Overview of the Employee Retention Tax Credit
The Employee Retention Tax Credit (ERTC) was created to help employers retain employees while they weather the economic impact of the COVID-19 pandemic. The ERTC is a refundable tax credit that allows employers to claim a portion of their wages paid in 2020 and 2021. Employers can claim a 50% tax credit on wages up to $10,000 per employee, meaning employers can receive up to $5,000 for each eligible employee in the form of a refundable tax credit.
This section will provide an overview of the ERTC and discuss how employers can claim the tax credit.
The Employee Retention Credit is a refundable tax credit against certain employment taxes equal to 50% of qualified wages that eligible employers pay to employees after March 12, 2020 and before January 1, 2021. Qualified wages include the cost of employer-provided health care coverage and wages paid up to $10,000 per employee.
To be eligible for the Employee Retention Tax Credit, employers must meet all of the following criteria:
- The business must have fully or partially suspended operations due to orders from an appropriate governmental authority related to COVID-19
- The business had gross receipts for any calendar quarter in 2020 that are less than 80% of its gross receipts from the same calendar quarter in 2019
- The business has not received a Small Business Interruption Loan under the Paycheck Protection Program (PPP)
In addition, employers whose annual gross receipts exceed $10 million before 2020 can claim the tax credit if their 2020 gross receipts are less than 50% of its corresponding quarter in 2019. The percentage decreases for businesses with annual gross receipts over $5 million but less than or equal to $10 million before 2020. For these businesses, the employer’s 2020 quarterly gross receipts must be less than 80% of its corresponding 2019 quarterly gross receipts. For example, a business with annual pre-2020 gross receipts greater than $5 million but less than or equal to $10 million would be eligible if its first quarter 2020 gross income was no more than 80% as compared to first quarter 2019 income.
Amounts and Calculation of Credit
The maximum credit eligible employers can receive under the Employee Retention Tax Credit (ERTC) is determined based on several factors, including wages paid to employees and the number of eligible employees, for the period between the beginning of their business’ closures or significant reductions in services due to covid-19 from January 1, 2020 onward.
To calculate their ERTC, employers will need to know:
- The allowable wages per employee that are paid during this period. In general, “allowable wages” include cash payments to eligible employees for amounts up to $10,000 per employee with respect to a taxable year.
- The total number of full-time equivalent (FTE) employees that the employer typically employed in 2019. For example, if two or more part-time workers were employed part-time during 2019 and those individuals collectively worked an average of 30 hours per week in 2019, then they would count as 1 FTE in calculating an employer’s eligibility for ERTC.
- The number of FTEs the employer has employed during either all or part of this period from Jan 1 2020 onward. This amount is then used to determine how much credit an employer may be able to claim based on their total allowable wages provided for this period versus what their Year 2019 FTE amount was.
Generally speaking, small businesses can qualify for a fully refundable tax credit equal to 50% of qualified wages if they employed 500 or fewer workes between Jan 1 2020 onward while larger employers with more than 500 workers may also qualify but only 50% of up to $10K/employee which is still eligible within certain restrictions based on specifics within the calculations surrounding these payments and taxation benefits within the CARES Act relief package references above that was passed by Congress in late March 2020.
Claiming the Credit
The Employee Retention Tax Credit (ERTC) allows businesses to claim a tax credit against their payroll taxes if they suffer from financial hardship due to the coronavirus pandemic. Additionally, you can also claim the credit if you had to reduce wages or hours due to the pandemic.
In this section, we will discuss how you can claim the credit and what you need to do:
Filing Form 941
Filing Form 941 is one of the most common ways employers utilize the Employee Retention Tax Credit (ERTC), making it an important form to understand for those looking to take advantage of this program. The ERTC was created as part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and allows employers who experience a significant decline in revenue due to COVID-19 to receive a refundable tax credit.
Form 941 is for “Employer’s Quarterly Federal Tax Return”, and is due each quarter that payroll taxes are paid or incurred. When using this form to file for the ERTC, eligible employer must include Line 11 of their Schedule A form attached to their Form 941 along with any Qualified Wages they have paid. On Line 11b, employers should then subtract the amount of ERTC they are eligible for from their top-line liability on Line 2b, resulting in their net pay on Line 4b. This means that eligible employers can take a dollar-for-dollar deduction against all or a portion of their Social Security tax liability up to set limits.
To stay in compliance with IRS guidelines when claiming the employee retention tax credit on Form 941, employers need to make sure that:
- Any wages used for this purpose were paid after March 12th 2020 and before January 1st 2021 in order for them to be considered qualified wages by the IRS.
