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Overview of Employee Retention Tax Credit
The Employee Retention Tax Credit (ERTC) is a refundable tax credit designed to provide relief to employers who have been affected by the COVID-19 pandemic. This credit can be applied against payroll taxes and can provide up to $5,000 for each employee that is retained.
This credit is complex and can be difficult to understand, so let’s break it down and understand how it is calculated:
Eligibility requirements
In order to be eligible for the Employee Retention Tax Credit, a business must have experienced a “significant decline” in gross receipts for either 2020 or 2021 compared to 2019. A significant decline is defined as a reduction of 20% or more in quarterly gross receipts. Small businesses with 500 or fewer employees, both U.S.-based and international, are eligible.
The calculation of qualified wages also varies based on the size of the employer. Employers with more than 100 full-time employees must calculate the credit against wages paid to workers while they are not providing services due to business operations being partially suspended during any calendar quarter. Smaller employers with fewer than 100 full-time employees may use all wages paid regardless of why they were paid in order to calculate their credit.
Employers who receive Paycheck Protection Program (PPP) loans may still be eligible for the Employee Retention Tax Credit. However, employers will not receive a tax credit for any wage expenses that are forgiven under forgiveness provisions in the PPP loan program. Furthermore, some employers cannot participate if they received Consolidated Appropriations Act (CAA) grants or “shuttered venue operators” through that act’s grant program because participation would result in double taxation.
Maximum credit amount
The maximum amount of credit available to employers is equal to 50% of qualified wages up to a limit of $5,000 in wages per employee for the year. For example, if an eligible employer paid $50,000 in qualified wages for the 2020 tax year, the maximum credit available would be 50% x $50,000 =$25,000. However, since this amount exceeds the limit that applies per employee ($5,000), the employer’s maximum credit would be limited to $5,000 x number of employees ($5,000 x 10 employees =$50,000). The employer’s actual credit will be fully or partially reduced by any other credits included on a previously filed return and any wages taken into account in determining any other credits.
Calculation of Employee Retention Tax Credit
The Employee Retention Tax Credit (ERTC) is a government incentive program designed to help businesses retain employees during the COVID-19 pandemic. It provides a refundable credit to employers who retain their employees and cover certain wages paid during the affected period. Understanding the calculation for the ERTC is essential for employers in order to make the most of the tax benefit.
Let’s look into the details of the calculation of the ERTC:
Qualified wages
The Employee Retention Tax Credit is a refundable credit available to eligible employers who pay qualified wages to their employees during the COVID-19 period. The credit is based on the qualified wages paid to each employee after March 12, 2020 and before January 1, 2021 and is determined by multiplying the applicable percentage (70% or 80%) by eligible wages paid up to $10,000 for each employee for all calendar quarters in 2020.
Eligible wages are defined as either:
- A wage payment pursuant to a written binding agreement that was entered into before 2021 for services performed during any calendar quarter in 2020; or
- Payments made during any calendar quarter in 2020 for which the employer has not taken a deduction pursuant to Section 162 of the Internal Revenue Code.
Eligible wages do not include amounts taken into account under other sections of the Internal Revenue Code, including but not limited to FICA withholding or income taxes withheld from an employee’s payroll.
In order to be eligible for the Employee Retention Tax Credit, employers must pay qualified wages up to $10,000 per employee per year. Qualified wages are calculated on a calendar-quarter basis and must total at least $5,000 per employer (maximum of $10,000). Qualified wages can include salary and gross income received from employment in addition to supplemental payments such as PTO compensation, vacation compensation and bonuses. The IRS allows employers to calculate qualified wages when submitting their quarterly employment tax returns on Form 941.
Calculating the credit amount
The employee retention tax credit is a generous credit for employers who are affected by the COVID-19 pandemic. The calculation of the credit can be complicated – it is best to seek professional help for a clear understanding of your potential benefits. The amount of the employee retention tax credit depends on three factors: eligible wages, number of employees and type of benefit.
- Eligible wages: The amount of the credit is equal to the qualified wages that are paid during 2020, but not more than $10,000 per employee and $5,000 per quarter (or $10,000). For example, if an employer pays an employee $20,000 in qualified wages in 2020 but only $15,000 before December 31st only $15K can be used to calculate the employer’s credits.
- Number of Employees: To determine whether you qualify for this credit you need to compare your workforce size at two different dates; on March 12th and on December 31st. If your average number of full-time employees in 2020 was fewer than your average number in 2019 then you may qualify for this credit even if you have 500 or more employees overall.
- Type of Benefit: Finally, you must also consider what type of benefits you are providing to your employees that are eligible for this tax break – premium wage or paid leave. Various components such as paid leave under FFCRA as well as premium wage payments count toward qualified wages up to certain limits – consult a professional about these specifics and determine whether any additional credits apply when applying for this tax break.
Claiming the Credit
The Employee Retention Tax Credit (ERTC) can be a valuable tax break for businesses that have had to make reductions or termination of employees due to the COVID-19 pandemic. The credit is available for companies that have seen a decline in gross receipts or have been forced to suspend operations due to the pandemic.
