Overview of Employee Retention Credit
The Employee Retention Credit is a refundable tax credit that has been available to employers since 2020. The credit is intended to help employers keep their employees on the payroll and offset some of the costs that come with pandemic-related business shutdowns.
This section will provide an overview of the Employee Retention Credit, including:
- Eligibility requirements
- The steps needed to claim the credit
To qualify for the Employee Retention Credit (ERC), an employer must have either:
- Fully or partially suspended operations due to a “library, a governmental order limiting commerce, travel or group meetings; or
- Experienced a significant decline in gross receipts.
Gross receipts must have declined by more than 50% compared to the same quarter in the prior year in order to qualify for this credit. Additionally, employers must show that they have generally had an average of fewer than 500 full-time employees during 2020 in order to claim the credit. Only employers who paid employees’ wages from March 13, 2020 through Dec. 31, 2020 can claim ERC credits.
Employers must make sure that their eligible wage and compensation kickback payments are adequately tracked and documented for verifying and reporting purposes before filing for their ERC credits. Employers should also be aware of any changes or updates with regard to their eligibility requirements or limits in claiming ERCs as these could affect their calculations and filings. In addition, employers should also ensure that they receive appropriate IRS guidance on how best to interpret and apply the rules pertaining to ERCs before they begin filing their claims.
Maximum Credit Amount
The maximum credit amount eligible is 50% of qualified wages paid to employees, up to $10,000 of qualified wages per employee. This means a taxable employer can receive a up $5,000 credit per employee for qualified wages paid between March 13 and Dec. 31, 2020.
The total credit an employer can claim is limited to the employment taxes reported on their quarterly federal employment tax returns (Form 941). For 2020 the amount of available Employment Tax Credits is limited to $5,000 x the number of quarters in the calendar year that an employer was affected by COVID-19 (maximum number being four quarters).
Generally, each quarter has its own set of wage limits and amounts that employers can claim:
Claiming the Credit
The Employee Retention Credit is a valuable credit available to help employers offset the costs of paying their employees during the COVID-19 pandemic. If you are eligible, this credit can mean thousands of dollars of savings for your business.
In this article, we will explain how to claim the Employee Retention Credit and the steps you need to take in order to ensure that your claim is successful:
- Step 1: Determine eligibility
- Step 2: Calculate the credit
- Step 3: Claim the credit
- Step 4: Report the credit
Gather Necessary Documentation
Before you begin to claim the Employee Retention Credit, there are several forms and documents that you will need to gather in order to make an accurate claim. The most important document that you must have before filing is information regarding your eligible wages paid. Here is a look at the necessary documentation for claiming the Employee Retention Credit:
- Payroll Tax Deposit Reports: Your Form 941 Payroll Tax Deposit report, which serves as proof of wages paid from quarter one and quarter two of 2020
- Quarterly Payroll Tax Filings: You will need copies of your federal Form 941 quarterly payroll tax filings from both quarters of 2020
- Form 5 Payer’s Quarterly Federal Unemployment Tax Filing: You must also provide a copy of your quarterly federal unemployment tax (FUTA) filing for quarter one and quarter two of 2020
- Form 1099 MISC: If applicable, a copy of your Form 1099 MISC with the recipient listed on line 7 along with their yearly wages should also be provided
- Details Related to Eligible Wages Paid: Any receipts or documentation related to any eligible wages paid should be collected before filing
Complete and File Form 941
To claim the employee retention credit, employers must submit Form 941 to the IRS each quarter. In addition to completing Form 941, employers must also make all other deposits due from the previous quarter and pay all taxes reported on the form on or before the due date of April 15. The amount of credit claimed is subtracted from any amounts owed for Social Security taxes and Medicare taxes reported on line 12c of Form 941.
When filing with an accredited e-file provider, Form 8109 will be sent to the relevant IRS branch office along with a copy of any tax return or amended return that was previously filed with that branch. Employers should only mail one copy of their returns and provide all documentation requested by their chosen e-file provider in order for them to receive prompt processing and avoid any potential delays in claiming the employee retention credit.
If not filing with an accredited e-file provider, employers should follow these steps:
- Complete Parts 1, 2 and 3 of Form 941 for each semester worked during the relevant period.
- To determine your eligible wages and related credits for each semester worked, complete Worksheet B on page 8 of Form 941.
