The employee retention credit is a new incentive created by the CARES Act to help employers continue to pay their workers during the COVID-19 pandemic. This credit is available to employers that had operations fully or partially suspended due to government orders, or experienced a significant decline in gross receipts. The credit covers up to 50% of qualified wages paid after March 12th, 2020, and before January 1st, 2021.
At first glance, it may appear that this is an incentive that is received tax-free; however, there are important aspects of the employee retention credit that employers need to consider when determining if the credit will be subject to taxable income or not. This guide will provide insight into those considerations and help you determine if you owe taxes on the employee retention credits your business has earned:
What is the Employee Retention Credit?
The Employee Retention Credit is a refundable tax credit for employers equal to 50% of qualified wages (including allocable qualified health plan expenses) that Eligible Employers pay to employees after March 12, 2020, and before January 1, 2021. It was established under the Consolidated Appropriations Act in December 2020 in an effort to support businesses affected by COVID-19.
This credit can be claimed on the employer’s quarterly employment tax return or Form 941. Employers who qualify for the Employee Retention Credit are not required to pay employer payroll taxes on their eligible wages during the taxable quarter in which they become eligible for and claim the credit. For example, if an employer qualifies for wages paid during the third quarter of 2021 and claims a $1 million credit on its quarterly employment tax return (Form 941), it would not be required to pay $2 million in Federal income taxes associated with that wages earned.
The amount of wages taken into account when determining this credit is limited to $10,000 per employee; however, certain employers may receive up to a maximum of $5 million in retention credits each quarter in 2021. The total amount taken into account by all employers for any taxable calendar year (2021) cannot exceed more than $50 billion. Additionally, if an employer received Paycheck Protection Program loans or Small Business Interruption Loans under section 7(a) of the Small Business Act, any Employee Retention Credit claimed must be reduced dollar-for-dollar since such loans are not eligible for a double benefit.
Who is Eligible for the Employee Retention Credit?
As part of the CARES Act, employers can claim a credit of up to $5,000 per employee for each quarter that they maintain their payroll. This credit is designed to provide an incentive for businesses that are financially impacted by the coronavirus pandemic to keep their employees on payroll instead of laying them off or furloughing them. The credit is available for employers that suspended operations due to government orders or those with some kind of economic hardship in 2020.
To be eligible for this employee retention tax credit, employers must meet certain criteria:
- Not be filing any Form 941 or Form 1099-MISC for any period in 2020
- Have half or more than half of their business operations disrupted either due to government restrictions or financial hardship related to the pandemic
- Have an average number of full time employees (FTE) per quarter during 2020 that is at least 20 percent lower than 2019
- Have average wages during 2020 that are at least 20 percent lower than 2019 (not applicable if your number of FTEs was unchanged between 2019 and 2020)
Employers must also have a valid tax identification number on record with the Internal Revenue Service (IRS). Certain types of organizations are not eligible for this tax credit including religious organizations and several nonprofit organizations specified by the IRS. Employers can check with their CPA advisor to determine whether they are eligible.
How Much is the Employee Retention Credit?
The Employee Retention Credit (ERC) is a fully refundable tax credit of up to $5,000 per employee in 2020 and 2021, depending upon the number of employees and amount of wages paid to them during these years.
Under the American Rescue Plan Act of 2021, eligible employers can receive the ERC if they meet all of the requirements listed below:
- Have a trade or business that was partially or fully suspended by a governmental order related to COVID-19 and/or experienced a significant decline in gross receipts.
- Have fewer than 500 employees
- Provide compensation for any period starting after March 12, 2020 through April 30, 2021.
The ERC is calculated based on up to 50 percent of qualified wages paid to each employee for each quarter in 2020 and 2021. The maximum wage limitation for eligible employees is $10,000 per quarter. Eligible employers can use their gross receipts from 2019 as long as those gross receipts were greater than those from the corresponding quarter in 2020 or 2021.
