Overview of Employee Retention Tax Credit
The Employee Retention Tax Credit (ERTC) is a relief measure available to many employers who have been impacted by the COVID-19 pandemic. The ERTC is a tax credit that allows employers to receive a credit against their social security tax payments. This credit can be used to reimburse employers for up to 50% of their qualified wages incurred to employees during the year. It is important to understand the rules and regulations around the ERTC in order to maximize the benefit and properly record the credit.
Let’s jump into the overview of the Employee Retention Tax Credit:
Employers of all sizes and many types of organizations qualify for the Employee Retention Tax Credit, which was established as part of the Coronavirus Aid, Relief and Economic Security (CARES) Act to help businesses confront economic hardship caused by the COVID-19 pandemic. To provide incentives for retained wages, the federal government offers a refundable credit against an employer’s portion of Social Security taxes.
The credit is available to employers whose operations were partially or completely suspended due to orders from a governmental authority related to COVID-19 in 2020 or who experienced at least a 50% reduction in revenue during any quarter of 2020 as compared to revenue during a quarter in either 2019 or 2020. Businesses that meet these criteria are eligible for the tax credit even if their operations were not suspended beyond December 31, 2020.
Eligible employers include any trade or business with one or more employees including corporations, partnerships, nonprofit organizations, self-employed individuals and trusts. A business operation may be included as long as it has been operating with employees when it qualifies for the credit; this could include newly formed and acquired businesses where there is no transition period between entities and none of the same employees immediately remain employed after acquisition. Individuals who receive wages from an employer and incur Social Security taxes may also qualify under certain conditions.
The amount available varies according to wage size and activities during particular periods. Eligible employers may claim up to $5,000 per employee in total credits for 2020 based on wages paid from March 12 – December 31; those who hire new workers previously unemployed due to COVID-19 prior to December 31 are eligible for increased credits based on wages paid prior May 1st (with additional restrictions). Incentives are retroactive so employers can recoup tax charges already paid prior to April 15th where applicable; partial refunds are available after April 15th provided requirements have been met by then.
Maximum Credit Amounts
The employee retention tax credit is a refundable tax credit established by the CARES Act offers businesses affected by the pandemic up to a $5,000 tax credit per employee, per quarter. The credits apply to all wages paid after March 12, 2020 and before January 1, 2021.
The maximum amount of the credit depends on the average number of employees employed by a business during 2020:
- For employers with fewer than 100 average full-time employees during 2020, the total amount of the credit is equal to 50% of qualified wages paid up to $10,000. This means that for these employers, their maximum eligible credit is $5,000 per employee for all four quarters in 2020.
- For employers with more than 100 average full-time employees during 2020, the total amount of the credit is limited to 50% of qualified wages paid between March 12 and December 31 up to $10,000 per quarter per employee. This means that for these employers their maximum eligible credit for each quarter would be $2,000 per employee ($4,000 total). Employers with 100 or more average employees will not be able to claim more than a cumulative limit of $14,000 inCredits from first four quarters combined (quarterly limits are not additive).
Calculating Your Employee Retention Tax Credit
The Employee Retention Tax Credit was created by the US government to help employers cover costs due to the pandemic. The credit can be as much as $10,000 per employee depending on different factors and can be applied to a certain number of wages.
In this section, we’ll take a look at how to calculate your Employee Retention Tax Credit and the steps you need to take to record the credit on your taxes:
Calculate Qualified Wages
Understanding how to calculate your employee retention tax credit requires a few simple steps. The Internal Revenue Service defines ‘Qualified Wages’ as wages paid during the calendar quarters in which a business has an eligible quarter and meets the requirements of either being fully or partially suspended due to orders issued by an appropriate governmental authority due to COVID-19 or experienced gross receipts that declined more than 20%.
For qualified wages, you can include all wages, including salaries and hourly pay, paid from March 13th, 2020 through December 31st, 2020. It is important to note that any employees that were not paid qualifying wages won’t count for the purpose of this tax credit calculation. A business must make sure all of their employees are paid wages consistent with the standard amount they would earn if the business was not fully or partially suspended or experiencing a decline in revenue.
To accurately calculate any qualified wage amounts, businesses should review their tax documents such as quarterly wage reports. It’s also important to note that any cost savings measures such as furloughs or reducing hours will also reduce your total amount of qualified wages earned according to IRS standards. For example:
- If an employee works 40 hours per week with a regular salary and is given a 10% pay cut due to furloughs and reduced work hour; then that employee would only have 36 hours (90% of 40) towards the total amount of eligible qualified wages for calculating this tax credit total.
Calculate Credit Amount
The Employee Retention Tax Credit (ERTC) is a federal tax credit designed to encourage businesses to keep their workers on the payroll and help them manage cash flow during the economic downturn caused by the COVID-19 pandemic. Calculating your ERTC is an important part of taking advantage of this opportunity.
To calculate your ERTC, you’ll need to total your eligible wages and find an appropriate base over which to apply the credit. Eligible wages are wages paid between March 13, 2020 and December 31, 2020, excluding those paid after December 31 if there is a lapse in appropriations by Congress that delays payments until 2021.
- Eligible wages include salaries, wages and health benefits in excess of $6,000 per employee on an annualized basis; however, only 50% of health benefits associated with group health plans funded as required by the employer are included in eligible wages for family medical leaves under Emergency Family Medical Leave Expansion Act (EFMLEA).
- Additionally, each employer’s taxable wage base for determining FICA taxes must be reduced for 2020 by the amount of qualified wages per employee for which EPI credits are disallowed.