- Include applicable protective credits from the Tax Cuts and Jobs Act (TCJA) in Part 2 of Form 941, Line 11a (Protective Credit).
- Add up all numbers in Part 3 Column A to determine your total net deposits due and enter them into Part 4 Line 16 (Total).
- Subtract any eligible protection credits taken as listed under Line 11a as reported in Part 2 from total net deposits due found at Line 16b in Part 4 before signing and submitting form 941 within one week after it is due (April 15th).
Submit Form 7200 to the IRS
Submitting Form 7200 is the first step in claiming the Employee Retention Credit under section 2301 of the CARES Act. This form must be completed by employers to notify the IRS of their eligibility and compute the amount they are claiming under this section of the act. The employer must submit this form even if they do not owe any taxes to the agency.
Form 7200 also provides an opportunity for businesses to request an immediate advance on any eligible credits. To receive such an advance, employers must include Schedules A and B with their submission, estimating any eligible credits that they expect to receive during that calendar quarter or year. The IRS will use this information to issue a credit that can be applied against current taxes or reduced from future tax payments.
Before submitting Form 7200, businesses should review all relevant rules pertaining to eligibility for employee retention credits and relevant completion requirements for both schedules of Form 7200. Employers can file this form either electronically or by mail, but should adhere to all procedures specified by the IRS for seeking advanced payment on a claim for employee retention credits.
Submit Form 5884-C to the IRS
When applying for the Employee Retention Credit, employers must submit Form 5884-C, Employee Retention Credit, to the Internal Revenue Service (IRS). This form should be filed along with your quarterly tax return in order to claim the credit. The form requires employers to enter their total wages and other compensation paid to all employees during the quarter, as well as any qualified health plan expenses made by the employer during 2020. Employers are not required to maintain documentation other than what is needed to complete Form 5884-C.
For employers who qualify for the employee retention credit, this form is essential in claiming the credit. You may choose a format for filing either Summary or Detail format for each employee depending on your preferences; however, most people prefer Summary Format which groups eligible employees together by filing status and number of dependents claimed on their Form W-4 without entering each individual employee’s information individually. In addition, completion of this one page form is required only once per year instead of every quarter like all other forms are submitted.
It’s important that employers accurately file Form 5884-C because if it is incomplete or incorrect it can result in delays or misunderstandings when attempting to receive the credits that you are entitled too. The IRS will review all submitted forms and notify you if there is any issue with your application that needs clarification or correction before any credits can be issued.
Calculating the Credit
The Employee Retention Credit (ERC) is a refundable tax credit provided to employers who continue to pay their employees and incur eligible wages, even during the COVID-19 pandemic. To estimate your potential ERC, you’ll need to calculate the amount of eligible wages and qualified health plan expenses you paid during 2020.
In this section, we’ll break down the steps for calculating the credit, so you can know how much you could potentially be eligible for:
- Calculate the amount of eligible wages.
- Calculate the amount of qualified health plan expenses.
Calculating Qualified Wages
The Employee Retention Credit (ERC) offers helps businesses financially impacted by COVID-19. Businesses that have seen a significant decline in gross receipts or been required to fully or partially suspend business due to government orders can receive a refundable payroll tax credit. The purpose of this credit is to encourage employers to keep as many employees on their payrolls as possible.
In order for an employer to qualify for the Employer Retention Credit, you must calculate your ‘qualified wages’ for each full calendar quarter of 2020. To determine your qualified wages, the following steps must be taken:
- Calculate ‘eligible wages’: These are the total wages paid after March 12, 2020 plus health plan expenses allocated to those wages during such period, not including any employee compensation in excess of $10,000 during any taxable period ending before 2021.
- Calculate ‘previous quarter gross receipts‘: This represents either (1) the total gross revenues of the trade or business for calendar quarter before 2020 multiplied by 50% OR (2) if the business was not in operation during such preceding calendar quarter, then the average total gross revenues for each of the two calendar quarters prior to such preceding calendar quarter multiplied by 50%.
- Calculate ‘qualified wages‘: This is equal to the smaller number between eligible wages and two times the amount of your previous quarter gross receipts determined from Step 2 above.
- Compute allowable credit amount: Used qualified wages from Step 3 above multiplied by 50%.
Businesses should remember that all eligible employees working full time in any given pay period during 2020 should count when determining qualified wages and do not need to be employed as of December 31st 2020 in order for their wages to qualify for ERC calculations.
