Overview of Employee Retention Tax Credit
The Employee Retention Tax Credit (ERTC) is a Federal tax incentive designed to encourage employers to retain their employees during the COVID-19 pandemic. It provides businesses with a refundable tax credit for wages paid to employees from March 13, 2020, to December 31, 2020.
This article will provide an overview of the employee retention tax credit, as well as how to calculate it.
Definition of Employee Retention Tax Credit
The Employee Retention Tax Credit (ERTC), established under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), is a refundable payroll tax credit available to eligible employers for qualified wages paid to their employees during the COVID-19 pandemic. It is designed to provide financial relief to businesses that have been adversely impacted by the pandemic and can be claimed in lieu of Job Retention Credits or unavailability of FFCRA credits. The credit is equal to 50% of qualified wages up to $10,000 per employee subject to certain restrictions and limits.
Under the ERTC, employers can claim a tax credit for half of an employee’s wages from March 12, 2020 until December 31st 2020. Qualified wages include health insurance costs. To be eligible for the ERTC, employers must be engaged in an active trade or business during 2020 and must have had gross receipts for any calendar quarter in 2020 of less than 80% when compared with the same calendar quarter in 2019. In general terms, this means that businesses must have experienced some decline in revenues due to COVID-19 in order to be eligible for this credit. Furthermore, certain partnerships or establishments with more than 100 full-time employees may have further eligibility restrictions they must meet when applying for the ERTC.
The Employee Retention Tax Credit (ERTC) is a refundable tax credit made available by the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020. The tax credit incentivizes employers to keep their employees on payroll despite economic hardships as a result of the COVID-19 pandemic. The IRS introduced guidance on how to calculate the ERTC and when businesses are eligible for it.
Eligibility Requirements: To be eligible for the ERTC, employers must have experienced a full or partial suspension of operations due to orders from an appropriate governmental authority limiting commerce, travel or group meetings due to COVID-19 in 2020, OR experienced a significant decline in gross receipts compared to the same quarter in 2019.
- Full or Partial Suspension: For businesses that have experienced full or partial suspension of operations due to governmental orders related COVID-19 restrictions – such as “shelter-in-place” orders – they remain eligible throughout each calendar quarter until they no longer meet conditions necessary for qualification under those rules.
- Significant Decline in Gross Receipts: For businesses that have not had a full or partial suspension but have instead experienced a significant decline in gross receipts, they remain eligible only through the calendar quarter during which the decline occurred and any subsequent calendar quarter until gross receipts reach 80% of what they were in the same quarter during prior year.
Calculating the Credit
The Employee Retention Tax Credit (ERTC) was put in place to help businesses cover their payroll costs during the pandemic. Calculating the credit can be a bit tricky and will require you to carefully analyze your business’ employee wages.
This section will explain the steps you need to take in order to accurately calculate the ERTC:
- Step 1
- Step 2
- Step 3
- Step 4
- Step 5
Calculating Qualified Wages
Qualified wages are calculated for the purpose of determining each employee’s credit under the Employee Retention Component of the CARES Act. Qualified wages include wages paid to or incurred with respect to an eligible employee who is not providing services due to circumstances related to the COVID-19 pandemic, such as a business closure or reduced service availability. Generally, these wages can be either fully or partially excluded from gross income for federal and state income tax purposes.
Qualified wages also include certain health plan expenses allocated to qualified health plan expenses of such employees, including costs and expenses associated with group medical care insurance coverage that is paid or incurred by an employer. Qualified wages do not include costs associated with vacation pay, holidays, severance pay, termination pay and deferred compensation.
For businesses with more than 100 full-time employees in 2019, qualified wages are those paid for hours that the eligible employee is not providing services based on 2019 full-time levels of service; for businesses with 100 or fewer full-time employees prior to 2020 who did not reduce staff levels in 2020, qualified wages include all amounts paid for service performed in either year; and for businesses that had 100 or fewer full-time employees prior to 2020 and reduced staff levels in 2020 due to COVID 19 circumstances, qualified wages include all amounts publicly by period regardless of when they were actually earned.
