The employee retention credit (ERC) is a tax incentive designed to help employers keep their employees on payroll during the COVID-19 pandemic. This credit can be claimed on the employer’s income tax return and can be up to 50% of the wages paid to the employee per quarter.
Let’s take a look at how to claim the ERC and how it can help you save money on your taxes:
Definition of Employee Retention Credit
The Employee Retention Credit (ERC) is designed to incentivize certain businesses to keep their employees on the payroll despite being adversely affected by the coronavirus pandemic. Employers who qualify for the ERC and who meet certain criteria, such as having experienced at least a 20% decline in gross receipts, are eligible for a refundable wage credit against up to 50% of wages paid in 2020.
Employers with fewer than 100 full-time employees can claim this credit against both qualified wages paid and/or health plan expenses allocated to these wages in order to receive the utmost benefit from it. Qualified wages are generally limited to those paid with respect to each individual in an amount up to $10,000 for all calendar quarters beginning after March 12, 2020 and before January 1, 2021.
Eligible employers will also need information regarding their gross receipts and payroll taxes reported on the relevant quarterly forms that they filed under IRC Section 6053(a).
In order to prove eligibility for this credit employers must:
- Maintain accurate records of their full time employees
- Be able plausibly explain how the pandemic financially impacted their business operations.
- Include documentation outlining any other tests used when calculating average gross receipts over prior quarters such as whether or not vacations were taken into account in arriving at that comparison of gross receipt years.
The Employee Retention Credit was created as part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) to help employers affected by Covid-19 retain their employees. The credit is designed to reimburse some of the wages or salaries paid to employees so employers can keep employees on the payroll despite economic hardship caused by the pandemic.
In order to be eligible for the Employee Retention Credit, employers must meet several criteria:
- Have an active business operation during 2020
- Experienced a full or partial shutdown due to government orders related to Covid-19 OR had a significant decline in gross receipts
- Have provided qualified wages or salaries from Mar 1, 2020 – Dec 31, 2020
- Filed Form 941 quarterly reports during 2020
- Reduced wages/salaries by more than 20% when compared with Q1 2019 wages/salaries
In addition to these eligibility requirements, the credit is available only in specific scenarios depending on the employer’s size (under or above 100 full time equivalent employees). It is important that employers consult with their tax advisor before submitting Forms 941 and taking advantage of this credit.
Claiming the Credit
The Employee Retention Credit is a refundable tax credit for businesses affected by COVID-19. The credit is available for employers who have been impacted by the pandemic and can be claimed on your tax return.
If you have taken advantage of this credit, here is how you claim it on your tax return:
Calculating the Credit
Employers can calculate the Employee Retention Credit by first determining their total qualified wages, health plan expenses and qualified health plan payments. To do this, an employer needs to add up the wages paid during the calendar quarter for which the credit is claimed. The employer should then subtract payroll taxes or other offsets related to wages taken under government programs.
Next, employers need to add their health plan expenses and qualified health plan payments (discussed in detail below). Employers will then subtract any portion of those amounts that has previously been allocated as a deduction or exclusion on Form W-2 or other tax forms including Forms 941 and 1040. After the calculation is complete, the employer should multiply all of these amounts by 50 percent, resulting in the total amount of eligible credit. Finally, if applicable, employers must subtract any amounts received as Business Economic Injury Disaster Loans. Note that an employer cannot claim a credit if they received more than $10 million in Paycheck Protection Program loans sought individually by business owners with less than 500 employees, or associated entities and businesses seeking forgivable loans from April 1 through June 30 of 2020.
Filing the Credit on Tax Return
When filing your tax return, claiming the Earned Income Tax Credit (EITC) can be beneficial and help reduce taxes owed. This credit is available for certain individuals and families with lower income levels than taxpayers without children. The easiest and quickest way to claim this credit is to file a Form 1040 return. Generally, the form can be filled out online or on paper using tax preparation software.
To claim the EITC when filing a Tax Return, you’ll need to provide address information for each member of the household claimed on the return, their Social Security numbers and their incomes. You will also be asked to include any independent contractor income or self-employment income earned by anyone in your household as well as any other taxable income received during the year.
When completing your 1040 form you’ll need to include deductions such as childcare expenses, applied business expenses and any other applicable deductible expenses allowed under the Internal Revenue Code (IRC). If eligible you may qualify for additional credits such as the Additional Child Tax Credit or Education Credits offered through the American Opportunity Tax Credit or Lifetime Learning Credit programs which qualify based on educational costs incurred during 2021 related to enrolled higher education courses.
