Overview of Employee Retention Credit
The Employee Retention Credit (ERC) is a tax credit that eligible employers, who have been affected by the COVID-19 pandemic, can take on their tax returns. The ERC allows employers to claim a credit of up to $5,000 per employee for qualified wages paid between March 13, 2020, and December 31, 2020.
This article will cover an overview of the ERC and how to reflect it on your tax return.
Definition of Employee Retention Credit
The Employee Retention Credit is a refundable tax credit available to employers in 2020 and 2021 to help them minimize the financial burden of retaining their employees and paying wages during the coronavirus pandemic. The Employee Retention Credit is designed to incentivize businesses to keep paying their employees, with the goal of preventing layoffs or furloughs.
The Employee Retention Credit is available to employers regardless of size or industry who face either full or partial operations shutdown due to an order from a governmental authority that limits travel, commerce, or group meetings due to COVID-19; or an employer’s gross receipts have declined by more than 50% when compared to the same quarter in the prior year.
Eligible employers are allowed a fully refundable credit for 50% (up to $5,000 per employee) of wages paid from March 13, 2020 – December 31, 2020. For 2021, eligible employers are allowed a fully refundable credit for 70% (up to $7,000 per employee) of wages paid from January 1 – June 30 2021. Employers must apply for the monies by filing Form 7200 through the IRS and provide documentation of qualified wages paid and eligibility status in order for funds received via this program.
The Employee Retention Credit is a refundable tax credit available to employers subject to closure or experiencing significant revenue losses due to the impact of COVID-19. Employers must meet certain eligibility criteria established by the IRS in order to qualify for the benefits provided by the program.
Eligible employers must:
- Have experienced either a full or partial suspension of their operations due to governmental orders related to COVID-19, OR
- Displayed a significant decline in gross receipts compared to the same quarter in 2019 (starting from March 13, 2020). The threshold for a significant decline depends on the size of your business – it’s generally more than 50% for businesses with average annual receipts of less than $1 million and 20% for businesses with average annual receipts of more than $1 million.
Furthermore, employers that take part must have fewer than 500 full-time employees (including full time equivalent employees) during 2020. Any applicable employee working on any day of the applicable quarter must count as an employee – even if they weren’t paid during that time period. If you are unsure whether you are eligible, it is important that you contact your tax advisor or IRS representative before filing any claims.
Claiming the Credit
The Employee Retention Credit is a refundable tax credit available for employers who have been affected by the COVID-19 pandemic. The credit is available for employers who are eligible for and take advantage of the credit. The credit is calculated based on certain criteria and can be used to offset the employer’s federal payroll taxes.
This section will cover in detail the process of claiming the credit and how to reflect it on your tax return:
Calculating the credit
Once you have determined whether you are eligible to claim the Employee Retention Credit, you can then calculate the amount of credit that is available.
When calculating your credit, it is important to consider all wages paid and credited for that specific quarter. This includes both qualified wages as well as qualified health plan expenses paid or incurred during the calendar quarter. Any covered periods where wages were paid and FSAs or HRAs were reimbursed may also be taken into account in this calculation. It is recommended that employers break out qualified wages separately from non-qualified wages when preparing their calculations so as to not overestimate their applicable credit amount.
The maximum amount of credit for each employee for each calendar quarter is $5,000 per quarter. For example, if an employer paid out $20,000 in qualified wages during a given calendar quarter and had 10 employees who were otherwise eligibility for the credit, then the total eligible ERC would be capped at $50,000 (10 x $5,000).
When claiming the ERC on your tax return form 941 Employer’s Quarterly Federal Tax Return or Form 943 Employer’s Annual Federal Tax Return you will be asked to include a breakdown of amounts by employee and include any associated health care costs for those employees in order to obtain the maximum allowed credit under the program.
Filing the credit on the tax return
The Employee Retention Credit is a federal payroll tax credit available to employers of any size impacted by the coronavirus. It provides a refundable tax credit on qualifying wages paid from March 13, 2020 through December 31, 2020.
To receive the credit, you must pay wages to eligible workers and also file Form 941–Employer’s Quarterly Federal Tax Return–and add the additional amounts of payroll taxes to be reported on Form 941.
When filing Form 941 for the employer’s quarter in which qualified wages were paid, employers may claim their employee retention credit by reducing their total deposits of federal income and Social Security taxes they are otherwise required to deposit with the IRS. You can claim these credits on your Form 941–Employer’s Quarterly Tax Return–or in one of two other ways: You can file application Forms 7200 (Advance Payment of Employer Credits Due To COVID-19) or 8849 (Claim for Refund of Excise Taxes).
