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Overview of the Employee Retention Tax Credit
The Employee Retention Tax Credit is a great way for employers to reduce their taxable income, as it allows employers to receive a credit for up to $5,000 for each eligible employee who remains on the payroll. This tax credit can be claimed for wages paid between March 12, 2020 and December 31, 2021.
Let’s take a closer look at how employers can qualify for the ERTC and what the requirements are.
Eligibility Requirements
The Employee Retention Tax Credit (ERTC) is a tax incentive from the Coronavirus Aid, Relief, and Economic Security (CARES) Act which provides eligible employers with a tax credit of up to $5,000 per employee. The credit is designed to encourage employers to keep employees on the payroll during any calendar quarter in which their business’ operations are fully or partially suspended as result of a government-ordered COVID-19 related shut down.
To be eligible for ERTC, employers must meet the following requirements:
- Business operations must have been fully or partially suspended due to COVID-19 during any calendar quarter in 2020.
- The business must have employed an average of fewer than 500 employees during 2020.
- The number of full time employees employed on any given day during the 2020 year should not be more than double the number of employees employed on any given day in 2019.
- Not have received assistance through another program that would provide a duplicative benefit such as Payroll Protection Program (PPP).
In addition to meeting these eligibility requirements, employers additionally must not have previously claimed ERTC or refundable Credits for federal taxes withheld from employee wages for wages paid prior to enactment date of CARES Act (December 27th, 2019). Employers who failed to qualify for the tax credit may apply for it retroactively if they meet all other eligibility requirements listed above and choose to claim retroactive amounts prior March 2021.
Benefits of the Employee Retention Tax Credit
The Employee Retention Tax Credit (ERTC) is an important new tax credit established as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. This credit is intended to help employers by providing them with a refundable tax credit that rewards employers for keeping employees on their payroll. Eligible businesses can claim this credit against their 2020 payroll taxes equal to 50% of up to $10,000 in wages paid per employee from March 13, 2020 through December 31, 2020.
The ERTC provides employers with the following benefits:
- The ability to reduce federal payroll taxes by taking a refundable credit up to 50% of wages paid to employees between March 13 and December 31.
- It incentivizes employers to retain their employees during the COVID-19 crisis.
- It helps businesses preserve job-related benefits such as health insurance and 401(k) contributions made by employers on behalf of their employees.
- It encourages businesses who have experienced a 50% reduction in gross receipts between last quarter and this quarter compared to 2019 the same quarter to keep their employees on payroll even if they are not able operate normally due to pandemic restrictions or economic downturns.
- An immediate cash flow benefit by reducing federal payroll taxes until year’s end or when total credits exceed total employment tax liability terms for 2020, whichever comes first.
How to Apply for the Employee Retention Tax Credit
The Employee Retention Tax Credit (ERTC) provides employers with a refundable payroll tax credit of up to $5,000 per employee for each taxable quarter, depending on the wages paid and their number of full-time employees. The ERTC applies to employers affected by COVID-19 and aims to encourage businesses to keep workers on their payroll and retain them when the pandemic subsides.
In this article, we will discuss the details of how you can apply for the ERTC:
Complete the IRS Form 941
A key element to determine the amount of Employee Retention Tax Credit an employer is eligible to claim is the amount of taxes paid by them through Form 941. This form is filled by employers each quarter.
To be eligible for the Employee Retention Tax Credit, employers must complete and submit Form 941, Employer’s Quarterly Federal Tax Return, and enter the total wages that have been paid in each quarter in Box 1 of the form.
Once an employer has completed their Form 941, they are ready to claim their Employee Retention Tax Credit in either their quarterly or their annual federal tax return. If claiming quarterly, enter the total credit amount on line 12a of Form 941; this will reduce your amount owed to the IRS for that quarter. Alternatively, those employers who are claiming a refund can elect to include all or part of it on line 12b instead.
If an employer refiles a quarterly return after receiving a notice from the IRS denying or adjusting a refund or tentative credit claimed from prior quarters, they must adjust their current-quarter entries as necessary to reconcile with prior-year totals using code Q on line 11c of Form 941. This includes reconciling payments made under Notice 2020-22 when filing a new return if adjustments are required.
For those employers who are filing an annual return at year-end instead, regardless if they have taken initial payments before 2020 year-end or deferred payments under Notice 2020-22 during calendar year 2020 may prospectively treat wages as qualified wages in determining their employee retention credit by noting “2020 Payroll Deferred” on Line 12a; this will reduce their overall balance due on Form 941 at year end.
Submit the Form 941 to the IRS
In order to qualify for the Employee Retention Tax Credit and receive the funds, all eligible employers must submit a completed, signed Form 941 to the IRS. This IRS form is due at the same time as all other quarterly Forms 941 – generally within 45 days from the end of each quarter of 2020. The tax credit can be taken either as a direct payment by reducing federal employment tax deposits (limited to 50%), or as a credit against income taxes when filing Form 940 annual return and Form 941 quarterly returns.
