Overview of Employee Retention Tax Credit
The Employee Retention Tax Credit (ERTC) is a refundable tax credit that helps employers cover the cost of wages paid to their employees. It allows businesses to reduce their federal income tax liability and maximize their cash flow with a credit equal to as much as $7,000 per employee.
This section will provide an overview of the Employee Retention Tax Credit and how to calculate it.
What is the Employee Retention Tax Credit?
The Employee Retention Tax Credit is an incentive designed to encourage employers to continue paying their employees during the COVID-19 pandemic. This is a refundable tax credit, meaning if the total amount of the credit exceeds taxes owed by the employer, then the employer may be eligible to receive a refund for any unused portion of the credit. The Employee Retention Tax Credit is available for wages paid between March 12, 2020 and December 31, 2020.
The amount of the credit is a percentage of Qualified Wages Paid and Eligible Health Plan Expenses. The percentage varies depending on how many full-time employees (FTEs) are employed:
- 50% of Qualified Wages Paid and Eligible Health Plan Expenses for employers with fewer than 100 FTEs at the beginning of 2020; OR
- 40% of Qualified Wages Paid and Eligible Health Plan Expenses for employers with 100 or more FTEs at the beginning of 2020.
Qualified wages consists wages paid (including qualified health care plan expenses) up to $10,000 per employee in any calendar quarter after March 12, 2020 and before January 1, 2021.. Additionally there are calculation provisions related to determining when employers are ‘open’ or ‘closed’. To be ‘open’ criteria must meet one or more tests such as due to governmental order businesses need to suspend operations or gross receipts have declined from a prior period. If your business was closed in any calendar quarter then you are not eligible for that quarter but still may be able to claim it in another if it satisfies one or more tests discussed above..Lastly there are rules related claiming this for certain employees such as certain disciplinary changes ineligible full-time equivalent employees etc..
Employers should consult with their tax advisors regarding eligibility requirements and proper claiming procedures additional information can also be found on IRS website regarding payroll tax credits specifically related to businesses effected by COVID-19 pandemic as well as instructions provided on form 941 used to claim these credits.
In order to be eligible for the Employee Retention Tax Credit, you must meet certain criteria. The following requirements must be met:
- You are a for-profit entity in operation on February 15, 2020. This includes corporations and S-corporations as well as some organizations exempt from federal income tax such as churches, agricultural and horticultural organizations, certain homeowners’ associations, and tribal entities.
- You have experienced either a full or partial closure due to mandated government restrictions related to COVID-19 or experience a significant decline in gross receipts of 50% or more when comparing the same quarter of 2019 with 2020.
- You pay wages to employees after March 12, 2020 and before January 1, 2021 that are no more than $10 million for all calendar quarters in 2020.
- You retained employees during any period when both the eligibility requirements were met, but did not lay off employees between March 12th-December 31st of this year. In other words, you kept at least 90% (or fewer) of your previous employees during that time period.
- The wages paid out qualify as wages creditable under IRC Section 3111(a) & 3121(a).
Calculating the Credit
The employee retention tax credit is designed to help businesses keep their employees during the economic downturn created by the COVID-19 pandemic. The credit is based on the amount of wages paid to each employee and can be claimed for wages paid from March 12, 2020 to Dec. 31, 2020.
To calculate the credit, employers must first determine their qualified wages and qualified health plan expenses. Let’s look at the details of how to do this:
Calculating Qualified Wages
The Employee Retention Tax Credit (ERTC) is a federal incentive provided under the Coronavirus Aid, Relief and Economic Security (CARES) Act. The purpose of the ERTC is to incentivize businesses to retain employees on their payroll during the economic crisis caused by COVID-19. Eligible employers can claim a refundable tax credit that is equal to 50 percent of qualified wages paid to employees between March 12, 2020, and December 31, 2020.
Calculating Qualified Wages
To qualify for the ERTC, employers must pay “qualified wages” to individuals performing services in the United States during an eligible period. Generally speaking, qualified wages are those wages paid to an employee in connection with services performed by such employee during an eligible period subject to certain limits depending on an employer’s size and applicable calendar quarter.
Qualified wages include health plan expenses that are properly allocable to qualified wages paid but do not include amounts allocated by an employer’s general ledger system for its self-insured group health plan on a pro rata basis or amounts that constitute retirement or fringe benefit contributions made to any plan or arrangement described in paragraph one of Section 3121(a) of the Internal Revenue Code (IRC). Additionally, the cost incurred for providing group health care coverage does not include payments from a governmental entity related solely to coverage under specified state or local laws requiring employers to provide health care benefits for employees and their family members.
Eligible employers may also claim qualified wages if they have furloughed employees but have continued benefits such as insurance towards them through December 31st, 2020. The amount of these kinds of qualified wages must be based on what would have been treated as paid had the individual received his/her salary without interruption without regard for whether any particular payment occurs before or after December 31st. Further guidance should be sought in determining whether benefits received through furlough offer eligibility for this tax credit.
