Overview of the Employee Retention Tax Credit
The Employee Retention Tax Credit (ERTC) is a type of incentive that was created to help businesses offset the costs of paying wages during the COVID-19 pandemic. It is a tax credit against employment taxes that an employer can claim up to a certain amount. It is important to understand the details of this credit and how it can be used.
In this article we are going to give you an overview of the ERTC and how it is paid:
What is the Employee Retention Tax Credit?
The Employee Retention Tax Credit (ERTC) was introduced as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act and is designed to help businesses retain employees during the COVID-19 pandemic. The tax credit provides a refundable payroll tax credit equal to 50% of up to $10,000 in wages paid from March 13, 2020 through December 31, 2020 and is available for businesses affected by the pandemic.
In order for an employer to be eligible for the ERTC, they must have:
- Partially or fully suspended their business operations due to governmental mandated health orders related to COVID-19
- Experienced a significant decline in gross receipts
Additionally, employers who receive a loan through the Paycheck Protection Program (PPP) are still eligible for the ERTC if they choose not to take advantage of loan forgiveness. All employers are also eligible regardless of size or type. For example, both large corporations and very small family run businesses can receive this tax credit.
The credit will be paid according to Internal Revenue Service Schedule R – “Credit for qualified wages paid during period of economic hardship“. Employers must complete Form 941-X each quarter that includes calculations and all required supporting documents when claiming ERTC on their quarterly payroll tax returns. Once employers apply for ERTC, they will be entitled to receive a full refundable payroll tax credit within days via direct deposit from the Internal Revenue Service (IRS).
Who is eligible?
The Employee Retention Tax Credit (ERTC) is a tax credit that allows employers to claim a credit against certain employment taxes of up to $5,000 per employee during the period beginning in 2020 and ending June 30, 2021. The credit is available for employers whose operations have been fully or partially suspended as a result of an order from an appropriate governmental authority limiting commerce, travel, or group meetings due to Covid-19. The tax credit applies to wages paid to employees after March 12, 2020 and before January 1, 2021.
To be eligible for this credit, the employer must:
- Have been fully or partially suspended due to orders from an appropriate government authority limiting commerce, travel or group meetings due to Covid-19;
- Experience either:
- A 50% reduction in quarterly receipts compared with the same quarter of 2019; OR
- Fully or partially suspend its business before June 30 due to such order
The ERTC also applies if the employer’s full time workforce declines by more than 20% when compared with the number of employees on its payroll during 2019 quarters one and two. A reduced workforce means that a new employee hired by December 31st can still qualify the employer for this tax credit.
How the Employee Retention Tax Credit is Paid
The Employee Retention Tax Credit (ERTC) is a tax credit designed to help businesses retain employees in the wake of financial losses due to the COVID-19 pandemic. The ERTC is paid as a tax credit that businesses can use to offset their payroll taxes. The tax credit amount is calculated by taking eligible wages paid to an employee during the credit period minus any credits previously received for the employee.
Let’s see how this works in more detail:
Direct Payment Option
The federal government provides an Employee Retention Tax Credit (ERTC) to businesses affected by the COVID-19 pandemic. The ERTC is available to employers that meet certain criteria and can be claimed against qualified wages paid between March 12, 2020 and December 31, 2020. The credit is equal to 50% of qualified wages up to a maximum of $5,000 per employee in 2020.
Businesses have the option to receive their ERTC payments through a direct payment option by filing IRS form 7200 or claiming it as part of their regular tax payment. The direct payment option allows businesses to receive the ERTC more quickly than claiming it against regular tax payments, making it a favorable choice for those who need financial relief sooner rather than later.
Under the direct payment option, employers must fill out IRS form 7200 and provide details about their company such as its payroll taxes for each calendar quarter of 2020 and how much in qualified wages were paid during that period. It’s important that employers include all relevant information on this form so that the IRS can process their request quickly and accurately. Once approved, businesses will be able to receive credit payments on an accelerated schedule within two weeks or less directly into their accounts.
Credit Offset Option
The Employee Retention Tax Credit (ERTC) is a tax credit available for employers to offset a portion of their payroll costs for qualified wages paid to employees after March 12, 2020 and before January 1, 2021. The tax credit is in the form of a federal payroll tax reduction and can be claimed quarterly or when filing an employer’s income tax.
