The employee retention tax credit is a special tax credit that was established under the CARES Act in 2020 to help employers keep their employees on the payroll during the COVID-19 pandemic. This credit is available to employers of all sizes, including self-employed individuals, and can be claimed as a refundable credit against certain payroll taxes.
To be eligible, employers must be able to show that their business has been affected by the pandemic. Employers may also qualify if they were able to partially close during the pandemic or if there were significant declines in their gross receipts. In this article, we’ll provide an overview of the employee retention tax credit and how to claim it.
Definition of Employee Retention Tax Credit
The Employee Retention Tax Credit (ERTC) is a refundable tax credit that incentivizes businesses to continue paying their employees during the COVID-19 pandemic. This tax credit was part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act and is available to certain employers regardless of size or industry. It allows employers to claim a refundable credit for wages paid after March 12, 2020, and before January 1, 2021.
The ERTC is equal to 50 percent of qualified wages paid up to $10,000 per employee per year. This includes both cash payments paid as well as certain health care costs. The maximum amount of this credit is $5,000. Eligibility for this credit begins when an employer’s business operations have been partially or fully suspended due to government orders related to COVID-19 imposed after March 1, 2020; or if an employer has experienced a significant decline in gross receipts during the quarter compared with the same quarter in 2019.
Employers can use their most recently filed Form 940/Form 941 quarterly tax return filing as proof of eligibility for this credit. An employer cannot also claim the tax credits under other provisions included in the CARES Act for distributions from a retirement plan or wages against which a Paycheck Protection Program loan was forgiven.
The Employee Retention Tax Credit (ERTC) is designed to encourage businesses to keep their employees on payroll. The credit applies to most employers who are otherwise eligible, including those who are not eligible for the Paycheck Protection Program (PPP).
To qualify for the ERTC, employers must meet certain criteria. Businesses may be eligible if they have been financially impacted by the economic disruptions caused by COVID-19. In order to determine eligibility, employers must show that their operations were either fully or partially suspended during a calendar quarter or their gross receipts during a calendar quarter were less than 50% of its gross receipts for the same calendar quarter in 2019.
Furthermore, for wage payments made on or after March 12, 2020 and before January 1, 2021, employers can qualify for the ERTC if they can demonstrate one of the following:
- An inability to operate at normal capacity due to government orders related to COVID-19; or
- A significant decline in gross receipts.
The ERTC provides a refundable tax credit of up to 50% of qualified wages paid up to $10,000 per employee (an aggregate maximum of $5,000 per employee). These wages must only include wages paid after March 12th and before January 1st 2021. The credit phases out as employer’s gross receipts exceed 80% of its 2019 pre-pandemic levels; businesses with greater than 80% pre-pandemic levels are not eligible for the tax credit. Employers may claim this credit against payroll taxes due and factored into quarterly Form 941 employment tax returns with an applicable IRS filing deadline date passed each quarter.
Maximum Credit Amount
Employer retention tax credits enacted by Congress in the CARES Act can help businesses of all sizes retain employees during periods of economic distress. The credit is available to employers whose operations have been fully or partially suspended due to COVID-19-related government orders or that have experienced a significant decline in gross receipts.
The maximum credit amount is equal to 50 percent of qualified wages paid after March 12, 2020 and before January 1, 2021, up to $5,000 in wages per employee. The foregoing limit is applied on an aggregate basis for all employees of the qualified employer. To be eligible for the credit, any previously earned wages that the employer paid in 2020 and that occur after March 12th may not be counted as qualified wages for purposes of the credit.
Furthermore, employers can receive a refundable tax credit against certain employment taxes equal to 50 percent of qualified health plan expenses allocated to periods that begin after March 12th in 2020 and end before January 1st 2021, up to a maximum of $10,00 per employee. This calculation applies separately from the wages credit mentioned above; however no more than $5,000 can be claimed per employee using both credits combined.
Calculating the Credit
The employee retention credit is a tax credit provided to employers to incentivize them to keep their employees on payroll during times of crisis. In order to calculate the credit, employers need to calculate their eligible wages, total credits available and their quarterly credit limit. It is important for employers to understand the process of calculating the credit in order to maximize their tax savings.