Calculating the Credit Amount
The Employee Retention Tax Credit is a federal program that can provide eligible employers with a dollar-for-dollar refundable tax credit for wages paid to employees between March 13, 2020 and December 31, 2020. The credit is equal to 50% of qualified wages up to $10,000 in total wages per employee, excluding health plan costs.
To calculate the credit amount:
- Start with your total qualified wages paid between March 13, 2020 and December 31, 2020. Qualified wages are defined as those paid to employees for services performed while the operations were fully or partially suspended due to a COVID-19 related governmental order, or if gross receipts declined by more than 50%. This includes salary, hourly pay and/or other compensation such as sick pay or vacation pay that is attributable to an employee’s work for the employer. Health plan costs are not considered in determining qualified wages.
- Calculate your credit rate by multiplying .50 (50%) by your total qualified wages from Step 1. Your credit rate is limited to $5,000 per employee (not including health plans costs) – this is considered your maximum eligible per employee credit rate and no more than $5K can be claimed in any given quarter for each employee. Short quarters and periods lag may affect calculations based on eligible payroll periods/pay dates under each scenario; please consult a tax advisor if facing special circumstances).
- Take the lower of Steps 2 or 3 and enter into IRS Form 941 filing OR 943 filing when applicable (employers subject to heavy highway vehicle use excise tax). Additionally you may need additional information in order qualify such as their employer identification number (EIN), full legal name etc., for more exact calculations consult with a professional tax advisor / CPA as needed when preparing returns earlier this year/year ahead returns scheduling process which should do at least annually on best practice sound bookkeeping management principles.
Maximum Credit Amount
The maximum credit available for an employer is generally equal to 50% of the qualified wages paid between March 12 and December 31, 2020, for each employee who meets the eligibility criteria.
For wages paid after December 31, 2020 and before January 1, 2023, the maximum credit is available on up to $14,000 that must be included in the calculation of qualified wages. The maximum credit amount will be decreased if there are eligible wage payments made during both 2020 and 2021. For example, if a business has $50,000 in qualified wage payments split between 2020 and 2021, then their maximum credit would be reduced to $35,000 ($25K (50%) for the 2020 wages + $10K (20%) for the 2021 wages).
In addition to the limitations on payroll costs experienced by businesses unable to pay salaries at pre-pandemic levels due to economic disruptions caused by the coronavirus pandemic (such as decline in revenues), businesses that qualify for this tax credit may not have sufficient profits from which to make tax payments without incurring additional debt in order to fund operations. It is important for employers affected by these economic disruptions to consider whether or not availing themselves of this tax deferral will result in an increase or decrease in their net operating income when calculating whether or not they should accept aid through this program.
Claiming the Credit
The Employee Retention Tax Credit is designed to help businesses keep employees on their payrolls during the COVID-19 pandemic. The credit will allow employers to receive a tax credit for part of the wages they pay to their employees.
To calculate the credit and claim it, there are a few steps to follow. It’s important to understand the terms used when calculating the credit and filing the claim. In this article, we will break down how to claim the credit:
- Determine Eligibility
- Calculate the Credit
- Claim the Credit
How to Claim the Credit
The IRS offers some guidance on how to calculate the Employee Retention Tax Credit (ERTC). To be eligible, employers must have experienced at least a 20% decline in gross receipts in any calendar quarter of 2020, compared to the same quarter in 2019. Employers should compare their gross receipts for similar calendar quarter in either 2019 or 2020 and verify that their decline meets the necessary requirement.
Once employers have determined eligibility, they can then begin calculating the credit amount. Prior to calculating the credit amount, employers must first identify all employees that were employed during periods of suspension and included them as qualified wages if they met certain criteria as outlined by the IRS.
For tax years beginning after December 31, 2020 and prior to December 31, 2021, if an employee’s salary has not been decreased more than 25%, then they are considered qualified wages for ERTC purposes. Any employee who was paid less than 80% of their normal salary can also be eligible for a portion of the credit based upon their reduced salary. Employers will need to take into consideration additional factors including whether any amounts received from Economic Injury Disaster Loan (EIDL) grants are included in any calculations related to ERTC wages.
In addition to considering eligibility requirements related to wages and payroll taxes already withheld from employee paychecks during this period, employers must also determine if any qualified health plan expenses including premium payments made on behalf of employees for group health coverage under an employer sponsored plan must be included in possible claims for ERTC benefits. Finally, employers should keep track of existing credits such as other credits already claimed under these provisions and against their allowable deduction such as Work Opportunity Tax Credit (WOTC), Securing American Families Employment (SAFE) Act or Pension Protection Act tax credits that may impact potential eligibility or available exemption limits applicable against applicable government entities or tax rate reduction where applicable.
Filing Form 941
The Internal Revenue Service (IRS) requires businesses to report the wages paid to their employees on the quarterly Form 941 filing. Business owners can claim the employee retention tax credit by including it on Form 941, which can be found on the IRS website.
