For some businesses and employees, the Employee Retention Credit (ERC) was a lifeline during lonely COVID-19 times. The credit can provide up to $5,000 in tax credits per employee each quarter that the employer retains employees on their payroll. Depending on the type of employer, the ERC may need to be reported on the business owner’s business tax return or individual income tax return.
This guide will help you understand how to report (and possibly claim) an ERC for your small business or department as well as highlight other important considerations for claiming an Employee Retention Credit. This guide also covers:
- Eligibility requirements and paperwork needed from each employee in order to qualify for an ERC.
- General information about other types of aid available related to COVID-19 relief.
Read through this guide to learn more about reporting and claiming an ERC on your tax return.
Overview of Employee Retention Credit
The Employee Retention Credit (ERC) was created to help businesses offset the cost of retaining their employees during the COVID-19 pandemic. This credit can be claimed on a business’s tax return, and can be worth up to $5,000 per employee.
This article will provide an overview of the Employee Retention Credit and how it can be claimed on a business’s tax return.
Definition of Employee Retention Credit
The Employee Retention Credit is designed to encourage businesses to keep employees on their payroll during the COVID-19 pandemic. The credit is available to businesses who have experienced the economic effects of the pandemic in 2020, especially those whose operations were fully or partially suspended due to government orders or who experienced a significant decrease in gross receipts.
The 2021 American Rescue Plan Act extended this program through December 31, 2021. The credit was previously established by the Coronavirus Aid, Relief, and Economic Security (CARES) Act and amended by subsequent legislation including the Consolidated Appropriations Act of 2021.
In order for employers to take advantage of this credit, they must meet certain qualifications and must be able to identify which wages are eligible for credit and which are not. Eligible wages include some qualified health plan expenses but do not include qualified sick or family leave wages that do not exceed specified limits as calculated under Section 45S(a) of the Internal Revenue Code (26 U.S.C.). Employers need to note that each employee’s wages may be subject to different calculations based on actual hours worked in 2020 compared with 2019–and they should use any safe harbor provision relating to the inclusion of full-time employees (employees expected to work 30+ hours per week) even if their actual hours worked do not reach this threshold amount. Additionally, eligible wages depend on whether an employer is taking advantage of its allotment under any other CARES Act relief programs which can affect its retention credits available.
Employers can also still claim Employee Retention Credits on any employee salaries paid after March 12, 2020 through January 1, 2021 provided there has been shrinkage in revenue year-over-year due to COVID-19 impacts like restrictions or lockdowns by local authorities (or if gross receipts are only down 20% from 2019). Employers can submit claims up until April 15th 2022 at which point taxpayers can claim a refundable amount for their relevant tax year(s).
The employee retention credit is a refundable tax credit of up to $5,000 per employee that applies to qualified wages paid in 2020 and 2021. Employers may be eligible if they operated or partially operated during 2020 or 2021 due to mandated shutdown restrictions or if their gross receipts declined due to the coronavirus pandemic.
In order to be eligible for the employee retention credit, both of the following criteria must be met:
- The employer’s business must have been fully or partially suspended by governmental orders due to COVID-19, OR
- Gross receipts for a calendar quarter are less than 50% of gross receipts taken in the same calendar quarter in 2019.
Qualified wages are those paid from March 13, 2020 through December 31, 2021 which would include wages paid for leave taken through the Families First Coronavirus Response Act (FFCRA) but not the payroll tax credits associated with that law. Businesses with more than 100 full-time employees should except those employees working at least 20 hours per week when determining eligibility for this credit. Businesses with 100 or fewer full-time employees should include all employees in their analysis. For businesses with greater than 500 full-time employees, only wages up to $10,000 per employee as counted towards early 2021 required by COVID relief legislation are eligible for this credit; however employers may still recapture any excess paid over the $10K limit in withheld income taxes and employer FICA contributions related to such payments even though they aren’t eligible for the credit itself.
If an employer meets all criteria outlined above, they may claim an employee retention tax credit equal to 70% of qualified wages (up to $7,000) plus applicable health insurance costs (not including those covered by FFCRA). This amounts to a maximum of $5,000 per employee eligible for this particular tax break which can significantly reduce companies’ overall tax liability on 2020 taxes filed this year.
How to Claim the Credit
The employee retention credit is claimed as part of the research and development tax credit on form 6765. When filing the tax form, businesses will be required to provide detailed information relating to their employee wages. Businesses that qualify for this tax credit should also attach their calendars showing the closure periods, documentation regarding financial losses due to COVID-19, and copies of all notices sent out to employees related to closures or cuts in hours.
Business owners must also note any income earned by its furloughed employees associated with employment benefits such unemployment insurance or wage replacement programs. Any wages received by an employee that are attributed to a wage replacement program must be accounted for separately.
Once all required documentation is obtained and filled-out appropriately, claim the employee retention credit as part of your research and development credit on form 6765. To be eligible for the full amount of this refundable tax credit, employers must provide documented proof of wages paid during the closure period or due to reduced work hours.
Calculating Employee Retention Credit
The Employee Retention Credit (ERC) is a refundable tax credit designed to help employers keep staff on the payroll during the COVID-19 pandemic. In order to take advantage of this benefit, you must include the employee retention credit on your tax return.
Here we will explain how to calculate and report the credit on your return:
Calculating Qualified Wages
To calculate qualified wages when preparing your tax return, begin by tracking the wages paid to laid-off employees and newly rehired employees beginning on March 12, 2020 and ending on January 1, 2021. Add the total wages paid during that period for all laid off employees and newly rehired employees. These wages are Qualified Wages for the credit.
