Is Employee Retention Credit Tax Exempt Income



The Employee Retention Credit (“ERC”) is a federal tax credit program enacted by Congress in 2020 in response to the Covid-19 pandemic to help employers retain their employees and offset some of the costs associated with keeping them on payroll. As the ERC is a tax credit, many businesses wonder if they should treat this rebate as taxable or exempt income.

The Internal Revenue Service (IRS) provides guidance on this issue both in Publication 5137 and Form 941-X which can be accessed through its website. Generally, taxpayers should apply the ERC to reduce an employer’s net income subject to withholding taxes. However, there are some exceptions that may allow certain businesses or circumstances to treat ERCs as non-taxable or exempt income for certain types of taxation such as self-employment taxes.

Specifically, the IRS advises that taxpayers who are eligible for ERCs may separately report them from their regular wages and salaries if certain situations exist which will exempt these payments from taxation either partially or entirely – for example, if payment were made for sick leave not covered by health insurance, FFCRA leave taken prior to PPACA being signed into law, compensation consistent with prior workforce practices exceeding normal payroll costs etc.

Taxpayers should consult a qualified tax advisor and review all relevant documents carefully when determining how best to code any credits granted under the CARES Act in order to ensure that they are properly declared in appropriate forms and reported accurately on their tax returns.

What is the Employee Retention Credit?

The Employee Retention Credit (ERC) is a tax provision designed to help employers that have been negatively impacted by the COVID-19 pandemic. The ERC provides employers with a refundable credit against their payroll taxes and can be claimed if they have reduced wages and/or experienced a decline in business.

This article will look into the details of the ERC, including:

  • How it works
  • If it is considered tax exempt income


The Employee Retention Credit (ERC) is a refundable tax credit allowed to eligible employers that retain their employees during the COVID-19 pandemic. The ERC applies to wages paid for the period of March 12, 2020 and December 31, 2020. This credit is designed to incentivize employers to keep employees on their payroll rather than allowing them to be laid off or furloughed.

To be eligible, an employer must meet two of the three following criteria:

  • The employer’s operations were fully or partially suspended due to orders from governmental authorities limiting commerce, travel or group meetings due to the COVID-19 crisis;
  • The employer’s gross receipts declined by more than 50% when compared with the same quarter in 2019;
  • The employer had more than 100 full-time employees in 2019 and experienced a decline in its number of full time employees in 2020 (junior full time excluded).

There are specific limits on amounts that can be claimed based on the size of an organization – up to $5,000 per employee for employers with fewer than 100 full-time employees and $7,000 per employee for those with more than 100 full time employees. Any excess credits can be carried forward into 2021. The ERC is not taxable income and should not have FICA taxes withheld from it or reported as income or wages earned by employees on their tax returns – it is an advanced employee retention credit issued against future payroll tax deposits by an affected employer during 2021.

Qualifying Wages

To be eligible for the Employee Retention Credit (ERC), employers must have wages that qualify for the credit. Qualifying wages are those paid to an employee who:

  • is not providing services due to an orders from a governmental authority limiting commerce, travel, or group meetings;
  • is not providing services, either due to the suspension of or significant decline in operations due to the COVID-19 pandemic and;
  • has wages reported on Form W-2.

The amount of qualifying wages paid depends on whether the employer is considered a small business or a large business under IRS requirements. A small business is one with gross receipts of less than $50 million in 2019. All other businesses, regardless of size, are large businesses. Smaller employers may use an average of their number of full time employees in 2019 and apply it to 2020 as well while claiming ERC credits.

Qualifying Wages for Small Employers: Qualifying wages paid by a small employer include up to $10,000 per employee in qualified sick leave wages (including qualified family leave) plus qualified health plan expenses allocable to the wages that were not taken into account for purposes of claiming credits under the Families First Coronavirus Relief Act (FFCRA). Additionally, all other wages that are paid during either 2020 and 2021 with respect to any employee count toward ERC eligibility for 2020. These may include vacation and holiday pay among others depending on company policy.

Qualifying Wages for Large Employers: For large employers with more than 100 full time employees in 2019, up to $10,000 of 2021 employment taxes incurred on qualified wages can count towards eligibility and $5,000 per employee including ($2,500 per quarter) taxes incurred on all the other types of CPIqwages paid during 2021 may count towards ERC eligibility. This includes vacation time, holiday pay etc depending on company policy as previously mentioned with regard to small businesses as well.

Maximum Credit

The Employee Retention Credit (ERC) is a refundable tax credit for employers who continue to pay employees during the COVID-19 crisis. The credit offsets the employer portion of up to 50% of the qualified wages paid for each employee for up to $5,000 per employee.