When claiming the credit on an employer’s income tax return, the employer must include a statement with the return that indicates they are claiming the ERTC under section 2301 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). Additionally, if wage expenses eligible for the credit have not already been taken as a deduction on an income tax return, then these should also be included in that statement.
The Credit Offset Option allows employers to elect to have up to 80% of their ERTC benefit paid out by way of announcing credits throughout any quarter after receiving IRS approval. This option can help employers maintain consistent cash flows throughout this period of economic uncertainty or allow them to quickly deposit savings from their ERTC claims into operational costs. Employers can choose this option by providing information about their Estimated Tax Payments when filing Form 7200 with the IRS. If unsure about which method best serves their needs, employers should consult professional advisors or contact local Small Business Development Centers for advice on making this election choice.
Credit Against Payroll Taxes Option
The Credit Against Payroll Taxes Option allows employers to receive the full value of the Employee Retention Tax Credit. Under this option, employers may claim a refundable tax credit equivalent to 50% of qualified wages paid in 2020 and 2021 up to $10,000 per employee.
To receive this credit, employers must reduce the amount they otherwise would have been required to deposit or pay with respect to their employment taxes. So the maximum allowable credit is equal to the tax liabilities an employer would owe with respect to Social Security taxes on all of its employees’ wages regardless of whether any employees actually receive qualified wages. Qualified wages also include both health plan expenses an employer pays or incurs in a year.
Tips for Employers
The Employee Retention Tax Credit (ERTC) is designed to incentivize employers to retain employees by allowing them to receive a refundable tax credit of up to $50,000. It is important for employers to understand the requirements and processes necessary to claim these credits.
In this section, we will provide tips to employers on how to make sure they get the best use out of the ERTC:
Employers must have required documentation in order to be eligible for the Employee Retention Tax Credit. This includes having employers retain records and documents to support their assertation for the credit for a period of four years from the date the return was filed.
The documents employers must collect and retain include:
- Payroll tax filings (Form 941)
- Payments of qualified wages
- State quarterly wage information (or equivalent documents)
- A list of employees for whom qualified wages or health care expenses were paid, including their name, address, social security number and the amount of wages plus applicable health care expenses
- Calculations regarding pay periods, average number of full-time and part-time employees employed during 2020 and 2019
- Calculations used to calculate qualified wages
- Copies of Forms 7200 requesting advanced payments with respect to any portion of the retention credit that were anticipated but not included in payroll taxes timely deposited during 2020
The IRS requires employers to keep records of the wages they paid in order to qualify for the Employee Retention Tax Credit. The records should include documents such as payroll tax filings, Forms W-2, and wage and hour documents. For employers that don’t use certified payroll software, additional records such as time sheets and supervisor bonuses may need to be kept as well. Employers should also store documentation demonstrating their employee’s full-time employment status for the prior year, including proof of health insurance coverage or flexible spending arrangements (if applicable).
In addition to these documents, employers must also maintain documentation related to the COVID-19 relief efforts used by them during 2020. Such documents might include:
- job retention plans or programs adopted in 2020
- other evidence demonstrating that an employer’s gross receipts experienced a substantial decline from 2019
- information about calendar quarters in which wages were not reduced for any reason other than due to seasonality or operations being fully or partially suspended in 2021 due to COVID-19 related reasons
- records of how they divided the credit among their employees
- any other related activities associated with calculating and claiming the credit
Employers who qualify for the Employee Retention Tax Credit benefit must report the credit on their quarterly federal tax returns (Form 941, Employer’s Quarterly Federal Tax Return). In addition to filing Form 941, employers must separate the tax liability reported and earned wages into two separate deposits on direct deposits for each payment period.
In order to report the credit accurately, employers must also provide documentation that supports their qualified wages paid (including payroll records, bank statements, accounts payable information) as well as a reconciliation of total wages paid versus total wages subject to the tax credit. While this process can take time and require some administrative support, retaining experienced accountants or payroll professionals can help alleviate some of this burden.
For larger organizations that operate in multiple states and/or territories, or have a significant number of employees located outside of those states or territories, there may be additional reporting requirements. Be sure to research all applicable filing rules before taking advantage of any credits or deductions associated with federal taxes.