- Wages claimed do not exceed $10K per employee per quarter during 2020 or $5K per quarter during 2021.
Employers who are unable or prefer not to file quarterly returns can file annually by submitting Form 944 instead of Form 941 when applicable.
Using IRS Form 5884
The Employee Retention Tax Credit is claimed using IRS Form 5884, The Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips. This form is used to calculate the amount of the credit that an employer can claim for eligible wages paid after March 12, 2020 and before Jan. 1, 2021. For eligible employers who pay wages in 2020, only half of the available credit can be claimed in calendar year 2020. The remaining credit must be claimed on IRS Form 941 (Employer’s Quarterly Federal Tax Return) starting with returns filed in 2021.
In order to claim the Employee Retention Tax Credit, employers must first determine whether they qualify under one of three categories. These include:
- Full-time Eligibility Rules
- Part-time Eligibility Rules
- Unaffected Business Eligibility Rules (Available March 13, 2021-Dec. 31, 2021).
Upon determining you qualify according to one of these rules, employers should then complete all relevant fields on IRS Form 5884 and submit it with their quarterly employment tax return (Form 941). Note that it is important to also keep any and all documentation related to the employer’s eligibility for the tax credit and any applicable special purpose credits for inclusion with a future tax filing or audit purposes.
Claiming the Credit on Your Tax Return
The Employee Retention Tax Credit (ERTC) is an important federal program that provides businesses with financial relief to help them keep employees and keep their doors open during the COVID-19 pandemic.
Businesses who are eligible for the credit may be able to recoup the cost of raising wages, providing health care benefits, or paying payroll taxes due to their inability to generate revenue.
Claiming the Credit on Your Tax Return:
- Once you have determined that your business is eligible for ERTC, you can claim the credit on your tax return. The credit can be taken as a general business credit or as an income offset when filing your federal tax return.
- To claim the ERTC, you must file Form 941-X or Amended Employer’s Quarterly Federal Tax Return which is available on the IRS website. You need to include all necessary adjustments, such as gross wages and make sure you provide detailed information about any payments made by third parties, such as payroll service providers.
- Be sure to also follow local requirements if applicable – in most cases these will state information about any filed holiday bonus plans or government subsidies received throughout the year.
- Once you have completed and filed form 941-X/Amended Employer’s Quarterly Federal Tax Return template with all applicable information including qualified wages paid by third parties and then any applicable refunds will be remitted directly back to your business from IRS automatically through direct deposit within 10-15 days of filing depending on your circumstances and how long it takes for them to process your return.
Record Keeping Requirements
It is important to keep track of all relevant documentation to be able to claim the Employee Retention Tax Credit (ERTC) as smoothly as possible. This documentation includes documentation verifying the business experienced an economic hardship due to the coronavirus (COVID-19). It also includes records of wages paid and the number of employees retained throughout the tax year. In addition to this, there may be other specific requirements depending on the type of business.
Let us go through all of the record keeping requirements in more detail:
Proper record keeping is essential when applying for the federal Employee Retention Tax Credit (ERTC). Organizations must be able to document that their business was operational and their employees were retained during the period from March 12, 2020 to Jan 1, 2021. Without these supporting documents in hand, many companies may be deemed ineligible for the ERTC.
Organizations should ensure that all employees’ pay stubs include ERTC eligible wages (less than $10,000 per quarter) for each quarter during which the credit is claimed. As well, organizations must audit internal spending records to demonstrate a 20% reduction in gross receipts over one quarter from 2019/2020 as a result of COVID-19. Record keeping should also include reliable documentation of hours worked by employees or acceptable alternatives such as time cards or payroll systems. Finally, employers may need to provide proof of their pandemic related costs applicable to various component deductions used to maximize their credit amount under the FFCRA regulations.
The most important takeaway? Have your records ready! Effective record keeping is vital to ensuring proper ERTC eligibility and optimizing the amount recovered through this financial relief program.
Tracking Employee Hours and Wages
The Employee Retention Tax Credit (ERTC) is a refundable tax credit for employers to keep their employees on their payroll during the COVID-19 crisis. In order to qualify for the credit, employers must keep accurate records of employee hours and wages paid. This includes tracking each employee’s weekly hours and wages paid during the period of April 1, 2020 through December 31, 2020.
