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Overview of Employee Retention Tax Credit
The Employee Retention Tax Credit (ERTC) is designed to help businesses financially recover from the impact of COVID-19. It provides businesses with a federal payroll tax credit worth up to $5,000 to offset the cost of retaining employees over certain periods.
It is important to understand the details of the ERTC and how it is treated for tax purposes. This article will provide a brief overview of the ERTC and discuss if it is taxable.
What is the Employee Retention Tax Credit?
The Employee Retention Tax Credit (ERTC) is a part of the Coronavirus Aid, Relief and Economic Security (CARES) Act established in March 2020. This nonrefundable tax credit is designed to provide financial relief to eligible employers through reduced payroll taxes. The overall goal of the ERTC is to encourage businesses that have been economically impacted due to the COVID-19 pandemic to keep their employees on payroll during this time.
To be eligible for the ERTC, employers must meet certain qualifying criteria including:
- Having experienced a full or partial suspension in operations due to a governmental order related to the COVID-19 pandemic
- Having experienced at least a 20% reduction in gross receipts when compared with the third quarter of 2019
Qualifying employers may be eligible for up to 50% of employee wages up to $5,000 per employee with a maximum of $7,000 per employee if employer health plan expenses are included as qualified wages. The maximum credit an employer can receive is $15,000 over all quarters. Also, additional restrictions apply depending on whether you are a small business or large business as defined by number of employees and amount of revenue earned.
It’s important for each business owner/manager to understand their options under this program and consult your professional advisors for guidance regarding available credits and planning strategies taking into consideration your business’s specific situation and financial condition.
Who qualifies for the credit?
The Employee Retention Tax Credit (ERTC) was created in response to the economic effects of COVID-19 and is available to employers of all sizes. To qualify, an employer must have experienced either a full or partial suspension of business due to governmental order related to COVID-19, or experienced a significant decline in gross receipts in 2020.
Full or partial suspension due to governmental orders related to COVID-19 includes government orders that cause an employer’s trade or business operations, including services performed by employees, to be shut down for any period during 2020.
Additionally, employers can qualify if they experience a significant decline in gross receipts for any calendar quarter during 2020 if their gross receipts are less than 50% of the same quarter in 2019. If the employer uses accrual accounting method and earns income from sources other than cash receipts then they can use their applicable financial statements instead as long as the financial statements are prepared according to GAAP standards.
The employer must also have been, with some exceptions (nonprofits), subject to federal income taxes on business profits (including those under Subchapter S), and not have received forgiveness on any Paycheck Protection Program loans.
Taxability of the Credit
The Employee Retention Tax Credit (ERTC) is a refundable tax credit available to eligible employers in certain industries who have been affected by the coronavirus pandemic. The credit is equal to 50% of an employer’s qualified wages up to certain thresholds.
Since the credit is refundable, the question arises of whether it is taxable. Let’s look into the details to find out.
Is the Employee Retention Tax Credit taxable?
The Employee Retention Tax Credit (ERTC) is a refundable tax credit designed to help businesses appreciate their employees and keep them employed during the COVID-19 pandemic. It provides eligible employers with a refundable tax credit that covers certain wages they pay their employees between March 12, 2020, and March 31, 2021.
Generally, businesses may be eligible for the ERTC if they have:
- operations fully or partially suspended by a governmental order due to the COVID-19 pandemic; or
- experienced a significant decline in gross receipts during the calendar quarter compared to the same quarter in 2019.
At this time, there is no clarity on whether or not these credits are considered taxable income by the IRS. The IRS has not provided any guidance on this issue yet, so it’s up to each employer to decide whether or not they want to include the ERTC as taxable income on their employees’ W–2 forms. It’s worth noting that some states may treat ERTCs differently than federal taxes—some may consider them taxable income for state taxes, and others may not. Employers should consult with an accountant or tax professional for advice on their specific situation.
Can the credit be offset against other taxes?
The employee retention credit, which is a refundable tax credit against payroll taxes, is permissible to offset certain other taxes in many circumstances. Employers who are eligible for the employee retention credit may offset the amount of any payroll taxes such as income and Social Security taxes due but have not yet been paid. Generally speaking, the credit cannot be applied to estimated or additional payroll taxes owed; however, there may be exceptions or other conditions where this will be allowed.