Please note that employers cannot file Form 945 in order to claim this tax credit; instead, those who have already previously filed should amend their initial application with Form 4466 in order to claim this credit. All applicable forms must be deposited electronically with the IRS, except in cases where an employer represents they are unable to do so due to insufficient staff or technical problems related to COVID-19. Alternatively, eligible employers may deposit or file using paper forms when necessary.
Claim the Credit on Your Tax Return
Claiming the Employee Retention Tax Credit on your tax return is a fairly straightforward process. Eligible employers are able to reduce their 2020 income tax liabilities or increase their refund amount by claiming a credit on their quarterly estimated tax returns or when they file their annual income tax return. When filing your income tax return, you should use IRS Form 941-X (Adjusted Employer’s Quarterly Federal Tax Return) and complete the Employee Retention Credit portion of the form.
You will also need to complete IRS Form 5884-A (Employee Retention Credit for Employers Subject to Closure or Experiencing Significant Financial Hardship). If you are eligible, you may either be entitled to a credit under Section 2301 of the CARES Act or qualify for an extended version of the employee retention credit via section 2302 with additional limitations.
When it comes time to actually claim your employee retention credit on your income tax return, you must also include some other documents and information, such as:
- Records related to retaining employees during the coronavirus pandemic.
- Payroll expenses qualifying for the employee retention credit.
- Other payments made in lieu of wages during the eligible period.
A number of forms may be required, such as Forms W-2 and Form 1040 Schedule C for business owners. Keep in mind that claiming an employee retention tax credit on your income tax return is voluntary, so review all necessary documentation prior to submitting any paperwork with your return.
Documentation Needed for the Employee Retention Tax Credit
In order to apply for the Employee Retention Tax Credit (ERTC), certain documents and information need to be provided to the Internal Revenue Service (IRS). These documents will vary depending on the type of business you have, as well as the number of employees you have.
This section will break down all the documents needed for the ERTC and how to submit them:
Documentation of Eligibility
Before you can apply for the Employee Retention Tax Credit (ERTC), your business must meet certain qualifications and provide evidence of eligibility. The size of your business, as well as the amount of revenue generated in 2020, will both impact your qualification. Additionally, you must also demonstrate how COVID-19 has caused a significant decline in gross receipts.
The following documentation may be required to prove eligibility:
- Written records to show revenue loss from 2020 compared with either 2019 or 2020
- Summary of paid wages for previous years
- Certificate of business formation and registration
- Documentation showing reduction or closure linked to a COVID-19 governmental order
- Proof that the impacted business is open for less than 50% capacity during the same quarter it’s claiming the credit
- Copies of invoices for goods/services that have been acquired since March
Documentation of Wages Paid
In order to apply for the Employee Retention Tax Credit, employers must provide documentation of wages paid to employees during the year. It is important to have accurate records of wages during both qualified periods, as employers will need this data to calculate their applicable credit.
During qualified period 1, which begins on March 12th and ends on June 30th of 2020, employers must document wages paid, excluding group health plan expenses. This includes any vacation or sick pay as long as it is not connected to a Qualified Sick Leave Wage (see below) and all other forms of compensation, such as bonuses or tips paid out by the employer. Any deductions for state and federal taxes should also be recorded for future reference.
Additionally, during qualified period 2 (July 1st through December 31st), employers must document wages paid under certain parameters again, excluding any group health plan expenses and Qualified Sick Leave Wages (expanded family leave and emergency family leave). Additionally, all wages paid under the payroll protection plan must be documented along with any result provider/factory-provided contributions when determining credit eligibility for temporary employee rehiring.
It is essential that all detailed payroll records are reviewed upon their filing before applying for the Employee Retention Tax Credit so that employers can ensure accuracy when claiming credit amounts. Records may be requested anytime within 3 years after making a claim or an extension is necessary if an IRS audit determines that additional information has been requested or needed in the review process. If further information is needed in addition to what was initially provided when claiming tax benefits from employee retention credits authorities will inform you prior to resolving your tax credit application eligibility status.
Documentation of Credit Claimed
In order to apply for the Employee Retention Tax Credit (ERTC), certain documentation must be provided in order to validate the claim of entitlement. This documentation is used to prove that a qualified employer’s wages and health plan expenses meet the criteria outlined in the Coronavirus Aid, Relief, and Economic Security (CARES) Act. Depending on what type of credit is being claimed, there are different documents that must be submitted in order to satisfy an ERTC application.
For those employers claiming standard reductions allowed in Section 899I of the CARES Act, appropriate payroll reporting forms for the 2019 calendar year must be submitted. These forms include Form 941-Employer’s Quarterly Federal Tax Return, Form W-2-Wage and Tax Statement, Form W-3-Transmittal of Wage and Tax Statements, or other equivalent third-party forms that report employee wages and tips for 2019.
If an employer is claiming a single employee replacement rate reduction under Section 899I of the CARES Act or claiming top line revenue reduction allowed under §2301(a)(2) or §2301(c)(1) of CARES Act then they would need to include IRS–approved methods along with annual financial statements. Some examples may include prior year audited financial statements such as Form 10K/Form 10Q or payroll statements such as Forms 1042-S/Form 945/Form 1120/Form 943. If these documents have already been provided to confirm wages or employment taxes during a previous regulatory compliance assessment then they may not be necessary for submitting an ERTC application.
