Contents
Introduction
The Employees Retention Credit (ERC) is a refundable tax credit that eligible employers can claim against the 6.2% Social Security taxes withheld from their employees. This credit was established to incentivize employers to keep their employees on payroll during the COVID-19 pandemic.
It is important to understand the details of this credit so you can determine if you are eligible to receive it and how to maximize your return on your tax filing.
Overview of Employee Retention Credit
The Employee Retention Credit (ERC) is a tax incentive available to help employers maintain their workforce during the COVID-19 pandemic. It is included in the Coronavirus Aid, Relief, and Economic Security (CARES) Act, and provides a refundable payroll tax credit for qualified wages paid after March 12, 2020 and before January 1, 2021.
Under the ERC program, employers can claim a federal employment tax credit of up to 50% of qualified wages they pay to employees after March 12, 2020 and before January 1, 2021. Eligibility requirements vary based on employer size and industry. For employers with fewer than 500 employees or those facing partial or full closure due to governmental orders related to COVID-19, up to $5,000 of wages paid to each employee can qualify for the ERC.
To receive the credit against taxes allocated under section 941 (i.e., employer payroll taxes), employers must reduce their deposits of employment taxes that are due between March 12th and December 31st in an amount equal to the credit they claim during any calendar quarter. If an employer’s credit exceeds its current year’s payroll tax deposits in any quarter during calendar year 2020, then it can obtain a refund for 50% of its eligible wages by filing Form 7200 with the government no later than two months after that fiscal quarter ends and using it as evidence on Form 941 when it files its quarterly return or annual return.
The rules applying to this program are complex and have been subject to several clarifications over time; therefore it is important that businesses seeking relief under this program seek guidance from a professional advisor who is familiar with all applicable regulations at both federal and state levels prior claiming the credit on their Form 941 filing later in 2020.
Eligibility Requirements
The Employee Retention Credit (ERC) is a tax credit that employers can claim when they retain their employees. In order to be eligible for the credit, employers must meet certain requirements.
This article will look at the eligibility requirements for the Employee Retention Credit and how it affects an employer’s tax return.
Qualifying Employers
Eligible employers are those that are not prohibited from the credit by a specific law and fall into one of the following categories:
- Businesses that currently operate or have resumed operations between February 15 and December 31, 2020, after being fully or partially suspended due to an appropriately issued order from an appropriate governmental authority due to COVID-19.
- Employers with wages paid to employees for providing services during any calendar quarter in 2020, prior to the calendar quarter in which the employer’s trade or business resumed operations.
Qualifying employers must use a special calculation when computing their Employee Retention Credit. To be eligible for this tax credit, employers must have seen a significant decline in gross receipts for more than 20% of any given quarter when compared to the same 2019 quarter. Employers are also able to draw from this credit twice – once before their business resumes operations and another time after it has resumed operations – as long as they meet all qualifications mentioned above.
Qualifying Wages
The Employee Retention Credit (ERC) provides a refundable tax credit to employers that continue or expand the level of wages paid to employees during the coronavirus pandemic. In order to qualify for the ERC, an employer must pay at least 50% of qualifying wages each quarter in 2020 and 2021.
Qualifying wages refer to wages paid to an employee for eligible periods as well as employee health insurance costs incurred or paid by the employer during these time periods. Qualifying wages must be “eligible” in order for the associated costs to count towards the ERC calculation. To be eligible, an employee must have worked for the employer “at any point” during either 2020 or 2021 and either has been retained despite experiencing reduced hours due to one of the following:
- operations affected by restrictions related to COVID-19,
- gross receipts declined due to COVID-19.
There are specialized rules under which certain agricultural labour qualifies as well. Additionally, some types of payments are specifically excluded from qualifying wages, such as qualified sick and family leave under FFCRA and qualified wages used for claiming Paycheck Protection Program loan forgiveness.
Calculating the Credit
The Employee Retention Credit is a tax credit that businesses can claim to help cover certain expenses incurred due to the coronavirus pandemic. The credit is typically equal to 50% of up to $10,000 given to qualifying businesses.
To calculate the amount of the credit to include in your tax return, you must determine your total qualifying wages and the number of employees you have. Then, you’ll need to figure out the amount of credit you’re eligible for. With this information, you can then input the right numbers in the appropriate field on your return.
Let’s dive into the details:
Maximum Amount of Credit
The maximum amount of credit you can receive for Employee Retention Credit is 50% of the qualified wages paid while the credit is in effect. Qualified wages include payments to eligible employees, up to $10,000 per employee during the period of February 15th through December 31, 2020. In addition, any costs associated with providing the eligible employee’s healthcare benefits (including health insurance premiums) are also considered qualified wages for this purpose.
