Contents
Introduction
The Employee Retention Credit is a tax break designed to help businesses recover from the economic losses associated with the coronavirus pandemic. The credit allows eligible employers to receive a refundable tax credit for up to 50 percent of wages paid in 2021, up to $5,000 per employee.
The amount of the Employee Retention Credit is determined by the employer’s average number of full-time employees in 2020 and its gross receipts. For employers with an average of 500 or fewer employees in 2020, the credit is based on wages paid during 2021 up to $5,000 per employee for each quarter that their gross receipts have significantly declined compared to 2019 or 2020.
When applying for the Employee Retention Credit, employers must include it as income when filing their taxes but then claim it as an offset on their total income tax. This means that any amount received through this credit will be considered taxable income and must be reported on your federal income tax return. However, you can use it toward your taxes due or as a refundable tax credit against withholdings and estimated payments you made previously. The total amount will be claimed on Form 941C: Employer’s Credit for Federal Taxes Withheld from Employees in respect of their Employment Taxes Return (Form 941).
What is the Employee Retention Credit?
The Employee Retention Credit (ERC) is a refundable tax credit each year against certain employment taxes equal to 50% of qualified wages paid to employees. This credit was created by the CARES Act, passed in March 2020, and was extended through December 31, 2021 for employers of any size. It is applicable for wages paid up to a maximum of $10,000 per employee per year with no limits on the number of employees that are eligible.
Specifically, the ERC applies if an employer:
- fully or partially suspended operations due to orders from an appropriate governmental authority limiting commerce, travel or group meetings due to COVID-19; or
- experienced a significant decline in gross receipts.
Qualified wages are those that are not more than $10,000 for any one employee during the entire year and must be actually paid after March 12, 2020 and before January 1, 2022.
The ERC only applies against certain employment taxes including Social Security taxes paid by an employer; Medicare taxes paid by both employer and employee; and federal unemployment (FUTA) taxes when wages are excluded from state unemployment insurance wage bases. The ERC cannot be used against self-employment tax obligations.
Generally speaking, employers have come out ahead as far as refunds since essentially being able to take a federal income tax deduction upfront with no corresponding increase in taxable income related to the wages for which the refund was received. However, if an employer claims a deduction for expenses that were also covered by the credit it must reduce its deduction accordingly by then amount of wage credit available under this program before considering other business deductions allowable under generally accepted accounting principles (GAAP). This means the employer cannot double-dip and take both benefits associated with these expenses resulting in tax savings twice over – once through a wage credit reduction now and later through a business expense earlier allowed on tax returns.
Eligibility Requirements
The Employee Retention Credit (ERC) is a refundable tax credit available to employers who retain employees during the Coronavirus pandemic. This credit helps employers offset some of the costs associated with keeping their employees on payroll.
To be eligible for the credit, employers must meet certain requirements. In this section we will discuss the requirements for eligibility for this credit:
Qualifying Employers
The employee retention credit is available for 2021. An eligible employer is any trade or business (including tax-exempt organizations) that carries on a trade or business during 2021, and either:
- Had their operations fully or partially suspended due to orders from an appropriate government authority due to the COVID-19 pandemic; or
- Experienced significant decline in gross receipts during the calendar quarter compared to the same quarter in 2019.
To determine whether a business meets either of these criteria, employers must calculate their “gross receipts” according to Internal Revenue Code Section 448(c)(3) as part of its eligibility determination. Employers may use a variety of methods for this calculation, such as comparing its gross receipts for the calendar quarter with either (1) its average quarterly gross receipts for 2020; or (2) the same calendar quarter in 2019.
Eligible employers also include certain businesses that receive employer subsidy payments under section 1400C(a). These businesses include employers engaged in agricultural production in 2020 and 2021, whose activities are affected by certain specified circumstances related to coronavirus, including:
- Reduced demand due to travel restrictions;
- Suspending production because of labor shortages;
- Disruptions due to illness as a result of coronavirus protective measures;
- Difficulty obtaining fuel and other inputs due to supply chain disruptions; and
- Losses caused by market displacement directly resulting from coronavirus.
Qualifying Wages
Qualifying wages are wages paid to an employee for any calendar quarter in which the employer is eligible for the Employee Retention Credit. Wages include wages paid by the employer that do not exceed applicable Social Security wage base limits. For most taxpayers, these are wages that are subject to Medicare tax withholding and reported on Form W-2, Wage and Tax Statement.