When preparing Form 941, employers should include both wages paid and employee retention credits that were received in that quarter. For example, employers can reduce their taxes due by an amount equal to 50 percent of qualified wages up to a maximum of $5,000 per employee. This means that if your business paid $10,000 in qualified wages for the quarter and has two employees, you can reduce your payroll taxes due by up to $10,000 (50 percent x 2 employees x $5,000 maximum credit).
On Line 14a of Form 941 employers should enter the qualified wages they paid and then enter “ERTC” and/or “Employee Retention Credit” on Line 14b. If you are also claiming any other credits or deductions that affect your payroll taxes due for that quarter, you should be sure to include them as well before submitting your form.
Deducting the Credit on Form 941
Claiming the Employee Retention Tax Credit on Form 941, Employer’s Quarterly Federal Tax Return involves taking an additional credit against the employer’s federal employment tax liability. To calculate the amount of this credit, employers must multiply the applicable percentage (50% for 2020 if covering full-time employee wages up to $10,000) times qualified wages paid during a taxable quarter to each eligible employee. This figure is then deducted from the employer’s total federal employment taxes for that quarter.
Since employers must reduce this tax liability from their total federal unemployment taxes owed for a period before claiming any other credits or deductions on Form 941, it is important for employers to consider how this would affect their net tax liabilities. For certain organizations that owe no federal employment taxes in a quarter, such as nonprofits, retirement plans and churches, the refundable portion of this credit can be taken as part of their quarterly Form 941-X filing.
Employers should also be aware that any unused portion of the credit claimed through Form 941 in one quarter can potentially be recovered on any subsequent quarterly form AND/OR by filing an amended return using Form 941-X and claiming a refund of unused credits within the three years after they are incurred. After that deadline has passed without action by employers to recover their full credits due them through quarterly forms or amendments made with respective Forms 941-X; any remaining unclaimed credits may then disappear forever!
As employers navigate their way through the Employee Retention Tax Credit (ERTC) program and its various resources, there are a number of additional resources available to help them. This includes calculators, templates, and other guidance that can help employers understand the different components of the program, such as the eligibility criteria, the calculations, and the credits. This paragraph will explore some of the additional resources available to employers.
The IRS website (http://www.irs.gov) is a source of valuable information and resources regarding the Employee Retention Tax Credit (ERTC). This includes the most up-to-date version of the Form 941, which is used to calculate and claim the tax credit. Additionally, taxpayers can find useful links to other forms such as Form 943, Statement of Federal Tax Liability for Railroad Retirement Tier 1 Taxes, and Form 8974, Qualified Wages and Allocated Health Insurance Costs for Small Employers.
Other important links on the IRS website include FAQs, summaries of recent updates on COVID relief changes to payroll processing, guidance on emergency paid sick leave payments, guidance on health insurance reimbursements related to emergency family medical leave payments. For employers looking for more in-depth information about ERTC calculations, there are also detailed tutorials available through their Virtual Workshop page.
IRS Publication 5251
The Internal Revenue Service (IRS) provides information on the Employee Retention Tax Credit via IRS Publication 5251. This publication is intended to help employers and employees understand the eligibility requirements, benefits, and potential reductions in costs associated with providing the Employee Retention Tax Credit.
IRS Publication 5251 covers topics such as:
- eligibility for the credit
- limits on amounts of the credit
- payment of qualified wages
- working condition fringe benefits that are excluded from wages for purposes of calculating the credit
- reporting of qualified wages paid
- limitations based upon IRC §§ 51(i)(1), 1(h)(2)(A)(ii) and 4980H
Additionally, it contains a worksheet for employers to determine their eligibility for taking the credit.
This publication can be used in combination with other sources to provide a comprehensive understanding of how to effectively implement an Employee Retention Tax Credit plan. The most current version of IRS Publication 5251 can be found on the IRS website under ‘Tax Information For Businesses‘.
Tax Professional Resources
Tax professionals may wish to consult with the Internal Revenue Service (IRS) for the latest information and eligibility requirements for the Employee Retention Tax Credit. Here are some resources that may be helpful:
- IRS website: The IRS has published materials on their website that explains the credit, including an expanded version of this article, and FAQs about how employers can claim eligible wages paid after March 12 and before December 31, 2020.
- Form 5884: Employers must complete Form 5884 to claim this credit. This form outlines the information employers must include when claiming wages paid after March 12 and before December 31, 2020 as eligible wages for this credit.
- Publication 15: Employers can refer to Publication 15 which provides detailed instructions on how to calculate wages paid after March 12 and before December 31, 2020 as eligible wages for this credit. It also provides guidance on other tax credits taxpayers may be eligible for.
- Help line resource: Taxpayers who need additional help understanding eligibility requirements or have questions about how to calculate their employees’ wages are encouraged to contact an experienced tax professional. The IRS’s help line is available at 800-829-1040 or 888-227-7669 (TDD/TTY).