Once you have totaled your eligible wages aggregated across all employees making over $100,000 per year from March thru December 2020 and found an appropriate base to apply the ERTC on (the first $10k of total compensation up to $10k for each employee per quarter or calendar quarter), it’s time to determine how much credit you qualify for. Your tax credit amount will be either 50% or 70%, depending on whether you kept your employees on payroll during this period or not –70% if they were kept on payroll; 50% if they were laid off then rehired prior before May 31st— multiplied by the applicable base determined earlier times a relevant tax rate (.0765). Generally speaking, employers can receive up to $7K per employee through the fourth quarter towards their income taxes.
Recording Your Employee Retention Tax Credit
As businesses slowly start to recover from the effects of the pandemic, the Employee Retention Tax Credit has become a popular option for businesses to benefit from. It allows businesses to receive a refundable tax credit for a portion of their wages to employees.
In this article, we will cover the steps for how to record your Employee Retention Tax Credit for tax purposes:
File Form 941
Filing Form 941 (Employer’s Quarterly Federal Tax Return) is an important step in realizing the benefits of the Employee Retention Tax Credit. Employers may claim the retention tax credit on the Form 941 that they submit to the IRS. To make a claim, employers must complete lines 19a and 19b if claiming the tax credit on wages paid in 2020. Alternatively, employers may use Lines 11a and 11b of 2019 Form 941 to claim the retention tax credit for qualified wages paid between March 12th, 2020 and December 31st, 2020.
It’s important to note that amounts reported on these lines will be adjusted for accrued vacation pay, tips, overtime pay or other payments when reporting FICA taxes with each quarterly return. The total amount reported on these lines must also match your sources records such as payroll reporting documents or timesheets. Furthermore, you must include retained taxes due with your Form 941 filing when claiming this deduction in order to receive any available refund of overpaid taxes related to this deduction.
At filing time you should keep supporting documentation related to employee retention credits including:
- Copies of forms filed with payroll processors
- Supporting information relating to calculations of qualified wages
- Relevant records demonstrating payments made during the respective calendar quarters
Businesses should also be aware that auditors may request additional supporting documentation such as payroll ledgers or proof of payment for various credits claimed throughout their filings.
Claim the Credit on Your Return
Claiming the Employee Retention Tax Credit on your business’s return is a simple and convenient process. To claim the credit, you must file Form 941 with the Internal Revenue Service (IRS). When filing Form 941 for each quarter, enter the ERTC amount in Line 12a and use code RE when filling out Line 12b.
You should also be sure to double-check that you are complying with all applicable IRS requirements. The IRS generally recommends keeping records of your business’s employee retention tax credit claims as part of its record-keeping regulations. These records should include documents such as:
- A copy of Form 941, which shows that employer paid wages during the relevant period;
- Supporting statements regarding wages paid to bring an employee to a full 40 hours a week during any impacted period;
- Supporting statements confirming that wages paid were reported to employees on Forms W-2, Wage and Tax Statement;
- Payroll records demonstrating eligibility for the credit, such as average hours worked per week by employees receiving at least one hour of compensation from March 13 – December 31st;
- Documentation showing any decrease in gross receipts, such as bank statements or supporting financial documentation;
- Other information necessary to support an employer’s claim for credits under Section 3111(a) or 3121(r) ofthe Internal Revenue Code (for corporations).
When recording the Employee Retention Tax Credit, there are a few additional considerations to keep in mind. This includes factors such as the wage caps, hours of service requirements, and eligible wages. Additionally, the employers must also consider factors such as how to calculate the credit amount, special rules for eligible employers, and how to apply for the credit.
We’ll take a look at all of these considerations in greater detail:
- Wage Caps
- Hours of Service Requirements
- Eligible Wages
- Calculating the Credit Amount
- Special Rules for Eligible Employers
- Applying for the Credit
When calculating refundable employee retention credits, it’s important to remember that not all of the qualified wages are treated equally. The portion of the wages subject to the applicable Social Security taxes isn’t eligible for refundability, so employers need to consider that when calculating their potential credit. Employers should also recognize their obligation for any applicable payroll tax deposits.
Additionally, employers should remember there may be reporting requirements related to these tax credits and consider whether any state-specific tax laws apply. Generally speaking, employees receiving Social Security or Railroad Retirement benefits may be excluded from the credit.
If an employer anticipates a high credit refund, they should make sure they comply with internal control procedures and deposit payroll taxes promptly in order to avoid interest and penalties on those payments. Finally, computing entities should consider working with software developers or independent contractors to develop interfaces for reporting information needed for claiming the ERCs on federal returns accurately and timely.
Tax Credits vs. Tax Deductions
When it comes to potential employee retention tax credits, you may have already heard the terms “credits” and “deductions” thrown around. Knowing the difference between the two can help you make an informed decision when deciding which tax reduction strategy is right for your business.
A deduction simply decreases the amount of taxable income that you will need to pay taxes on. For example, if a taxpayer has $50,000 in taxable income and a $20,000 deduction, only $30,000 would be subject to taxes.
A credit directly reduces your tax liability but is often limited by certain qualifications or other factors. For example, a taxpayer with $50,000 in taxable income would typically have a total tax obligation of $7,500 but with a $3,000 tax credit they would only owe $4,500 in taxes.
Not all deductions are considered credits; in fact many deductions are referred to as nonrefundable credits because they will only offset taxes up to their entire value – no excess portion can be refunded as cash or stored for future use against future taxes owed. Additionally, many credits are not available for taxpayers with higher levels of adjusted gross income (AGI). Most employee retention tax credits offered during this time do not differentiate based on AGI as some other types of obligations or benefits might require; however it is important to double-check all details before making any decisions about using these credits.