The credit is one of several business tax credits created by the Coronavirus Aid, Relief and Economic Security (CARES) Act and applies only to employers that did not receive a Paycheck Protection Program (PPP) loan. You cannot claim the Employee Retention Credit if you have already taken a PPP loan or are claiming other refundable credits on your tax return such as certain payroll credits or refundable business income tax credits.
The maximum amount of wages considered for each quarter is capped at $10,000 and varies depending on when the employer’s calendar year begins/ends. Calculating how much credit an employer is eligible for depends on how many employees qualify under this program and how much qualified wages were paid out between February 15th and December 31st, 2020. Generally speaking, however, employers that meet all eligibility requirements may be able to claim a maximum Employee Retention Credit worth 50% of up to $10,000 in qualified wages paid per eligible employee between February 15th through December 31st this year for a total credit of up to $5,000 per eligible employee in one year ($10k x 50% = $5k).
Limitations on Amount of Credit
The Employee Retention Credit (ERC) is available to employers that experienced a full or partial suspension of operations due to government-mandated shutdowns related to COVID-19. To qualify for the credit, the employer must have seen its gross receipts decrease by more than 50% compared to the same quarter from 2019. The amount of credit available is 50% of up to $10,000 in wages paid after March 12, 2020 and before January 1, 2021.
While it can be tempting for employers to take advantage of this tax benefit, it’s important to note the limitations on the amount of credit available. As an example:
- If an employer has 50 employees and each employee makes $100 per day (for a total of $5,000), then the maximum ERC would be limited to $2,500 ($5,000 x 50%) instead of $10,000.
- If an employer has 10 employees and each employee’s gross pay was more than $1,667 ($10,000/50%) per day (for a total of more than $16k), then the ERC would still be limited at $2k ($10k/50%).
Additionally, any wages already used for other credits such as Paid Family and Medical Leave or Sick Leave Credits cannot be used for the Employee Retention Credit either in part or whole. It’s essential that businesses consult with their tax professional before taking advantage of this opportunity so they can understand their specific eligibility requirements and calculate their potential benefit accurately.
Claiming the Credit
The Employee Retention Credit (ERC) is a refundable tax credit against certain employment taxes equal to 50% of the qualified wages an eligible employer pays to employees after March 12, 2020, and before January 1, 2021.
When claiming the ERC, it is important to know the details of the credit as it may reduce taxes owed, increase your refund, or both. This section will explain the details of how to claim the credit on your tax return and how it affects the amount of taxes you owe:
- How to claim the credit on your tax return
- How the credit affects the amount of taxes you owe
How to Claim the Credit
The Employee Retention Credit (ERC) is a refundable tax credit for employers who have been affected by the coronavirus pandemic. It is available for up to 50% of qualifying wages that eligible employers pay to employees between March 13 and December 31, 2020. Eligible employers can claim the credit against employer Social Security taxes, therefore reducing their payroll tax expenses.
When filing your federal tax return, you must complete IRS Form 7200 – Advance Payment of Employer Credits Due To COVID-19 to claim the Credit. Here are the steps you will need to take:
- Calculate Qualifying Wages – use IRS Form 941, Employer’s Quarterly Federal Tax Return, and Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, to calculate Qualified Wages paid during the eligible period for each employee that meets the requirements for receiving ERC benefits.
- Fill out Form 7200 – This form includes questions about your business and identifies any advance payments you may be entitled to from previously withheld payroll taxes or other sources. You will also enter the total amount of Qualified Wages paid during the eligible period on Line 10a – “Total qualified wages” box of your Form 7200. Also include any combination of other credits claimed in a prior quarter or year related to Coronavirus relief efforts that should not be carried over into current quarters or years on Line 10b – “ Other refunds adjusted” box on your Form 7200.
- File Your Return – Use IRS supports like e-file and direct deposit options when filing your return to speed up processes as well as eliminate paper filing errors or mishandling at local post office locations/affiliates. Once completed forms are electronically sent through certified E-File providers it will take approximately 15 days or less for refunds processing begins. If all information is accurate with multiple verified sources such as W2s, bank statements, etc.. final approval time will be much quicker in many cases. Upon approval process customer service agents may make contact with clients through text email or phone calls with any updates regarding potential issues that require client attention before taxes can be released/approved/finalized.
What Forms to Use
Employee retention credit handled through payroll is claimed on IRS Forms 941, Employer’s Quarterly Tax Return, by using Code “ER” in box 12 for each reported employee who qualifies for the credit. The maximum amount you can claim for regular wages that vary by quarter must be prorated in proportion to the days in the pay period. Additionally, employers should provide Schedule A (Form 941) with each quarterly return filed electronically, which should include a statement indicating total wages and wages from which the credit was calculated.
