How to Report Employee Retention Credit on Tax Returns?

Contents

Introduction

The IRS encourages businesses to take advantage of the Employee Retention Credit, which for tax years 2020 and 2021 allows for eligible employers to receive tax credits for employee wages and certain health care or group life, disability and vision insurance costs.

In this guide, we’ll cover how to qualify for the credit, understand how to calculate it, as well as how and when you report it on your taxes. By following these steps you can ensure that you are positioned to receive the credit available from the Employee Retention Credit and maximize your tax benefits.

Overview of the Employee Retention Credit

The Employee Retention Credit (ERC) is a refundable tax credit for employers that are affected by the COVID-19 pandemic. The ERC was established by the Coronavirus Aid, Relief, and Economic Security (CARES) Act in 2020 and allows employers to claim a refundable tax credit against their quarterly payroll taxes.

In this article, we will be discussing the basics of the ERC and how to report it on your tax return.

Eligibility Requirements

To be eligible to claim the employee retention credit, organizations must meet two general requirements:

They must have been partially or fully closed as a result of governmental orders related to COVID-19 or had their gross receipts decline by more than 20%.
It must have been in operation during either 2019 or 2020 and its employees must have no employment gaps greater than 30 consecutive days.

In addition, organizations should be aware of some noteworthy conditions related to the employee retention credit:

Qualified wages paid before April 1, 2021 can be included when filing for the Employee Retention Credit. In this case, employers may apply for advance payments rather than complete IRS Form 941 quarterly payroll returns.
Qualified wages paid after April 1, 2021 do not qualify for advance payments and should be reported at year-end when the organization files its return.
For those on furlough, employers generally cannot claim a tax credit for their salaries; only wages actually earned count towards the limit of $10,000 reimbursement per employee per calendar quarter. The exception is that businesses may include kept on payroll who were laid off prior to March 12th retroactively back as wage expense since January 1st as long as they were rehired by December 31st 2020.
Businesses are required to reduce several other tax credits they may qualify in order to utilize the ERC – including work opportunity tax credits (WOTC) and federal employment taxes previously deferred under the CARES Act act – with an offset calculated between the amount chosen and base ERC rate used.

How the Credit is Calculated

The Employee Retention Credit is equal to the lesser of:

50% of qualified wages (up to a cap of $10,000 in wages per employee) that an eligible employer pays between March 12, 2020 and January 1, 2021; and
The maximum amount of applicable credit per employee: $5,000 for employers with less than 100 full-time employees on average in 2019; and $7,000 for employers with more than 100 full-time employees on average in 2019.

Generally, qualified wages are limited to compensation (including health plan expenses) that employers pay to an employee during the eligible period (March 12, 2020 through January 1, 2021). Qualified wages may include payments for vacation days or other paid leave taken by the employee during the period when he or she was unable to work due to a Coronavirus related slowdown or shutdown of operations imposed by law or government order. The credit also applies to amounts paid for group health plan expenses allocated when employers cannot provide work due to one of these criteria. For example, an employer can take into account premiums it continues paying on behalf of laid-off employees due to a Coronavirus related event.

Note that the full amount of qualified wages taken into account for purposes of calculating the credit takes into account the fact that health care expenses may be excluded from federal income tax income under Code Section 106(a).

Maximum Amount of Credit

The maximum amount of the employee retention credit a business is eligible for is up to 50 percent of qualified wages paid from March 13, 2020 through December 31, 2020, not exceeding $10,000 in wages per employee for all quarters combined. The amount of the employee retention credit a business can be eligible for is limited to the business’ total employment tax liability for the period in which it was available. The total employment tax liability includes Federal income taxes withheld from its employees as well as both employer’s and employees’ share of Social Security and Medicare taxes.

Consequently, if a business owes no more than $5,000 in total employment taxes per quarter in which it was available (including Federal income taxes withheld), then it may not claim any credit.

If a business has opted to defer its deposit and certain payment obligations relative to its Federal employment taxes until 2021 or 2022, then such deferred deposits and payments cannot be counted toward its total employment tax liabilities when calculating its potential maximum credit under the ERC.