After you have completed your 1040 form with all relevant information relating to your eligibility for EITC then it’s time to submit your return either electronically via an approved electronic service provider or via mail by including Form 8879 IRS e-file Signature Authorization form along with accompanying paper returns if applicable. If UNABLE TO FILE ELECTRONICALLY FORM 8879 must accompany paper returns mailing them directly to IRS processing center:
Enter Appropriate Address HERE///
If eligible resulting refund will result in a lower balance due when filing future tax returns resulting in reduced taxes owed; getting money back sooner plus recent passage of The American Rescue Plan includes provision where up 85% of federal funds are accessible within three days of IRS acceptance EITC when filing electronically which provides quicker access funds increasing financial flexibility during these challenging times!
Documentation is an important part of claiming the Employee Retention Credit (ERC) on a tax return. Because of this, it’s important to make sure that you have all the documentation and records necessary to prove that you meet the criteria for this credit. Documentation should include eligible wages paid, qualified health plan expenses, and other records related to your business operations.
Let’s look at other documents that may be needed when claiming the ERC:
To make a claim for the Employee Retention Credit, employers must provide documentation demonstrating that they have been affected by the COVID-19 pandemic. This includes proof of wages paid, qualified health plan expenses, and other requirements as determined by the IRS. Records and supporting documents must be maintained for up to four years after filing the company’s federal income tax return.
Documentation that may be required includes:
- Credible evidence of Business Closure or Gross Receipts Decline: Employers must show that excessive government regulations or shutdown orders prevented them from operating completely or caused gross receipts to decline. Examples could include government-mandated closure directions or reports from public health authorities regarding COVID-19 cases in the area.
- Documentation of Wages Paid: Employers will need to document all wages paid during each quarter and also provide evidence that wages were paid to employees who performed no duties during this period due to business closures or substantial decreases in revenue (as described in 2 above). This could include payroll records that verify how much each employee was paid during these periods and when these payments were made.
- Documentation of Qualified Health Plan Expenses: Any employer claiming the Employee Retention Credit will also need to document expenses incurred for providing medical insurance coverage under a qualified healthcare plan during periods where they employed full-time workers who were not providing services due to business closures or substantial decreases in gross receipts during specified timeframes due to COVID-19 related disruptions. The CARES Act allows employers can elect one quarter during 2020 where their 2020 qualified health plan expenditures incurred are treated as if incurred by them during 2019, so documentation should include any relevant information related to such expenses incurred during this period as well as any other quarters in 2020 where they are eligible for an Employee Retention Credit based on qualified health care expenditures incurred outside the election period described above.
- Qualifying Event Documentation: Employers should include all documentation verifying that their workforce was impacted by COVID-19 disruptions such as layoffs, terminations, reductions in hours/pay, etcetera as part of their supporting evidence for a potential credit claim under section 2301 of the CARES Act (IRC Section 45S). This might include copies of applicable executive orders issued by local governments or public health departments significantly prohibiting businesses from operating partially instead of completely halting operations due to the pandemic such notices from state unemployment offices verifying layoffs/terminations related specifically to COVID-19 disruptions rather than seasonal labor trends typical found throughout certain industries annually (such as travel agencies and airlines).
In order to successfully claim the Employee Retention Credit, you will need to have proper documentation of your reduced payroll. The Internal Revenue Service (IRS) requires that an employer maintain records to verify eligibility for the credit and that documentation is maintained for the four-year period following the date of the tax return filing or two years after any taxes due are paid, whichever is later.
Documentation should include records such as payroll tax reports, Forms 941, 1099-MISC records, worksheets and calculations used in determining credits taken on Form 941 and deposition transcripts obtained in response to third-party information requests. Employers also need records that show amounts paid to each employee including wages and total hours worked. You should also keep documents which confirm how payments were made: whether they were a reduction in existing funds or funds from grants or loans eligible for forgiveness, forgivable loan forgiveness programs, subsidies received from other applicable sources or other applicable reimbursements available with respect to certain expenses related to paid leave taken by employees under certain laws, etc. A document detailing the amount of qualifying wages per employee must also be kept.
When claiming the Employee Retention Credit on your tax return, it’s important to make sure you understand the eligibility requirements and other considerations that may affect you. If you aren’t careful, you could end up with a hefty tax bill.