Do You Pay Tax on Employee Retention Credit? No! The Employee Retention Credit is not taxable income and does not need to be included on your annual income tax return. It’s instead treated as an advance refundable credit on your business tax return. This means it reduces (or refunds) any federal income taxes you owe your business when filing its taxes each year.
Does the Employee Retention Credit Need to be Paid Back?
The Employee Retention Credit (ERC) is an employer tax credit offered by the U.S. government, designed to incentivize employers to keep their employees in place when they temporarily cannot operate due to the coronavirus pandemic. The ERC is part of the CARES Act and offers financial relief to affected employers through a refundable payroll tax credit.
To be eligible for this credit, employers must show that their business operations have been impacted by government shutdown or restrictions related to COVID-19 and that they have experienced a significant decline in gross receipts of at least 20 percent compared with the same quarter in the prior year. Employers are also eligible for the credit if their operations were fully or partially suspended due to compliance with governmental orders related to COVID-19 or their gross receipts dropped by more than 50 percent when compared with the same quarter in 2019.
Employers who meet these qualifications can then receive a refundable tax credit of up to $5,000 per employee paid during either of 2020’s quarters (Q2 and/or Q3). The ERC is treated as an expense, so while it is credited against employees’ wages, it does not need to be paid back by either employers or employees on their income taxes – provided they qualify for it subjectively according to Internal Revenue Service (IRS) rules.
Do You Pay Tax on Employee Retention Credit?
Employee retention credits are a tax incentive provided by the federal government to help businesses keep their employees on payroll during the economic downturn caused by COVID-19. The Employee Retention Credit (ERC), enacted in the Coronavirus Aid, Relief, and Economic Security (CARES) Act, allows employers who experienced economic hardship to receive a refundable federal payroll tax credit of up to $5,000 per employee.
The ERC is designed to incentivize employers who keep their employees on payroll during difficult economic times. To be eligible for this credit, employers must fully or partially suspend operations due to government orders or significant decline in gross receipts compared to the same quarter for 2019. These entities may be eligible for a refundable tax credit equal to 50 percent of qualified wages per employee from March 12, 2020 through December 31, 2020 up to $5,000 per employee with an overall maximum of $10 million in credits for any one business taxpayer within the year.
Qualified wages are determined based on whether you had more than 100 full-time employees in 2019 or fewer than 100 full-time employees in 2019. For those with more than 100 full time employees in 2019, qualified wages are wages paid after December 31, 2019 and before January 1, 2021 as long as they meet certain criteria such as payments made while operations were suspended due to government orders; or payments made when gross receipts were reduced by 50% during certain times defined by IRS regulations. For those with fewer than 100 full-time employees in 2019, all wage payments during 2020 are considered qualified wages regardless of fluctuations caused by the pandemic and meet certain other criteria specified within IRS regulations. Employers can use Form 941 Credit Reduction (Z), Form W-2 Wage Reporting (X) and other relevant forms when filing their taxes each quarter and claim refunds if applicable.
Though an employer may qualify for a ERC credit there is no requirement that it pay taxes on these amounts received since this is essentially a refundable tax credit against prior quarters’ taxes paid by the employer that has been temporarily waived per legislation passed pursuant to COVID-19 relief efforts. This differs from most other forms of compensation such as bonuses which would generally require withholdings and taxable income reporting given IRS regulations around miscellaneous income. Employers should review notice 2020 – 21 concerning employee retention credits issued by the IRS along with all applicable legislation pertaining thereto carefully regarding additional details surrounding eligibility criteria / testing; limitations; definitions; phase -outs; key terms & provisions etc before making decisions surrounding payment processing & returns preparation related thereto.
In summary, the Employee Retention Credit is a significant tax benefit for businesses. It is non-refundable and not subject to payroll taxes, so the full amount may be credits toward any applicable federal income tax liability. Businesses should consider consulting with a trusted accountant or tax professional when calculating the amount of credit they can claim or when applying this credit to their overall financial plans.
Additionally, employers should also be aware of applicable state laws, as they may impact eligibility for the ERC. With careful planning and attention to detail, businesses can maximize their savings and avoid potential tax pitfalls associated with the Employee Retention Credit.