Let’s look at the steps involved in calculating the credit:
To calculate the tax credit, employers must first identify the wages they want to be considered “qualified wages“. Qualified wages are those paid during calendar quarters in 2020 to an employee who performs services while attending a full-time, onsite job and whose principal place of employment is in the United States.
The amount of qualified wages depends on when an employee was hired, as well as payroll tax withholding that has already been paid for 2020. Employers are eligible for up to $7,000 per employee for each calendar quarter; this includes the combination of all wages covered by the credit.
Specifically, qualified wages are generally made up of:
- Payroll taxes already withheld (Form 941) and deposits made between March 13 and December 31.
- Wages (basically pay subject to Form 941):
- For existing employees, wages paid from March 13th through December 31st (The maximum amount an employer can claim is $7000 per employee).
- For new employees, wages paid between February 15th and December 31st (the maximum amount that can be claimed is prorated based on when they were hired).
The employer’s total refundable tax credit will depend primarily on their total qualified wages associated with each qualifying employee during each calendar quarter in 2020.
Qualified Health Plan Expenses
Qualified health plan expenses are medical expenses paid to participate in a health plan. Qualified healthcare expenses are generally those considered deductible for income tax purposes. In addition to the cost of premiums, other eligible forms of payment can include coinsurance, copayments, and certain services not covered by your insurance company but prescribed by your doctor. It is important to note that health plans purchased through the Health Insurance Marketplace may qualify for a tax credit.
To calculate the credit, start with total medical expenses the taxpayer has incurred throughout the year, including both premiums and out-of-pocket costs (copayments and coinsurance). These expenses must exceed 10% of their adjusted gross income; any amount that is less than 10% of their adjusted gross income will not be eligible for a credit. Calculate their allowable deduction based on their individual circumstances – taxpayers filing as married joint filers may deduct up to twice as much as individuals filing alone or married people filing separately – then subtract it from their qualifying healthcare expenses for the year. Multiply this slightly reduced amount by their applicable tax credit percentage rate to determine how much they could still receive in credits towards paying for their premiums throughout the year. Each taxpayer’s situation will vary; consult with a tax professional if you have more questions or need more guidance calculating your specific credit amount.
Claiming the Credit
The Employee Retention Tax Credit (ERTC) was created as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act to help companies that were affected by the pandemic by providing a refundable tax credit for a portion of wages paid to employees.
To claim the credit, eligible employers must complete certain steps and calculate the eligible wages. Here, we’ll explore the steps for claiming the credit:
Filing Form 941
To properly claim the credit, employers will need to report it on Form 941, which is the quarterly payroll tax return they are required to file with the IRS. This form will show total amounts paid in wages or compensation during each quarter and the total amount of qualified leave taken by employees.
To ensure accurate pay, employers should maintain accurate records about each employee’s time off and wages for up to four years after filing Form 941. Employers must also prepare a separate Schedule R on an annual basis that details amounts of qualified leave wages and related credits claimed for every quarter of that year. This will help verify any information offered to employees regarding their hours taken as well as the corresponding wage calculations from their employers.
Filing Form 7200
The IRS Form 7200 is used when claiming certain credits against the amount of tax your business owes. The form has two sections. The first section is used to compute the General Business Credit and must be completed by all taxpayers regardless of the type of credit being claimed. This part of the form must provide details about your business or organization, as well as sufficient information about estimated taxes, real estate taxes, employment taxes and other related payments due to the IRS in order for them to properly determine your eligibility for a credit.
The second part is known as “Part II: Claiming Credits” and requires specific information based on the particular credit you’re trying to obtain. For example, if filing for the Small Business Health Insurance Tax Credit, you’ll need to provide your qualifying wages for up to ten previous tax years or periods along with any associated certified members you’re claiming as part of that calculation. Depending on which credits you’re eligible for and claim on this form, it could ultimately reduce or eliminate any balance due on other IRS forms such as Form 941 Schedule B.
When considering the employee retention tax credit, there are some additional factors to consider. These include determining the eligibility of employees, understanding the different types of relief available, as well as particulars of certain reporting and recordkeeping requirements.