In this section, we’ll discuss how to calculate and claim the ERTC:
Form 941: Employer’s Quarterly Federal Tax Return
Form 941: Employer’s Quarterly Federal Tax Return is the form businesses must use to report wages and withheld federal income tax of their employees as well as their portion of Social Security and Medicare taxes.
Since the Employee Retention Tax Credit (ERTC) passed with the CARES Act in 2020, eligible employers may use Form 941 to claim an employer retention credit for 50% of eligible wages paid from March 13 through December 31, 2020. Eligible wages are up to $10,000 for each employee. This amount includes health benefits related to qualified sick leave and family medical leave.
If an employer includes qualified health plan expenses that have already been taken into account when filing IRS Form 941-X before Dec 31, 2020 they may also claim them when they file Form 941. To take advantage of ERTC however, employers should not reduce their deposit amount because this could result in interest or penalty if it results in underpayment or overpayment of deposit amounts.
To properly calculate ERTC, employers should include the credit line on Line 11b on Forms 941 when they file subsequent quarters. Separate due dates and different filing rules apply to non-calendar year and newly formed businesses so be sure to review all instructions carefully before submitting your form.
Form 943: Employer’s Annual Federal Tax Return
Form 943 is the document that employers must use to report Federal Income Tax Withheld and any taxes paid for the year. The form will also reflect any employee retention credits which you are eligible for according to the U.S. Internal Revenue Service (IRS).
The credit is based on wages paid during the calendar year in which those wages were earned, up to a maximum amount of $5,000 per employee per calendar year. To qualify, businesses must have experienced a full or partial suspension of their operations due to governmental orders related to COVID-19, or if they have experienced a greater than 50% reduction in gross receipts during 2020 compared with 2019.
In calculating this credit, there is an eligibility test similar to that used by the IRS in determining interest deductions from a taxpayer’s income on Form 1040. You may claim the Employee Retention Tax Credit for any wages paid between March 13 and December 31 of 2020. Qualifying wages include vacations, holidays and sick leave pay, as well as wages for up to 10 weeks provided under certain employer-funded health plans.
To report this information, employers must complete Form 943 and enter their qualifying accommodations after Line 5b but before Line 11a on Form 941 (Employer’s Quarterly FICA Tax Return). You’ll need to use separate lines for wages reported on each form. When reporting your tax liability associated with your direct deposit payments or automated clearing house payments made during 2020 on line 6c (direct deposit/ACH payments), enter “6034” followed by “CRP” then “EWRT.” In addition, when completing line 8k (income tax withholding rates) enter “ERTC” instead of simply entering “0.” This indicates that you will be claiming the Employee Retention Tax Credit against those withholding amounts reported in lines 8b – 8j before allowing it as an offsetting credit against taxes due reported in lines 1-5a instead of entering 0 for each rate below line 5b. Keep good records so you can properly monitor and support your claim for any adjustments made later on Form 941C after filing Form 943 initially or making adjustments through balance due returns through Line 11a adjustment refund requests.
Reporting the Credit
Employee Retention Tax Credits (ERTC) are a great way to offset some of the costs associated with keeping employees on payroll, even during the economic downturn. This credit is available to many employers who have had to reduce their workforce due to the pandemic.
The calculation of the ERTC is important in order to qualify for it and report it to the IRS. We’ll go into the details of calculating and reporting the ERTC in this article.
Form 5884: Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips
Form 5884 is used by employers to report the amount of Social Security and Medicare taxes (FICA) they have paid on certain tips earned by their employees. The information reported on the form will be used to determine the amount of credit the employer should receive from the Employee Retention Tax Credit (ERTC) program.
The ERTC is a refundable tax credit that encourages businesses to retain their workers during the COVID-19 pandemic by offsetting some of the costs associated with FICA payments. To qualify for this credit, employers must have provided full-time employment for more than half of 2019 for each employee but then suffered a decline in business due to COVID-19 within 2020.
To receive a credit from ERTC, Form 5884 should be completed and submitted along with Form 940 or Form 941 depending on which form is used to report tips. On this form, employers must provide information such as:
- Total tips received
- Tip allocations
- Total wages before qualified tips are included
in order to calculate your tax credit amount. After you submit all required forms and documentation that proves your eligibility for ERTC, you will receive a tax credit equal to 50% of qualified Social Security and Medicare taxes paid due on certain employee tips allocated or distributed during 2020 up to $10,000 per employee.
Form 945: Annual Return of Withheld Federal Income Tax
Form 1045, Annual Return of Withheld Federal Income Tax (ARW), allows businesses to claim a tax credit for their Employees Retention Credit described in the Coronavirus Aid, Relief and Economic Security (CARES) Act. The form must be submitted to the Internal Revenue Service (IRS) each year along with appropriate payment.
The Form 945 should be filled with the following information:
- retainee information
- company information
- pay period details
- amounts withheld from retainer wages
- other relevant details as applicable.
This form should include information about the amount withheld from each employee’s wages subject to the federal income tax withholding for calculation of the Employee Retention Credit. Additionally, this form should be filed out accurately and completely in order to receive any respective credit or refund due to the IRS.
Lastly, while paper filing this form is an option it is recommended to electronically file Form 945 as it is easier and more accurate than paper filing. Filers using electronic services approved by IRS may be able to transmit their forms directly over secure internet connections without mailing or dropping off at a post office.