If an eligible employer paid wages during two or more consecutive calendar quarters during 2020 (such as from March 13 – June 30) that were equal to or greater than $10,000 per quarter for each employee, then only one-half or $5,000 of such wages shall be taken into consideration for purposes of §2301(a).

Reporting the Employee Retention Credit

The Employee Retention Credit (ERC) is a tax incentive offered to employers to help them retain their employees during the COVID-19 pandemic. It is important for employers to understand how to properly report the credit on their tax returns in order to maximize the benefit.

This article will provide an overview of how to correctly report the Employee Retention Credit on a tax return.

Filing Form 941

The employer will claim the Employee Retention Credit using the quarterly Form 941, Employer’s Quarterly Federal Tax Return. Generally, employers must submit Form 941 before the last day of the month following each quarter. Form 941 allows employers to report wages, salaries, and compensation payable to employees as well as any necessary tax payments or deposits to the Internal Revenue Service (IRS).

When submitting your quarterly return, report employee wages and other compensation in Part 1 of form 941. The amount eligible for the employee retention credit should be reported in Part 2 of form 941. The amount claimed should be listed in category C. To complete Section 5 of Form 941, use Table 5-A to reconcile with Schedule R instead of Table 4 or 4-A usually used for reporting tips.

The employee retention credit can also be calculated on your annual Form 940 if it was not taken on any quarterly Forms 941 during that same tax year and all other eligibility requirements have been met. In this instance, you would list employee wages in part I and then enter your credit into Part 2 Line 10d “Employee Retention Credit”.

In either instance – whether claimed on Forms 941 or reported through annual filing with Form 940 – you must attach detailed records showing:

Total qualified wages paid under each program
Names and last four digits of SSNs for all individual employees receiving benefits
Qualified health plan expenses allocated to each employee
PERP coverage information
Amounts allocated to each pay period
Proof that credit is being properly calculated through payroll software systems

Filing Form 944

The Employee Retention Credit (ERC) is a refundable credit for eligible employers who pay their employees’ wages during the coronavirus pandemic. To take advantage of the credit, employers must report it on their quarterly Form 941 or Form 944 filing with the Internal Revenue Service (IRS).

For businesses that file quarterly payroll tax returns for 2020 under Form 944, you’ll need to report the ERC on Line 18b of Form 944. For filers who use Form 941 to report their taxes, report the ERC in Part 2, line 17.

If your business has elected to first use the Advance Credit method and then switch to receive ERC payments at a later date, you will need to cross out and void any unused credits claimed while using that method initially. Then demonstrate your claim for ERC by giving an additional explanation in Part 5 of IRS form 941 or by including an explanatory statement with Form 944 when filing.

When claiming refunds based on estimated total wages paid out during a particular quarter, you should include any positive figures found on lines 10 & 15a of IRS form 8109-B as part of your annual taxable wages for that particular quarter when you file Form 944 or Form 941. Additionally, double check any carryover from one period before adding it onto another period’s calculations when finalizing your numbers before filing. It is important to remember that all claims are subject to verification by IRS examiners. Inaccurate or incomplete forms will significantly delay processing times and could result in penalties being imposed.

Filing Your Tax Return

If you have received the Employee Retention Credit (ERC) due to the COVID-19 pandemic, you will need to file it on your tax return. The credit is available for businesses that have experienced a full or partial shutdown or have seen a decline in gross receipts of more than 50%. It is important to understand how to properly report the credit so you can maximize your tax benefits.

Let’s take a look at how to report the ERC on your tax return:

Form 941

Form 941, the Employer’s Quarterly Federal Tax Return, is the form used by employers to report and pay taxes such as withholdings to the Internal Revenue Service (IRS). Employers must complete Form 941 on a quarterly basis and report taxes due for Social Security and Medicare withholdings, federal income tax withholdings, additional Medicare tax (if any controls it), and employer’s share of Social Security and Medicare tax for their employees.