Be sure to use a separate line item on your return for this claim so it is easy to identify later when reviewing your tax returns. The credits are refundable and will be issued within 90 days after filing Form 941 for the applicable quarter; however, if an advance payment application was made, it will be processed first.
The Employee Retention Credit is an important benefit that can help employers protect jobs during these difficult times and support their employees’ financial security. By properly claiming the credit when filing your return, you can make sure that you receive all the financial benefit available to you.
Documentation is key when it comes to reflecting the Employee Retention Credit (ERC) on your tax return. The IRS requires employers to keep detailed records and documents that show the wages paid to employees, the amount of the ERC received, and other information. It is important to keep accurate records in order to correctly reflect the ERC on your tax return.
Let’s take a look at the required documentation:
Required documents to substantiate the credit
In order to substantiate their claim for the Employee Retention Credit (ERC) on their tax return, employers must document that their business experienced full or partial suspension of operations due to the COVID-19 health crisis or they experienced a significant decline in gross receipts (at least a 50% decrease when comparing quarterly earnings in 2020 to 2019). Employers will be responsible for gathering records/documentation and retaining them as proof of eligibility.
A few common types of documents employers should compile and retain include:
- Terms of federal, state, or local orders related to COVID-19
- Paid time off policies
- Documentation related to layoffs or furloughs
- Financial statements from 2019 compared with 2020 earnings
- Filed corporate income tax returns from 2019 and 2020
- Proof of payments made for employee wages during shutdowns and/or declines in gross receipts.
It is important for employers who claim the ERC credit on their tax return to maintain comprehensive documentation proving that their business was impacted by the pandemic. Without this documentation, the IRS may question an employer’s eligibility for the credit or potentially deny any refund.
How to keep records of the credit
In the event that you are claiming the Employee Retention Credit (ERC), it is important to maintain detailed records of the credit. You are required to keep all documentation that supports the eligibility and amount of the credit as long as these items remain relevant for federal income tax purposes.
Depending on your accounting method, this could include documentation such as:
- Payroll records that show qualified wages paid
- An itemized list of recipients and qualifying wages paid
- Payment calendars should incorporate payroll dates within a quarter
- Statements from financial institutions relating to payments made
- IRS form 941 quarterly filings
- Copies of canceled checks or other evidence substantiating payment or refundable taxes discharged via credit.
Be sure to take into account all deductions and retirement plan contributions when calculating qualified wages so you do not miss out on any potential credits. It may also be beneficial to seek professional advice regarding your specific circumstances so you can maximize the availability of this credit for your business.
If you’re considering taking advantage of the Employee Retention Credit, there are a number of additional resources available to help you learn more. This includes a variety of websites, books, and other sources that can provide additional information on the credit, how to claim it, and how to reflect it on your tax return. Let’s take a look at some of these resources:
- Other sources
IRS publications and forms
Understanding how to maximize tax savings typically involves hours of research and specialized knowledge. For certain deductions, such as the Employee Retention Credit, professional advice is especially helpful when filing complicated tax returns. But the Internal Revenue Service (IRS) has multiple resources to help you learn more about the rules and regulations surrounding various credits and deductions that you can use in your own research.
IRS Publications: The IRS creates documents with detailed information related to tax breaks, refunds, investments and more. They are regularly updated and can be referenced during the filing process when questions arise. Information on the Employee Retention Credit can be found in IRS Publication 511, Taxable and Nontaxable Income.
Forms: A variety of forms can be downloaded from the IRS website related to different credits or deductions. These forms must be included with your tax return if you are claiming a given deduction or credit. The form for claiming an Employee Retention Credit is Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund; it must be submitted after quarterly taxes have been paid.
Other helpful resources
Part of filing your tax return can be complicated, and it’s important to make sure you’re up to date on all of the eligible credits. The Employee Retention Credit (ERC) is a refundable credit against certain employment taxes, equal to 50% of qualified wages that an eligible employer pays to employees during the COVID-19 pandemic.
If you need help understanding how ERC should be reflected on your 2020 tax return, there are many additional resources available. Here are some that may help:
- Internal Revenue Service (IRS) website: Visit the IRS website for more detailed information about the Employee Retention Credit, including Frequently Asked Questions and additional guidance documents.
- Tax preparer or accountant: It may be beneficial to consult a tax preparer or accountant who can provide expertise in navigating the specifics of filing this along with other credits and deductions associated with your taxes.
- State government webpages: Check your state government webpages for mandated reporting information that may apply when claiming ERC.
- Financial advisors/tax attorneys/business advisor: Contact these professionals for advice related to any aspect of filing a business tax return in relation to the ERC program.