The eligible amount of qualifying wages is based on the average number of employees employed by the taxpayer during 2019. For employers with more than 100 full-time employees in 2019, qualifying wages are limited to those paid to employees who were not providing services during any elapsed period from March 13, 2020 through December 31, 2020 due to a reduction in:
- Business operations due to governmental orders related to COVID-19;
- Services provided at the employer’s business locations; or
- The uttermost capacity of customers at its trade or business locations due to COVID 19.
For employers that had less than 100 full-time employees in 2019, all wages paid after March 12th qualify as long as they don’t exceed available credit amounts allocated for each calendar quarter.
Calculating the Credit
The federal government provides a tax credit for employers who retain their employees during the pandemic. This employee retention credit can help businesses keep employees on the payroll during challenging times. The credit can provide a maximum of $5,000 per employee over the course of the year.
To calculate the credit, employers must understand the rules for the credit and how it is taxed. Let’s break down the calculated steps for the employee retention credit:
Maximum Credit Amount
The maximum credit available to an eligible employer is $5,000 per employee, per year. This means that the total credit an employer can receive under the Employee Retention Credit is limited to $5,000 for each employee retained by the eligible employer during the calendar year 2020 or 2021.
The amount of credit taken by an eligible employer must not exceed what it paid in qualified wages and allocable qualified health plan expenses for retaining an employee during such calendar quarter (and for any prior quarter in which such wages were paid) multiplied by the applicable retention rate. The applicable retention rate can be either 50% or 70% depending on when the employer paid these wages and health plan expenses.
- For 2021, employers with 100 or fewer full-time employees may take a 70% of qualified wages tax credit up to $7,000 per employee per quarter (limited to a total of $14,000 per employee for all four quarters). An additional allowance may be available in some cases if collected health plan expenses are included as part of qualified wages.
- For 2020, employers with 500 or fewer full-time employees may take a 50% credit up to a maximum of $5,000 per employee (also limited to a total of $10,000 per employee for all four quarters). Again, including collection health plan expenses as part of qualified wages allows employers further incentive to retain employees.
Credit Calculation
The Employee Retention Credit (ERC) is a refundable tax credit for certain employers affected by the COVID-19 pandemic. Eligible employers can receive up to $5,000 in tax credits for each employee kept on payroll from March 13, 2020 through December 31, 2020. To calculate the credit, employers must subtract an income tax withholding amount and their liability for the employer portion of Social Security taxes paid in respect of all employees from the credit amount.
The actual amount of credit employers will receive is based on their total wages paid during a three-month qualifying period beginning February 15 and ending November 30, 2020. The credit amount is equal to 70% of qualified wages paid during that period which are up to $10,000 per employee (or up to $5,000 per quarter). Qualified wages do not include amounts an employer allocates towards Coverdell Education Savings Accounts (ESA) or Health Savings Accounts (HSA).
In addition to calculating qualified wages paid during the specified three-month window, employers must also consider their qualified health plan expense allocations when determining their eligibility for the ERC. Employers must allocate at least 50% of total qualified costs towards eligible health coverage premiums in order to be eligible for full ERC benefits. This means that they will only be able to take advantage of their eligibility if they have allocated at least 50% of total costs associated with employee health coverage plans towards eligible premiums throughout the three-month period used as part of their calculation efforts. Alternatively, employers are allowed to use another method provided by the IRS instead if they choose.
Taxation of the Credit
The Employee Retention Credit (ERC) is a tax credit for employers who pay wages or salaries to retain or hire employees. Depending on the size of the employer and how much the employee earns, employers may qualify for a refundable tax credit amount of up to $10000 per employee.
Here, we will be discussing the taxation rules of the credit and the tax implications it may have on employers.
Employer Obligations
Employers are required to include the amount of any employee retention credit on their employment tax filings for the year. This includes all applicable forms, including Form W-2, Form 941 (wage and payroll taxes), and other related forms. Additionally, employers may need to use other specific forms such as Form 8921 to report a refundable payment.
As directed by the IRS who are responsible for collecting such credits as income tax payments, employers must withhold federal taxes from employees who received a credit under the Employee Retention Credit program.
In general, businesses should:
- Include any qualified wages paid in the previous year in their taxable income when filing their tax return.
- Subtract out the credits that were issued for such wages as part of their return calculations; this will provide them with a net payroll tax liability or liability credit balance that can be applied towards future payroll taxes due.