Calculating the Credit Amount
The amount of the Employee Retention Credit that an eligible employer can take is based on two factors – the number of employees that the employer maintained in 2020 and the qualifying wages paid to those employees.
The credit, calculated as outlined below, is paid by claiming a reduction on taxes owed by the employer. The credit is refundable and will be paid in up to two tranches if the full amount is not used against employment tax deposits and when filing Form 941.
- For employers with greater than 100 full-time employees, such employers must calculate their eligible credit based on wages paid to employees who are not providing services due to COVID-19 related reasons (e.g., employee furloughs or layoffs). This calculation is equal to 70% of the qualified wages up to $10,000 per employee for all calendar quarters in 2020.
- For employers with 100 or fewer full-time employees (including part-time and seasonal workers), these employers are allowed a smaller per-employee amount but are able to consider all employee wages (regardless of whether or not they were laid off) provided during 2020 in calculating their eligible credits. In this case calculation would be equal to 50% of qualified wages up to $10,000 per employee for all calendar quarters in 2020.
Reporting the Credit
Claiming the Employee Retention Credit requires careful consideration of the applicable requirements, including filing the credit and reporting it appropriately. This section will discuss how to report the credit, including the differences between Quarterly and Annual filing. In addition, it will review the proper procedures for claiming the credit and the credit limitations.
Report the Credit on Form 941
The employee retention credit (ERC) is a refundable tax credit available under the Coronavirus Aid, Relief and Economic Security (CARES) Act. To claim the ERC, qualifying employers can include the amount of the credit on Form 941 when filing their quarterly payroll tax returns. The total amount of the ERC claimed should be added to Line 11c of Form 941 and a corresponding entry should be made to Line 10 for any deferred Social Security taxes that are subject to the employee retention credit. It is important that employers use IRS Form 7200 Advance Payment of Employer Credits Due To COVID-19 when requesting an advance from the IRS for any ERC amounts in excess of taxes due on their otherwise timely-filed quarterly return.
Qualifying employers must also make additional entries in Part III: Qualified Retention Employee Wage Reduction Credit of Form 941. This includes an entry at Line 19a, which requires entering an employer’s total wages paid to all employees during each calendar quarter. In addition, employers should make entries at Lines 19b and 19c respectively to report wages paid because they were subject to employer social security tax liability and wages that received no such tax withholding treatment as employees previously excluded from such liability as discussed in IRS Notice 2020-22.
Finally, qualified employers should make entries at Lines 20a – 20d reflecting both qualified wages (defined by individual employee salaries earned from March 13th through December 31st) and related health plan expenses allocated over period of time used for FICA tax calculations for given quarter. Once completed, employers must sign and date form before uploading or submitting by mail or fax as appropriate.
Report the Credit on Form 945
The Employee Retention Credit (ERC) is an incentive passed in the Coronavirus Aid, Relief, and Economic Security Act of 2020 (CARES Act) to help businesses retain their employees during the Coronavirus pandemic. Eligible employers can claim the ERC on their quarterly IRS Forms 941 with wages and other payroll taxes that are reported each quarter and when filing form 943 for agricultural employers. The credit will be reported on IRS Form 945, Annual Return of Withheld Federal Income Tax, which is filed annually by most employers who have withheld federal income tax from employee’s wages.
Employers must report the following information when filing Form 945:
- Amount of credit claimed
- Total social security and Medicare wages used to calculate the credit
- Total qualified health plan expenses used to calculate the credit
- Total qualified wages used to calculate the credit
Form 945 must be completed to properly report the ERC for all quarters in which it is claimed.
Report the Credit on Form 1040
To claim the Employee Retention Credit, employers must report the totals on their 2020 Form 1040 or 941 (for an agricultural employer). Eligible employers should submit Form 5884-C to the IRS to receive the credit. The form should include all qualifying wages, as well as any other information required by the IRS.
In addition to submitting Form 5884-C and reporting total wages on Form 1040 or 941, employers should also complete Form 7200 – Advance Payment of Employer Credits Due to Covid 19 to request an advance of up to 70% of the credit they expect they’ll receive. The form must be filed four days after end of each calendar quarter; any advance credits are limited to the amounts that are reported on Form 1040 or 941 for each respective quarter.