The maximum amount of ERC that may be claimed depends on the number of employees in a company’s workforce. For employers with less than 100 full-time employees, the maximum allowable credit is equal to 50 percent of qualified wages up to $10,000 for all calendar quarters in 2020 or 2021 (or a combined total of up to $10,000 between 2020 and 2021). For employers with more than 100 full-time employees, the maximum allowable credit is equal to 40 percent of qualified wages up to $6,000 per employee in all calendar quarters in 2020 or 2021 (or a combined total of up to $6,000 between 2020 and 2021).

Qualified wages are generally those paid after March 12, 2020 and before January 1, 2021. Qualified wages do not include certain payments made under certain federal assistance programs such as the Paycheck Protection Program (PPP) loans or forgivable grants issued under Section 7(a) Small Business Act and any associated credits which are taken into account for purposes other than payroll costs under PPP or any similar program. Also excluded from “qualified wages” are those required by legally binding employment agreements entered into before February 15th, 2020.

The ERC offers companies experiencing business disruptions due to COVID-19 an incentive to continue paying their workers versus layoffs. This incentive provides much needed financial relief during this difficult time while also protecting jobs that otherwise may have been lost due to revenue decreases caused by coronavirus related lockdowns and other mandated business restrictions.

Is the Employee Retention Credit Tax Exempt Income?

The Employee Retention Credit (ERC) is a tax credit created in response to the COVID-19 pandemic. It is meant to provide employers with a financial incentive to retain employees and keep them on payroll during this difficult time.

The big question is: Is the money earned through the ERC considered tax exempt income? Let’s delve in to this question to better understand the answer.

Taxable Income

The Employee Retention Credit (ERC) is a refundable payroll tax credit enacted under the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The purpose of the ERC program is to provide economic relief to employers who have been affected by the COVID-19 pandemic. ERC payments are not taxable income for federal income tax purposes.

However, it is important to note that employee retention credits are taxable for certain types of state and local taxes. For example, some states may require employers to include amounts received from the employee retention credit as taxable wages on their payroll reports and may tax such income as salaries in accordance with state and local rules.

Additionally, if the employer has elected to treat payments made under the program as additional wages for federal and/or state unemployment compensation insurance purposes, then those payments will normally be included in an employee’s gross wages subject to applicable income taxes withheld by an employer.

It’s also important to consider individual state laws when it comes to whether ERC payments are considered taxable or non-taxable. If you’re unsure how your particular state treats ERC payments, ask your certified accountant or contact a qualified tax professional for advice specific to your situation.

Exempt Income

The Employee Retention Credit (ERC) is a tax credit that applies to employers who provide qualifying wages to employees during the COVID-19 crisis. The purpose of the credit is to help protect businesses from being forced to lay off or furlough workers and allow them to remain on payroll while they weather financial difficulty.

The ERC can be deducted as a payroll expense and provides eligible employers with a flat 50% tax credit on wages paid between March 12, 2020, and June 30, 2021. Questions have been raised about whether the employee retention credit is considered taxable income for employees in terms of filing taxes.

The IRS has answered those questions very clearly – the amount received from an employer from employee retention credits is not taxable income for the employee filing taxes, even if the employer pays such amounts for certain employee benefits such as health insurance premiums. Additionally, payments received under an employer’s wage continuation policy are excluded from tax as compensation for former services when paid due to continuous employment disruption caused by COVID-19 workplace shut-downs or similar circumstances.

For an employer claiming this tax benefit, it should be noted that it may have implications under state payroll taxation laws and regulations which need to be addressed separately by employers before they claim any credits. Employees will not be required to report or pay taxes on amounts received under this program upon receipt nor will they need to list it as taxable income when filing their 2021 taxes. In other words, employees can enjoy this benefit of receiving funds without worrying about additional paperwork or future tax liabilities related to it at year-end!


The Employee Retention Credit is a valuable program created to help small businesses during the COVID-19 pandemic. It can provide businesses with refundable tax credits of up to $5,000 per employee, which can help employers cover wages or expenses that have been impacted by the pandemic.

The good news is, the Employee Retention Credit has been deemed tax exempt income and is not subject to payroll taxes, federal income tax or self-employment taxes under section 6426(a) of the Internal Revenue Code. This is great news for employers looking to get back on their feet as it provides additional cash flow and more incentive for employers to retain their staff during these challenging times.

It’s important for employers to take advantage of this credit and make sure that their situation meets all of the eligibility requirements established by the IRS in order maximize their benefits. Employers should also closely monitor any changes made to the ERC as they could have an impact on qualification requirements and potential credit amounts that may be received by employers.