Calculating the Credit Amount
The Employee Retention Credit is designed to help businesses reduce their costs of paying wages due to COVID-19 related disruptions. The amount of the credit is based on the employer’s qualified wages paid in a calendar quarter. There are two main parts to calculating the credit:
- Qualified Wages: Qualified wages are those paid between March 12, 2020 and December 31, 2020 to employees who are not providing services due to business operations that have been fully or partially suspended as a result of government orders related to COVID-19. For employers with more than 100 full-time employees in 2019, qualified wages may exclude amounts above $10,000 in a taxable quarter for any given employee.
- Credit Amount: The credit will be equivalent 50 percent of the eligible employer’s eligible qualified wages, up to $5,000 per employee for all taxable quarters in 2020. For employers with fewer than 100 full-time employees, the calculation of the maximum is increased by multiplying it by number of full-time employees for each quarter (at a rate of 9 multiplied by the number of individuals employed by such employer during such calendar quarter).
The Internal Revenue Service also provides detailed instructions on how to calculate the Employee Retention Credit on its website at http://www.irs.gov/pub/irs-pdf/i7200a Employers should carefully review these instructions when they begin their calculations and follow them closely as they determine their credit amount owed.
Applying the Credit
The Employee Retention Tax Credit (ERTC) is one way that businesses can help offset the financial hardship of the pandemic. Under the CARES Act, employers of all sizes and industries are eligible to apply for the tax credit if they are retaining their employees and paying an eligible wage.
Here we will discuss the process of applying for the credit:
Filing Form 941
Filing Form 941 is necessary for employers to take advantage of the Employee Retention Tax Credit. This one-page form must be completed and mailed to the Internal Revenue Service (IRS) on or before April 15th of each year. It is important to know that this credit only applies to employers with fewer than 500 employees and that only wages paid after March 12, 2020 are eligible for the credit.
Form 941 covers employer contributions to Medicare, Social Security, federal income tax withholding, and federal unemployment taxes – also known as FUTA taxes (Federal Unemployment Tax Act). The form must include all taxable wages paid during the quarter in which your organization is claiming the Employee Retention Tax Credit. The information required includes employee salaries and wages, employer contributions towards healthcare benefits, incentives for certain employees such as bonuses and commissions, fringe benefits based on hours worked or fixed amounts that you contribute towards pensions or insurance premiums for your employees. Additionally, it requires any taxable postponed payments from 2019-2020 that have been paid during a calendar year in 2021.
Once all applicable data has been entered into Form 941, you must calculate total tax liability by adding together the income tax withholding from your workers plus any applicable employer contributions listed on the form (Medicare, Social Security taxes). Next step is subtracting any credits you may be eligible for including those related to Family Medical Leave Act (FLMA) Emergency Paid Sick Leave Act(EPSLA), qualifying healthcare plan expenses, or other credits defined by IRS Publication 15-T – Employer’s Tax Guide To Fringe Benefits.
Lastly fill out Parts 1) through 8) which includes information such as business name/address if different from employer’s address, total number of employees during current quarter and year-to-date totals associated with each payroll item listed on Form 941. Following this steps will result in providing a clear overview of how much an employer needs to pay in order to apply for the Employee Retention Tax Credit.
Filing Form 945
Filing Form 945 is one of the steps required to apply for the Employee Retention Tax Credit. This form must be completed to report federal income tax withheld on a payroll-by-payroll basis each quarter, similar to other reporting such as Form W-2 or Form 1099-MISC.
When filing Form 945, employers must provide the following information:
- Federal Employer Identification Number (FEIN)
- Name and address of the employer
- Total wages that are subject to federal income tax withholding
- Total amount of federal income tax withheld from employee wages for the calendar year or quarter
- Any adjustments required for overwithheld taxes during the current reporting period (e.g., from an earlier payroll period)
- Any potential refund due to underwithholding/overwithholding in previous years
After completing Form 945 and submitting it with required attachments, employers can then proceed with filing for the Employee Retention Tax Credit by providing additional information about their organization and employees including headcount data, wages paid and taxes withheld in each eligible quarter. Furthermore, employers will need to provide proof that their business was organized or operating after February 15th, 2020 and before July 22nd, 2020 in order to be eligible to claim this credit.