Let’s dig a little deeper into this and explore the other considerations for the employee retention tax credit:
Payroll Tax Deferral
The Coronavirus Aid, Relief and Economic Security (CARES) Act employee retention payroll tax credit (ERTC) is available to most employers in 2020 to defer the payment of a portion of their 6.2% share of Federal Insurance Contributions Act (FICA). The employer will be able to take advantage of this tax benefit as long as they retain their current employees and pay eligible wages, up to the allowable tax credit amount.
In order to qualify for the ERTC, employers must meet all of the following criteria:
- have been in continuous operation since February 15th, 2020;
- experienced either a full or partial shut down due to an order from a governmental entity due to COVID-19;
- experienced a significant decline in gross receipts during any quarter compared to the same calendar quarter in 2019.
In addition, employers must generally meet certain payroll tax filing thresholds and requirements dictated by the IRS. This includes filing quarterly returns on Form 941 for each quarter with respect to which ERTC is claimed and ensuring that all eligible wages reported during that time period are properly allocated when claiming ERTC benefits on Form 941. Employers should also make sure they properly apportion their qualifying wages both by calendar quarter and across covered periods. If these guidelines are not followed, it could result in an incorrect calculation or denial of an employer’s claimed credit amount.
Interaction with PPP Loans
The passage of the CARES Act in March 2020 provided U.S. businesses with access to the Paycheck Protection Program (PPP) loan. This program offers business owners access to financing to cover employee salaries, rent and utilities and help maintain operations through the pandemic. It also provides business owners with incentives such as loan forgiveness and tax credits for qualifying expenses.
Businesses that have already used a PPP loan should review their particular situation to determine whether utilizing a PPP loan in combination with other financial strategies might be helpful for their specific needs during the course of this pandemic. For example, businesses can choose to use new PPP loans to replace current loans or old debt that has been deferred due to COVID-19, while also considering other options such as restructuring existing debts or finding another form of financing.
When examining their options, it is important for business owners to look at liquidity, debt service obligations and compliance components if they are exploring ways in which they can optimize available resources over time without violating program guidelines set by the Small Business Administration (SBA). Additionally, by understanding the differences between secured and unsecured debt along with its respective risks, companies will gain an appreciation of how best working capital can be allocated within a company’s operations infrastructure.
It is important for business owners to take advantage of available advice from knowledgeable professionals when considering alternative solutions such as combining PPP loans with other financing options. It will help ensure that their decisions are based on financial models that are tailored to their specific needs in order to maximize positive outcomes during this unique period created by the pandemic outbreak.
Other Tax Credits
In addition to the Employee Retention Tax Credit, employers may also qualify for additional tax credits depending on the size of their business, industry and certain other criteria. If you are an employer who has been impacted by the COVID-19 pandemic, it may be beneficial to research additional tax credits and incentives that have been put in place in your state.
Examples of tax credits that may apply include:
- Small Business Health Care Tax Credit: This credit is available to employers who provide health insurance coverage for employees and pay at least half of the total cost of coverage premiums.
- Unemployment Insurance Tax Credit: This credit is available to employers who pay unemployment insurance taxes on or after January 1, 2020.
- Work Opportunity Tax Credit: This credit is available to employers who hire some categories of workers such as veterans, ex-felons or recipients of public assistance.
- Employee Educational Assistance Plan Tax Credit: This credit is available to employers who offer educational assistance benefits to employees through an employer’s written educational assistance plan. The employee must complete college/technical education or coursework related to their current job or qualified industry before being considered eligible for this credit; the maximum benefit per employee per year is $5,250.
- Small Business Investment Corporation (SBIC) Program: This program provides access to capital for businesses that have difficulty raising funds from traditional sources due to lack of collateral or credit history. Through this program a business can obtain up to $5 million in capital; however, there are certain requirements that must be met before being eligible for such funding.
It’s important for businesses affected by COVID-19 pandemic related disruption to take advantage of any possible tax savings opportunities available to them through new government tax regulations and incentives such as the Employee Retention Tax Credit and other applicable credits listed above. Doing so can help reduce taxes owed while allowing your business operaç~oes remain viable during these challenging times.