In addition, all businesses seeking an ERTC credit would need to provide documentation of 2020 health care expenses associated with their Group Health Plan plan including their Consolidated Omnibus Budget Reconciliation Act (COBRA) premiums paid into your Small Employer Health Reimbursement Arrangement (HRA). Examples could include payment statements from COBRA costs billed by a carrier or agent invoice paid directly by you or an IRS 1095–C form or equivalent form providing proof of minimum Essential Health Coverage (EHC) offered in 2020 which was completed by their group health carrier as part of Affordable Care Act reporting requirements.
Reporting Requirements for the Employee Retention Tax Credit
Obtaining an Employee Retention Tax Credit (ERTC) can be an invaluable way for businesses to continue to thrive and retain employees during financial hardship or a recession. In order to be eligible for the ERTC, businesses must adhere to certain reporting requirements.
In this section, we will look at the reporting requirements for the ERTC and how to apply for the credit:
Quarterly Reporting
The Employee Retention Tax Credit (ERTC) requires employers to report quarterly to the Internal Revenue Service (IRS). In order to qualify for the credit, employers need to provide basic information regarding their employees who are covered by the ERTC. This includes an employees’ name, Social Security Number, wages paid and the applicable quarter. The IRS requires this information to be completed and submitted quarterly via Form 941 and Employees’ Quarterly Federal Tax Return in order for employers to receive their ERTC credit.
Employers must make sure they have correctly reported all of their employee’s information as any changes or corrections that need to be made throughout the year must also be reported on Form 941. Additionally, employers will also need to complete Form 7200 – Advance Payment of Employer Credits Due To COVID-19 in order for them to request an advance payment of any credits they may expect based on their expenses or wages paid.
It is important that employers accurately report all relevant details as failure to do so could result in penalties or ineligibility of the ERTC with respect to specific quarters.
Annual Reporting
For organizations that are approved for employee retention tax credit and applied the credit to payroll taxes in the quarterly period, an annual report must be filed with the IRS within 30 days of the last day of a taxable year. This report must include certain information like wage costs, qualified wages and qualified health plan expenses. Additionally, employers must retain records and adequate supporting documentation for at least four years from when annual reporting is due. These records may also be used to help employers in compliance with other legislative requirements like recordkeeping for qualified wages for additional credits or refundable payroll tax credits.
The annual report should include information such as:
- Detailed records of total wages paid by calendar quarter
- Details of any cost-sharing amounts incurred related to health plans (if applicable)
- Calculations made to determine:
- Average number of full-time employees employed during 2020 (for small employers)
- Qualified wages & employee retention credits claimed
- Documentation that proves employer qualification and certification by US Treasury/IRS
Other Considerations
One of the most important factors to consider when applying for the Employee Retention Tax Credit is the eligible wages you can claim and the limits for the credit. Other considerations include the base period of claimable wages, how to claim the credit, and the types of employers who are eligible for the credit.
Let’s look in detail at how to make the most of the Employee Retention Tax Credit:
Interaction with Other Tax Credits
When considering if you are eligible for the Employee Retention Credit, you should also consider any other available tax credits that may be applicable to your situation. The IRS has stated that the Employee Retention Credit is not allowed to be “double counted” against any other applicable tax provision or program (e.g., PPP loan). Additionally, while the Employee Retention Credit may reduce the amount of wages subject to taxes, it is important to consider if other available credits can help further reduce your taxable wages or even provide a refundable credit.
Other potential credits include:
- Family and Medical Leave Credit: Employers can use this credit when provided paid leave for employees taking time off for family and medical reasons.
- Small Business Health Care Tax Credit: Applies when an employer pays at least half of their employee’s health insurance premiums.
- Social Security Payroll Tax: Available in certain situations depending on when medical leave was taken and employer size.
- Work Opportunity Tax Credit (WOTC): When hiring disadvantaged or unemployed individuals.
- Transportation Fringe Benefit: Available if an applicant pays at least 50 percent of commuting costs for their employees.
- Research and Development Tax Credits (R&D): Apply when businesses carry out innovative research project activities.
Impact on Filing Deadlines
Filing deadlines for certain documents and forms that could impact an employer’s ability to claim the employee retention tax credit (ERTC) have been modified as a result of the COVID-19 pandemic. The applicable documents include Forms 940, 941, 1040, 2120, and 2121.
Forms 941, 1040 and 2121 are generally due on or before April 15th each year. For the 2021 tax year employers filing those forms will have until May 17th to file their return and take advantage of ERTC if they meet the necessary criteria.
Forms 940 and Form 2120 are due July 31st of each year and no extension is provided for 2020 or 2021. To qualify this credit employers must be able to document sufficient decrease in gross receipts on a quarterly basis over comparable quartiles. This documentation must be completed in advance of filing such forms which generally means items like P&L statements need to be finalized by July 31st so that employers may claim their credits with certainty prior to filing their returns by August 15th for 2020 or August 16th for 2021.