Businesses should provide accurate information to employees when issuing Forms W-2 so that employees receive appropriate federal withholding amounts and are aware of their specific Employee Retention Credit situation. Employers must also immediately report any recapture amounts due on private or public depositories directly associated with wages paid throughout the year; this reporting will enable employers to ensure they deduct any relevant recapture amounts from workers’ paychecks when needed most effectively while ensuring they remain compliant with current financial regulations.
Tax Form 941
Employers who have taken advantage of the Employee Retention Credit are required to report the amount of the credit on IRS Form 941. Employers filing Form 941 quarterly will need to reflect their use of the Employee Retention Credit, if applicable, on line 13c for the second quarter return, line 14c for the third quarter return and line 15c for all other quarters. Employers who are eligible to use Form 944 will need to reflect their use of the credit in Box 3f when filing.
The amount reported on Form 941 or 944 is considered a reduction of employer’s Social Security and Medicare taxes due. Any excess credit that cannot be used against employer’s Social Security and Medicare Taxes is then a refundable tax credit that can be used to offset any other federal taxes owed by the employer. Employers should file an amended Form 941 or Form 944 if they wish to claim a refundable tax credit for any excess credits remaining after reducing their Social Security and Medicare taxes due.
In cases where employers have reduced their wages paid due to closures or significant decreases in gross receipts, they may claim refunds (refundable credits) for these overpaid taxes on retrospectively amended Forms 941 or Forms 944 as well as with an application through Fiscal Service now Guideline via Paycheck Protection Program lender portal: Guideline Connect.
Tax Form 943
Form 943 is the document used by agricultural employers to report the wages, Social Security and Medicare taxes for agricultural employees. This form is used instead of the much more common Form 941–Employer’s Quarterly Federal Tax Return.
In addition to reporting income tax payments, Form 943 can also be used by employers to report their liability for Emergency Unemployment Compensation on behalf of qualifying employees and activity related to qualified employer trusts, including elective deferrals made under a salary reduction agreement.
Form 943 is due annually by January 31 if total wages paid during the year were more than $2,500; otherwise if total wages were equal or less than that amount then payment must be received monthly or semi-weekly (depending on amount of total payroll taxes). To file an annual return, taxpayers complete Form 943 including their name and address, current business information (such as EIN and state identification number), totals of all wages paid during the year and taxes due from those wages. In addition to federal income tax withholding from employee paychecks, employers must also pay certain Social Security and Medicare taxes in accordance with Internal Revenue Code Section 3102(b). Employers must complete this form whether they operate as a sole proprietorship or as a corporation in order to accurately report federal income tax payments on behalf of farm employees.
Tax Form 944
Employers who receive the Employee Retention Credit will report the amount on their Form 944, Employer’s Annual Federal Tax Return. This form is used by employers to report their total federal tax liabilities for the year. It is filed annually with the Internal Revenue Service (IRS).
On Form 944, employers will be required to fill out a separate section for the employee retention credit, providing detailed information about the credit amount and which employees it applies to. The employer must also ensure that they are eligible for this tax credit and provide supporting documentation as required.
Once all of the information has been reported on Form 944, employers must submit it to the IRS along with their other yearly payments. After submitting Form 944, employers will receive an acknowledgement from the IRS that verifies that all of their taxes were paid in full for the specified year.
Conclusion
The Employee Retention Credit is a promising way of providing financial support to employers and incentivizing them to retain their employees during the Covid-19 pandemic. The IRS has established a method for employers to claim the credit, which includes filing Form 941, documenting and keeping records of wages or medical plan expenses, filing an amended return if needed, and filing Form 7200 if eligible.
After the credit has been claimed and approved, it is important to understand how it will be taxed so that companies can properly assess their tax liability. The Employee Retention Credit is treated as part of the employer’s general business credits for the taxable year in which it was paid. These credits are generally nonrefundable but any excess can be carried back one year or forward 20 years. Additionally, employers who have already claimed a payroll tax deferral may also be able to claim this credit since they are technically not considered “qualified wages” according to the IRS.
Overall, as employers consider taking advantage of this recently available incentive they must also be aware of their potential tax liabilities. By understanding how the credit will be taxed upon receipt by the company, employers should be better able to evaluate if taking this incentive is right for them based on their cash flow needs in a given time period and over time.