Employers must also have records showing that they qualified as an eligible employer under the ERTC program and records supporting the amount of wages paid to each employee during the qualification period. This includes copies of payment documents such as pay stubs or cash receipts as well as information related to employer contributions such as retirement plan contributions or health care costs.
In addition, if employers have furloughed employees due to COVID-19 related circumstances then they must also have records documenting each furlough with its start and end dates so that this period can be excluded when determining whether an employee has worked at least 20 hours per week in order to qualify for the ERTC program.
Ultimately, any records that can help demonstrate that an employer was eligible for the ERTC should be kept on file in case there is a need for additional documentation in order to process the claim:
- Tracking each employee’s weekly hours and wages paid.
- Copies of payment documents such as pay stubs or cash receipts.
- Information related to employer contributions such as retirement plan contributions or health care costs.
- Records documenting each furlough with its start and end dates.
Tips and Considerations
The federal government provides a tax credit to employers in order to help them retain their current employees. This credit is known as the Employee Retention Tax Credit and it can be claimed on the employer’s tax return.
In this article, we will provide some tips and considerations to help you maximize the use of this tax credit:
Consider Claiming the Credit Even if You Don’t Qualify
Although the Employee Retention Tax Credit (ERTC) is only available to employers who have experienced an interruption in business or a full or partial shutdown due to COVID-19, that doesn’t mean that all employers should pass up the opportunity to claim this valuable credit. In many cases, there are important qualifications that must be met in order for a taxpayer to claim the credit, but if these qualifications are met, then it could prove to be a very helpful tax break.
Before determining whether you qualify for the ERTC, it’s important to understand what the credit covers and how it works. The ERTC is a fully refundable tax credit equal to 50% of qualified wages paid between March 13, 2020 and December 31, 2020 up to a maximum of $5,000 per employee. This means that if an employee earns $10,000 during this time frame, then their employer would be eligible for an Employee Retention Tax Credit equal to $5,000.
To qualify for the ERTC:
- Eligible employers must experience either a complete shut down of operations due to government orders related to COVID-19 or gross receipts declined by more than 50% compared with 2019 levels in any quarter from March through December 2020.
- Full-time employees and part-time employees who work at least 30 hours per week on average can qualify for credit benefits.
- Employers must pay all of their employees at least monthly; weekly payments do not count towards qualifying wages for calculating this tax credit.
Even if you don’t think your business will meet these requirements in order to take advantage of the Employee Retention Tax Credit it pays off to investigate your options further as there may be other special advantages associated with properly filing your taxes and claiming this tax break. Certain groups such as 501(c)(2) organizations may have additional rules that govern their ability to use this form of relief so make sure you read through all available information carefully before deciding not take advantage of possible benefits associated with claiming this credit.
Don’t Forget to Claim the Credit for the First Two Quarters
If an employer qualified for the Employee Retention Tax Credit for 2020, it’s important to remember that the credit is claimable over the two quarters of 2020 where it was available. For Q2 and Q3 of 2020, employers are permitted to reduce their federal payroll taxes withholding due at those times by the amount of their Employee Retention Tax Credit. They can also request an advance just as if the credit was served as a refundable credit on their income tax return. Employers then need to file IRS Form 941-X to receive the benefit of this credit when filing a 2020 form 941 by January 31, 2021.
In order to claim this tax benefit, employers will need to provide documentation regarding their hiring wages and other compliance requirements that must be met in order to qualify for the credits. Additionally, employers who opt for an advance may be subject to additional reporting requirements at year end which could include:
- Updated version of Form 941-X.
- Amended payroll tax returns claiming the Employee Retention Tax Credit on line 22(a) when filing IRS Forms 940 or 944.
Coordinate with Your Tax Professional
When considering how to claim the Employee Retention Tax Credit (ERTC), it is important to coordinate with a qualified tax professional. This credit is complex and it has numerous eligibility requirements, application procedures, and potential pitfalls. A certified tax adviser can help you make sure that you take full advantage of the credit and that you make no mistakes in incorporating the credit into your financial reporting.
In addition to helping you understand which employees may qualify for the credit, your tax professional can also help identify any potential coordination issues between the ERTC and other government programs such as Sick Leave Credit or Family Leave Tax Credit. They can also answer questions about related areas such as:
- Filing requirements
- Income limits
- Timing considerations
- And more.
It’s important to start these conversations early – before filing your taxes – in order to ensure that you take advantage of every benefit available through this program. With careful coordination with a qualified tax professional and sound knowledge of the additional considerations required for claiming the ERTC, small business owners can maximize their savings from this important federal assistance program.