When filing Form 941, employers must enter any available credits that are claimed for the quarter on Part 5 of Form 941. This includes the Employee Retention Credit that may be claimed if your business’s annual gross receipts were less than 50% of those reported in 2019. To apply for this credit on your quarterly return, you’ll need to complete two steps:

Line 19 of Part 5: Enter the amount of Employee Retention Credit claimed for this quarter.
Line 20 of Part 5: Enter total amount of employee wages and compensation you paid during this quarter that are eligible for the Employee Retention Credit.

It’s important to remember that there may be certain limits or exclusions based on requirements set by IRS regulations when claiming this credit so it’s important to check with your CPA or review any rules provided by IRS before submitting your return.

Form 944

Form 944, Employer’s ANNUAL Federal Tax Return, is used by employers who have had $1,000 or less in income tax withheld from their employee’s wages during the calendar year. Employers filing Form 944 are not required to make advance payments of income tax and Social Security taxes.

When completing Form 944, the employer will line 14a of the form to report the amount of employee retention credit that they are eligible for based on their qualified wages paid after March 12, 2020, and before January 1, 2021. To be eligible for this credit an employer must have reduced wages by more than 20 percent compared to the same period in 2019. The amount reported on line 6 of Form 944 should include any credits for qualified wages, health plan expenses and any Employee Retention Credit claimed.

On line 14b of form 944 employers can also enter any election made using Form 7200 Advance Payment of Employer Credits Due to COVID-19 related Reasons. On line 14c the employer can enter any other credits they may be eligible for when claiming the employee retention credit such as excess Social Security taxes or advance earned income credits etc.

By completing form 944 employers can accurately report their income tax withholding from employee salaries paid throughout the year and take advantage of any applicable credits due them including those due to COVID-19 such as Employee Retention Credit earned in 2020 for 2021 reporting purposes.

Form 1040

Employers may use their Form 941 to claim the Employee Retention Credit for the 2020 taxable years and then show that credit on the individual’s tax return. To report this credit, individuals must complete and file an IRS Form 1040.

To start, you will need to provide information about your 2020 employer, such as their Employer Identification Number (EIN) and name, address and zip code. Next, select the Line 9a of Form 1040 to review if you qualify for the employee retention credit.

Then enter your employer’s EIN from line 17b in Part 1 and enter in this same number on line 17b of Part 2. The amount entered for line 17b and for Part 1 should match in both amounts entered. If not, check closely with your employer’s Forms 941 or Schedule H to give you more details needed to complete entries here.

Next continue with followed screens of “Wages Paid in 2021” section located on part 2 lines 18a-18e then 23a-23e until you reach the total wages under “total wages paid by eligible employers after December 31, 2019 but before January 1 2021” selection located on Line 40 (total dollars) on part 3 of form 1040 then Claiming Employee Retention Credit which begins at Lines 48a/b where it will be required at some point during this section also enter withheld FICA tax found at Line 59.

Including what is requested to prove claim for Employee Retention Credit which should include: forms 941 or schedule H supplying necessary information needed for proof of qualifying wages along with other necessary documents requested by IRS such as tax returns from prior years, confirmation from 2020 employers or similar documents that prove best documented answer or information available regarding any particular questions asked related to credits/qualifying wages etc., are answered as accurately possible.

Conclusion

Employers who have taken the taxpayer relief credit for the coronavirus aid, relief, and economic security (CARES) Act need to properly report it on their tax returns. The instructions for filing taxes require employers to attach Form 7200, Advance Payment of Employer Credits Due to COVID-19 and complete the information requested in this form. Employers must also complete lines 27-35 of Schedule R of their Forms 941, Employer’s Quarterly Federal Tax Return in order to properly report their Employee Retention Credit.

Properly reporting your Employee Retention Credit can be complex with different rules related to wages, hours worked, and furloughs. It is important that employers understand all applicable guidelines and follow the instructions carefully so that they maximize this valuable benefit while minimizing their risk of audit.

Businesses should seek counsel from a qualified tax accountant or lawyer before filing their 2020 taxes as new legislation or other developments could change these rules in future years.