When calculating an Employee Retention Tax Credit, there may be other considerations to take into account. This includes:
- Eligibility requirements
- How to make the calculation
- Any limitations
- How to properly utilize the credit
By understanding these other considerations, individuals or businesses can ensure that they are taking advantage of the full potential of the Employee Retention Tax Credit.
Impact on Other Tax Credits
When calculating the available Employee Retention Tax Credit, businesses should consider other potential impacts. Depending on your business’s financial situation, the ERC may offset tax credits and deductions that could have provided significant tax savings and help your business become more profitable.
These other tax credits may include:
- The Work Opportunity Tax Credit (WOTC): Generally applies to employers who hire new employees who typically face substantial barriers to employment.
- Research & Development Tax Credit: Offers a credit for expenditures on research activities related to developing new products or processes, improving existing products or services, or improving a company’s existing manufacturing methods.
- General Business Credit Carryforward: Allows businesses to carry forward unused credits from prior years for use in future tax years.
- Qualified Small Business Stock Exclusion: Covers up to 50 percent of gains on applicable stocks if they are held more than five years, which reduces the effective rate of capital gains tax on those stocks.
- Section 179 Expensing Deduction: This deduction allows businesses to deduct all or part of either the cost of purchasing an asset or their lease payments in the year they are made as opposed to depreciating it over several years.
Businesses should also consider any state and local changes that may affect their eligibility for these additional incentives and credits before making any decisions regarding their taxes and potential savings. It is important that companies have a full understanding and appreciation of how their taxes could be impacted by spending decisions before moving forward with any agreements or decisions related to their own tax liabilities arising from employee retention benefits programs such as the Employee Retention Tax Credit program.
Impact on Other Tax Liabilities
When calculating the Employee Retention Tax Credit, it is important to consider its impact on other tax liabilities. This credit can reduce an employer’s withholding liabilities, as well as any regular taxes it may owe.
Some employers have specific requirements when calculating the credit. For example, if an employer is eligible for both the Credit for Small Businesses and the Employee Retention Tax Credit, they must consider which one offers a greater benefit and apply that one first. Other considerations include:
- How does this affect your FUTA or FICA tax liabilities?
- Are you qualified for any state or local credits related to wages?
- How can you maximize the benefit of using this credit through combined federal/state filing?
- What forms do you need to file in order to claim the Employee Retention Tax Credit?
- What accounting methods are commonly used to track employee retention expenses?
It is important for employers to understand how these various tax credits work together and what forms need to be filed in order for businesses to maximize their benefit. Working with professionals such as accountants, attorneys and financial advisors will help ensure compliance with applicable laws and regulations.
Impact on Employee Benefits
Employee benefits can be adversely affected by the Employee Retention Tax Credit. Payroll taxes are essentially a tax that employers pay in order to cover an employee’s Social Security, Medicare and unemployment taxes. As a result of qualifying for the Employee Retention Tax Credit, employers may have to reduce some employee benefits such as vacation time, holiday pay or bonuses in order to cover their payroll tax costs. Additionally, there may be limits placed on other types of compensation such as overtime wages or hazardous duty supplemental pay.
Employers should also be aware that if they received the credit but then begin laying off employees before January 1, 2021, they may be required to repay any Employee Retention Tax Credits for which they were eligible. It is important to consider these issues carefully when planning out how best to use the credits in terms of managing overhead expenses and employee compensation packages:
- Reducing employee benefits such as vacation time, holiday pay or bonuses.
- Limiting types of compensation such as overtime wages or hazardous duty supplemental pay.
- Repaying any Employee Retention Tax Credits if laying off employees before January 1, 2021.