For those filing paper returns, Forms 941-X and Schedule B (Form 941) must be submitted to claim the employee retention credit. If claiming part of an overpayment refunded from an earlier quarter’s Form 941, use Form 843 to claim allowable claims refunded or applied during a prior period.
When claiming small business payroll tax credit using Employee Retention Credit on your yearly 2020 tax return, employers need to complete and file Schedule R (Form 940 or Form 944). Update your year end wage information includes with W-2 forms before you submit it with your taxes. Employers filing form 1040-C should also include form 8849 to report payments made under this program. Employers who received advance Payment of this Credit through their bank accounts may need to use special procedures when filing their annual tax returns while others will reduce their 2021 taxes associated with this program when they submit 2020 tax returns.
Impact on Tax Return
Employee Retention Credit is a refundable tax credit available to employers who are experiencing economic hardship as a result of the COVID-19 pandemic. This refund can have an impact on your tax return depending on how much of the credit employer retains. It is important to know how this tax credit works to ensure you get the full benefit of the refund.
Let’s explore the impact of the credit on your tax return:
How the Credit Affects Tax Return
The Employee Retention Credit is a fully refundable tax credit for employers equal to up to 70% of qualified wages (up to certain limits) paid by the employer to employees during 2021. The tax credit was enacted in 2020 as part of the COVID-19 emergency financial assistance package, and it has been extended through 2021 as part of the Consolidated Appropriations Act of 2021. The maximum amount of this tax credit is $7,000 per employee, per quarter.
For taxpayers filing Form 941 or Form 943, the additional payroll taxes associated with this tax credit can reduce their payroll liability in the quarter when an eligible wage expense is claimed. Those who are unable to offset their additional payroll taxes via reducing an eligible wage expense can use Form 7200 to request an advance refund from the IRS.
Taxpayers filing Form 1040 will be able reimburse certain employer costs that would otherwise need to be reported as taxable income—with no reduction in net income—and deduct them as business expenses for federal income tax purposes on Schedule C or another applicable form under ordinary trade or business rules. They should note that such deductions may also reduce their self-employment taxes if applicable. Further, there may be opportunities for taxpayers PAYE (pay-as-you-earn) income tax filers claim a deduction for all or a portion of expenses reimbursed by the employer if they qualify under the trade or business provisions of Section 162(a).
In addition, any withholding requirements related to this credit will not reduce reportable wages or any other deductions related to wages on Form including those reported on various schedules attached thereto (eg – W-2 box 1 and/or Social Security self-employed earnings reported on Schedule SE).
Impact on Withholding and Estimated Tax Payments
The Employee Retention Credit (ERC) included in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) allows eligible employers to claim a refundable payroll tax credit against Social Security taxes up to 50% of qualified wages they pay to employees. Eligibility for the credit is determined by whether or not the employer experiences a full or partial business disruption due to the COVID-19 pandemic or has been required by government regulations to reduce services operations.
To claim this credit, it’s important for employers to understand how it will impact their current withholding and estimated tax payments for 2020.
When an employer opts to take advantage of this credit, they must forego claiming it against payroll taxes previously withheld from employee wages. Rather than adjusting employee withholdings with the credit, employers may use any refundable credits as a reduction of their current estimated taxes due. This means that even if taxable wages would trigger additional quarterly estimated tax payments that were not previously required, employers may reduce them with any credits earned through ERCs before making estimated tax payments for 2020.
Another great use of the ERC and its effective date back in 2020 is that it can be applied towards payment of third quarter 2020 estimates (due September 15th). If unable to maximize the full value of credits earned due to previous lower wages during Q2 & Q3, amounts paid can be applied retroactively towards quarter 1 & 2 estimates as well, providing more flexibility when trying optimize refunds and limit potential penalties due on underpayments.
Conclusion
Based on the information discussed in this guide, we can come to the conclusion that IRC §2301 provides valuable assistance to employers affected by COVID-19 through the application of the Employee Retention Credit (ERC). By participating in this program, qualified employers can benefit from increased financial resources and have access to better employee retention plans.
The IRS has made substantial strides in providing guidance to employers, though some complications may still exist and require further scrutiny. Employers should review all material available, consult a tax professional if necessary, and make sure they adhere strictly to any additional rules set forth by their state when looking for assistance through this program.
Ultimately, understanding how Employee Retention Credit affects your business and your tax return is essential for making sound financial decisions and asking for help when needed.