The maximum amount of Qualified Wages that can be used to calculate the Employee Retention Credit is $10,000 per employee for all eligible quarters during 2020. If an employer has paid qualified wages of more than $10,000 for an employee for a particular quarter period then those additional wages are taken into account in calculating the credit in a subsequent quarter period in which such wages have been included in qualified wages.
It is important to note that vacation pay or other forms of leave provided to laid-off or furloughed employees can be considered as Qualified Wages if they are included in calculating unemployment benefits or severance payments. Likewise, state or local government coronavirus-related calls can be used as Qualified Wages if they were part of a government fund or program eligible payroll expenditure but are not eligible if those expenditures could qualify under any other tax benefit such as the Work Opportunity Tax Credit (WOTC).
Calculating the Credit Amount
The Employee Retention Credit (ERC) is a tax credit that can help employers manage the impact of the coronavirus (COVID-19) pandemic on their businesses and employees. The Federal government has allocated funds towards the establishment of this credit, available to employers who have continued to offer employment to their staff despite being impacted by COVID-19. Calculating the credit amount is essential before filing your business’s tax return.
To calculate your business’s eligibility for ERC, start by using one of these two methods:
- Using wages paid between March 12, 2020 and January 1, 2021
- OR Using wages paid January 1–December 31, 2020
For each quarter within this period, you’ll then need to subtract any PPP loan proceeds from that quarter’s total wages and taxable wages. If you received a second round of PPP loan proceeds in the first or second quarter of 2021, you must subtract that amount from your fourth quarter 2020 wages as well.
Once you have done so, if the amount remaining for a particular period is greater than what was previously reported on Form 941 for that period as its “total wages subject to Social Security taxes”, you may use this higher figure instead. Then determine what portion of those total taxable wages constitute 50% (or 25%, if required) of your qualifying ERC eligible wages. Finally multiply that number by 50% (or 25%) and you will have calculated the credits available to your business against those particular taxable wages at hand in accordance with Section 2301(a)(2)(A)(i)-(viii). Dependent on each individual case or situation requiring consultation with an accountant or other professional well versed in taxation matters should be sought as needed before finalizing any calculation related procedures.
How to Report Employee Retention Credit on Tax Return
The Employee Retention Credit (ERC) is available to employers as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The ERC is designed to help eligible employers to keep their employees on payroll during the economic crisis and to ease the burden of their rising costs. Employers must report the ERC on their tax return in order to receive the credit.
In this article, we will look at how employers can report the ERC on their tax return:
IRS Form 941
The IRS requires employers to report their Employee Retention Credit on IRS Form 941, Employer’s Quarterly Federal Tax Return. This form must be completed and submitted quarterly, within one month after the end of the calendar quarter to which it applies. When completing this form, you should use either Line 4 or Line 6 of Part 3 depending on whether you received your Employee Retention Credit for the quarter before filing.
On Line 4, you should enter your total eligible wages for all employees for the quarter. On Line 6, you should enter any ERTC amount related to that same quarter. If your return is processed by a payroll processor like ADP or Paychex, they will likely submit Form 941 and adjust Lines 4 and 6 accordingly. However, if you manage payroll without assistance from a third-party processor, it’s important that these required lines be correctly adjusted with accurate amounts to properly report your ERTC benefit.
Once filed, if there are any discrepancies between what was recorded on Form 941 and the previously-submitted Form 7200 Advance Payment of Employer Credits Due to COVID-19 Claims filed by the employer with the first Paycheck Protection Program (PPP) loan application (or through any subsequent PPP loan applications), then a corrected version of Form 7200 attributed to both Forms 7200 and 941 will need to be filed with the IRS as soon as possible in order reconcile those discrepancies before preparing a 2020 tax return associated with these funds.
IRS Form 940
To report the Employee Retention Credit, employers must complete Form 940: Employer’s Annual Federal Unemployment (FUTA) Tax Return. The form can be filled out manually or electronically using an IRS-approved program such as IRS e-file.
The form requires specific information from the employer, including their EIN, legal name, address and primary contact information. It also requires the following information related to claiming and reporting the ERC:
- The total number of eligible employees in each quarter
- Total qualified wages paid in each quarter
- Total Employee Retention Credit claimed for each quarter
- Any Advance Payment of the credit taken in any quarter
For more information about how to complete Form 940 to claim the Employee Retention Credit or other details and requirements relating to the ERC, visit the IRS website.
IRS Form 1040
For those employers who received an Employee Retention Credit (ERC), reporting this is done on IRS Form 1040 Schedule J. This form includes a line for the “credit for employee retention” amount that should be filled out. The ERC amount should be reported as wages and taxes on line 24 of the IRS 1040 schedule J form and is subject to self-employment tax.
In addition, the employer may need to complete other forms depending on the situation, such as form 941 for payroll taxes or form 945 for federal income tax withholding from non-payroll amounts. A good tip is to check with your tax preparer or accountant before filling out any IRS forms, as there may be specific requirements that apply to you depending on your jurisdiction. Once completed, you can file these forms along with your federal income tax return (IRS Form 1040) and claim the credit amount listed in your total liability section of your return.
The employee retention credit can help businesses with carrying payroll costs during the COVID-19 pandemic. As outlined above, businesses incur expenses for wages and can take a tax credit for those wages that were subject to the credit, up to certain thresholds depending on how many employees are retained and how much money is spent.
Businesses should consult with their tax preparer or accountant to compute the correct amount of employee retention credits eligible for use. Ultimately, understanding these rules will help ensure businesses can maximize the amount of employee retention credit available and carry payroll costs more effectively during this difficult time.