses to keep employees connected by providing them with part of the cost of providing their service or goods.
For taxable years 2020 and 2021, employers are eligible for a refundable ERC equal to 50% of qualified wages paid up to $10,000 in a calendar quarter, for a total maximum credit of $5,000 per employee. Qualified wages can include remuneration that is paid to an employee for providing services during the coronavirus crisis period and includes certain health plan expenses.
Businesses can take advantage of the ERC by claiming it against Social Security taxes they are liable for under Section 3111(a) or Railroad Retirement Tax Act taxes they are liable for under section 3221(a). The amount that can be claimed as an ERC each calendar quarter cannot exceed the employer’s share of these taxes (6.2% multiplied by qualified wages). In addition, if you have received Coronavirus Aid, Relief and Economic Security (CARES) Act funds through the Paycheck Protection Program (PPP), you may be excluded from claiming both the PPP loan forgiveness deductions and the ER Tax Credit in one tax year.
As part of its expanded provisions, qualified employers may also be able to use the Employee Retention Tax Credit against income tax withholdings from their own pocket as well as some existing overpayment credits previously used on Form 941 deposits. It is important to remember that no taxable wages taken into account for purposes related to any other federal tax credit like earned income tax may also be taken into account for purposes related to ERCs.
What Types of Businesses Qualify for the Employee Retention Credit?
The Employee Retention Credit (ERC) is designed to help businesses, including non-profit organizations, retain their employees during the COVID-19 pandemic. The credit is for employers whose businesses are operating at a significant decline due to the pandemic.
“Eligible employers” are those that meet one of the following criteria:
- Their gross receipts have declined by more than 20% in any quarter of 2020 compared with their gross receipts from a corresponding quarter of 2019.
- Operating and/or suffering financial hardship due to an order from an appropriate governmental authority limiting commerce, travel or group meetings due to COVID-19 that restricts the eligible employer’s business operations during any calendar quarter in 2020.
- With fewer than 500 employees and either saw restrictions on their business operations as a result of coronavirus regulations or had reduction in their year over year gross receipts by more than 50%.
Businesses must ensure they meet all requirements in order to be eligible for this credit, including tax filing requirements related to the payroll taxes used to claim ERCs. Employers should also review applicable state and territorial compliance rules that may also apply for employee retention credits for workers outside of the Federal government jurisdiction when claiming ERCs as part of their taxes. Failure to comply with these requirements could lead to additional costs or penalties being assessed on top of Federal obligations owed when claiming this benefit.
How to Calculate the Credit
Once an employer completes the process of determing their eligibility for the Employee Retention Credit, the next step is to calculate the amount of credit they are due. The key factors when doing so are:
- Qualifying wages: All wages paid to each employee for work performed from March 13 until December 31 up to $10,000 in total wages per employee during that time period are eligible for the credit.
- Calculating Credit: Employers may take a 50% credit (on a maximum of $10,000 in jobs costs), of up to $5,000 in payroll taxes – Social Security and Medicare – that were not already forgiven through government stimulus programs. That means $50,000 of wages incurred would give you a credit worth up to $5,000. Tax credits act like direct payment against payroll taxes due in future quarters of 2021 or potentially towards any 2020 tax liability owed by employers partially offsetting other quarter liabilities or balances to zero in certain instances. Note that all self-employment taxes imposed are also eligible for this credit if employers did not receive other relief through the PPP program.
- Additional Information: Employers must also keep records about total number of employees (full and part-time) and total wages paid so that demonstrating compliance is possible should it be requested during or after filing return or application with IRS or Treasury Department respectively regarding Employment Retention Credit usage.
Do You Have to Pay Tax on Employee Retention Credit?
The Employee Retention Credit is a refundable tax credit available to many employers to help them retain employees during the current pandemic. However, it is important to understand the rules and regulations of the program, especially when it comes to paying taxes on the credit.
In this article, we will discuss the tax implications of using the Employee Retention Credit:
Tax Treatment of the Credit
The Employee Retention Credit was established to assist employers who have experienced a significant decrease in gross receipts or continue to keep their workers employed despite the economic hardship caused by the COVID-19 pandemic. This credit is intended to offset some of the costs of keeping employees on the payroll during this difficult period.
The credit is generally claimed as part of any eligible employer’s quarterly estimated taxes; however, there are a few important points to understand concerning how these credits may be treated for tax purposes.
Tax Treatment of the Credit
- Generally, an employer must take into account 50 percent of any employee retention credit it claims when calculating its federal employment tax liabilities for both current and future quarters. This means that if an employer claims $50,000 worth of employee retention credits on current quarter’s estimated taxes, then it will have $25,000 in reduced federal employment tax liabilities for that quarter and all subsequent quarters until such time as it exhausts the $50,000 in credits or there are no longer any eligible employees or wages from which to claim additional credits.
- The remaining 50 percent portion of any employee retention credit not applied against future employment taxes can then be used as a dollar-for-dollar reduction in total deposits due that must be made with Form 941 (as opposed to being refunded) when those deposits are made.
How to Claim the Credit
If employers meet the conditions of the employee retention credit, they are eligible to receive up to $7,000 for employees who were on their payroll for all of 2020. Employers must fill out Form 941C, Employer’s Credit for Employee Retention in 2021, which can be used to offset employment taxes. This form must be filled out and submitted by the due date on the form – April 30thm 2021 – or within three months from when the employer pays wages in order to claim the credit.
Employers should subtract any amount that was already included in their quarterly deposits from total wages paid when calculating their wage reduction under Form 941C, or if they have claimed it as a payroll tax credit on their tax return. If employers have not yet filed a tax return for 2020, they may use the tax liability reduction authority provided by Section 2302 of The Coronavirus Aid, Relief, and Economic Security (CARES Act).
In order to receive this credit an employer must retain eligibility requirements including having operations partially suspended or gross receipts declines by at least 20% compared with equivalent quarters in 2019. They must also pay employee salaries and wages during these quarters including health plan expenses and qualified retirement plan expenses that otherwise qualify for payment during the given period. Other qualifying criteria include those outlined by section 3114(a) of the Internal Revenue Code (IRC).
In conclusion, the CARES Act established the Employee Retention Credit. It is available for eligible employers who pay wages to retain employees on their payroll during 2020. The credit does not need to be repaid if used appropriately and gives eligible employers a refundable tax credit against their employer’s quarterly employment taxes equal to 50% of the qualified wages that are paid after March 12, 2020, and before December 31, 2020.
The IRS provides guidance on computing the number of employees for purposes of claiming the employee retention credit under sections 2301 and 2302 of the CARES Act, as well as how to file IRS Form 941 (Employer’s Quarterly Federal Tax Return) correctly in order to receive the credit. Employers should review applicable instructions, forms and publications carefully before taking advantage of this opportunity.