Let’s look at some of the important considerations to keep in mind when claiming the credit:
- Eligibility requirements
- Tax implications
- Timing considerations
- Calculation of credit
Interaction with Other Credits
When claiming the Employee Retention Credit, there are a few important considerations regarding the interaction of this credit with other types of credits already established by the Internal Revenue Code.
For individuals, one of the most important considerations involves whether to claim the Employee Retention Credit or an Earned Income Tax Credit (EITC). In most circumstances, it is beneficial to claim the EITC if it is available because a larger credit amount can be realized.
In addition, taxpayers may also vary their combination of payments between wages and qualified health plan expenses in order to optimize their credits and optimize their overall tax savings. It is important for taxpayers to consider all variables when planning for both current and future tax years that include months with qualified wages or qualified health plan expenses eligible for either or both of these credits.
Finally, pre-existing earned income tax credits discussed above can greatly reduce the effectiveness of the Employee Retention Credit because many effective credit amounts only begin after these other credits have been maximized. For example, job creation-based WOTC credits are often claimed first and then reduced on a dollar for dollar basis for any additional Earned Income Tax Credits and/or Emplotee Retention Credits in force. It is important to take this into account when planning for taxes due after potential ERC eligibility has begun because all of these other existing tax credit mechanisms must be taken into account prior to calculating any additional savings from ERC claims.
Application of Credit to Payroll Taxes
The application of credit to payroll taxes is an important consideration when it comes to filing tax forms. Employers are required to withhold taxes from their employees’ wages, including federal income tax, Social Security and Medicare taxes. Employers who withhold more than their actual liability for these taxes may apply the excess payment as a credit against future liabilities. There are several options available, and each should be reviewed carefully before proceeding in order to ensure that the most beneficial option is selected.
The first option available is referred to as the net method. Under this system, employers can offset their individual tax liability by subtracting previous payments from current liabilities. This option allows employers to reduce or eliminate their specific withholding amount from each employee’s wages as needed and may result in smaller withholdings for employees who have been with the company for some time since prior payments can be counted towards current obligations.
The second option for applying credits towards payroll taxes is called the aggregate method and this process applies equally to all employees within a company regardless of tenure or status. With this method, credits are applied across all repayment categories such as income tax, Social Security, Medicare or other withheld amounts reducing total obligations accordingly.
Finally, some employers opt for a hybrid approach whereby they begin with an aggregate system but then switch over to a net system later down the line depending on which system yields more favorable results at individual pay periods.
Claiming the Employee Retention Credit on your tax return can be tricky, and you’ll need a few more resources to help you get started. Thankfully there are a variety of resources available to help you through the process. This section will provide an overview of the best resources available, from IRS publications to online tutorials and more.
The Internal Revenue Service (IRS) provides a variety of publications that provide guidance about your responsibilities as a taxpayer, including information about filing taxes, understanding tax forms and credits, deductions, and other topics. IRS publications are available online or by mail.
Publications can be helpful when you have questions about the filing process and advancements in tax law. In addition to general informational documents like Taxpayer’s Rights or Understanding Your IRS Notice or Letter, there are also dedicated resources for:
- Businesses, such as Guide to Business Tax Planning;
- Self-employed professionals;
- Nonprofit organizations;
- Retirement plans;
- Estate and gift taxes;
- International tax laws;
- Foreign individuals living in the United States (U.S.);
- U.S. citizens living abroad.
By reading these documents you can gain more insight into your situation, as well as any benefits that you may be able to claim. It is important to note that the information provided in IRS Publications is provided for educational purposes only – it is not meant to replace legal advice from a professional tax advisor or attorney who understands specific laws in detail.
Tax Professional Assistance
Most small businesses are able to complete their taxes with the help of a tax preparation software, but those businesses seeking assistance from a qualified tax professional should be mindful of the unique qualifications that may be needed when claiming the Employee Retention Credit (ERC).
A tax accountant or other qualified tax preparer should have experience in business and individual taxes, as well as knowledge of ERC credits, in order to completely and accurately file all of the necessary forms.
It’s important to note that while many large accounting firms may have an experienced staff that has dealt with ERC credits before, they may also drive up costs due to their overhead. Those seeking help with claiming their ERC should engage with a smaller local firm, who is more likely to provide more personalized attention at an affordable rate. Like any major purchases before making a final decision it can also be helpful to do research on different firms and read reviews of customer experiences.