The final step is filing both Forms 1040-NR and 8844 for those taxpayers who paid estimated taxes impacted by the Employee Retention Credit. These two forms help reduce estimated payments rates for those eligible for the credit and avoid overpayment penalties from underpayment.
Common Mistakes to Avoid
The Employee Retention Credit (ERC) is a valuable tax credit available to certain employers and self-employed individuals affected by the coronavirus pandemic. Understanding the eligibility requirements and filing for the credit can be complicated, and small mistakes can result in large financial implications. To ensure you maximize your ERC benefit, it is important to be aware of some of the most common mistakes people make when filing for the credit:
- Mistake 1
- Mistake 2
- Mistake 3
- Mistake 4
- Mistake 5
Failing to Claim the Credit
Failing to claim the employee retention credit on your tax return is a very common mistake. This is because many employees may not be aware that they can get this credit and the process can be complex and overwhelming. If you are eligible for the employee retention credit, make sure you are correctly claiming it by following the steps outlined below.
To claim the employee retention credit on your tax return, fill out Form 941 (Employee’s Quarterly Federal Tax Return) for each quarter when you’re claiming this credit. It’s important to note that if you have had a significant reduction in your average number of full-time employees, only then can you use this form to claim a portion of your qualified wages expenses as an employee retention credit. Additionally, if under CARES Act subsidies or Section 139 on disaster related expenses, there could be limitations or credits not allowed per IRS rules resulting in receiving less than what was claimed as qualified wages.
You must also ensure that Form 941 contains all information related to eligible wages paid which include all taxable income such as bonuses and healthcare benefits by using line 13a and 13b (or line 11a, 11b and 13c in cases with no tips). Also confirm any amounts paid using PPP loan forgiven amount will not reduce other acceptable wages amount and it should instead be reflected in Form 941 – Line 25c – Non-Refundable Credits Limitation Amount. This way, you will get to know how much money is actually available based on these deductions and credits.
Failing to file all deemed necessary forms can create compliance issues for businesses when trying to claim employee retention credits later on down the road. Accurate information must be provided so keep track of all figures from any previous quarters. Proper documentation must supplement any claims being made so that IRS codes are complied with at all times throughout the process of filing returns seeking assistance with these credits which can provide relief during economic hardship situations brought about by natural disasters or COVID-19 pandemics whenever they arise.
Not Meeting Eligibility Requirements
Employers who wish to take advantage of the Employee Retention Credit cannot do so without first meeting certain eligibility requirements. Specifically, the business must have operations that are fully or partially suspended by government order due to the COVID-19 pandemic and/or have gross receipts that are less than 50% of those they reported during the same calendar quarter in 2019.
In addition, employers must meet certain wage limits when it comes to qualifying employees. The wage limit is $10,000 per employee per calendar quarter and may not exceed $10,000 total regardless of how many different quarters have passed since the start of 2021. If an employer has more than one eligible employee for whom wages exceed this limit, then only one can be used in calculating the credit amount.
To maximize eligibility for the Employee Retention Credit, business owners should:
- Ensure that their operations qualify as either partially or fully suspended due to a COVID-19 order from government authorities.
- Ensure that their gross receipts and wages fall within established limits.
- Keep track of their expenses throughout the year as these will be needed in order to claim the credit with clarity when filing taxes for the current year.
Calculating the Credit Incorrectly
In order to take advantage of the Employee Retention Credit, employers must calculate the credit correctly. There are certain eligibility guidelines that employers must meet in order to qualify for the credit. Ineligible wages, such as sick and vacation pay, cannot be counted towards the calculation of the credit. Also, employee wages are capped at $10,000 per employee which includes compensation AND employer-sponsored health care expenses.
Employers must also take into consideration other programs they have received such as a PPP loan or state unemployment benefits, as these exclude them from qualifying for the ERC. Additionally, employers should ensure they provide complete and accurate documentation including Form 941 filing records and 1099 forms when claiming their tax credits.
Finally, when calculating average wages paid in 2020 versus 2019 or 2018, employers should be aware of the following:
- Only those employees who made over $731 per week will qualify for the ERC; any wages paid to employees earning below this rate will not be eligible for credit purposes.
- Any fractional employment hours are not eligible for credit purposes under IRS regulations.
- Employers must take seasonal factors into consideration when calculating average rates.
Careful calculation of all eligibility factors is paramount if an employer is looking to maximize their tax savings through this program.