Furthermore, employers may also use the employee retention credit to offset their federal income tax liability as well as state and local income tax deposits. The amount of the credit available to be used against income and/or payroll taxes is determined when employers file Form 5884-A. The most common situation in which employers will use the employee retention credits against income and/or payroll taxes is if they have received more credits than the amount legally payable due to estimated or additional payroll deposits that were made during that period of time. In any case, employers should consult with a qualified tax professional prior to attempting to utilize any version of credits for different types of taxes.
Impact of the Credit
Under the Employee Retention Tax Credit (ERTC) program, employers can claim a credit on federal taxes for up to $5,000 of qualified wages they pay to their employees. The credit is taken against payroll taxes and can be used to offset the employer’s federal tax liability.
It is important to understand the impact of the ERTC and whether it is taxable.
How does the credit affect a company’s tax liability?
The Employee Retention Credit (ERC) created by the CARES Act encourages businesses to keep employees on their payrolls by offering eligible employers a refundable payroll tax credit with certain requirements. Under certain conditions, employers may be able to claim up to 50% of the wages paid in 2020, up to $5,000 per employee.
The ERC is a credit against federal employment taxes. If an employer’s total amount of credits for the year is more than their employment tax liability for that year, the employer can be refunded the difference. However, these taxes are not offset against other taxes such as Social Security self-employment and disability insurance taxes; instead, any excess credit would be reimbursed through a refund from the IRS of up to $14,000 per employee.
In addition, the employees of companies that claim this credit will also experience a reduction in their tax bills at end of year as they are no longer liable for Medicare/ Social Security withholdings on wages covered by this form of tax relief extended through The CARES Act. Employers must meet certain conditions before they can claim this credit – be sure to consult your tax professional or check IRS website for details on eligibility and how it affects your company’s tax planning strategies.
What other benefits does the credit provide?
In addition to the retention credit, The Employee Retention Credit provides a refundable payroll tax credit of up to $5,000 per employee against taxes due from employers equal to 50 percent of wages paid from March 13, 2020 until December 31, 2020. In other words, for every dollar in wages up to $10,000 paid by the employer during this period, the employer will receive a tax credit of 50 cents.
The tax relief also provides employers an incentive to continue paying employees who have been laid off or had their hours reduced due to COVID-19 by allowing them to claim a payroll tax credit. For example, an employer that laid off employees between March 13 and December 31 can get a $5,000 reimbursement for each employee retained on payroll during that period.
Additionally, employers are able to use refundable payroll credits in advance of filing their quarterly Form 941. This makes it easier for businesses struggling with liquidity issues as they will not have to wait until the end of the quarter before claiming their credits against taxes due and receiving any additional cash flow benefits from the program. The IRS has also clarified that employers can offset twenty-five percent of its federal income tax deposits against qualifying expenses even if no deposit is necessary because previously made deposits fully cover expected taxes for that quarter.
Finally, employers can reap additional benefits from this program by taking advantage of more than one type of emergency parental leave and sick pay credits available under Families First Coronavirus Response Act (FFCRA). These can be used in conjunction with each other or separately depending on an individual’s circumstance.
Planning Considerations
Employee Retention Tax Credits (ERTC) are a way for employers to help offset the cost of retaining employees during the coronavirus pandemic. Not all employers are eligible for ERTC. But for those that are, there are some planning considerations around it that should be taken into account.
To help you understand the details and implications of the ERTC, let’s dive into the details:
What should companies consider when deciding whether to take the credit?
When determining if the Employee Retention Credit is a worthwhile choice for a business, companies must consider several factors. Here are some basic points to consider when making your decision:
- Who are the target credit employees? The Employee Retention Credit can only be claimed for wages paid to “qualified employee[s]”—that is, employees who were employed as of March 12, 2020 and whose services were either fully or partially suspended due to governmental orders related to COVID-19 within the qualified period.
- What are the eligibility requirements? An employer will not be able to claim the credit in any period in which it was deemed “any trade or business of an employer that operates with more than 500 full-time employees”—this number includes full-time equivalents if applicable.
- What types of wages qualify for the credit? As long as an employer pays “eligible wages” during an eligible period, generally between March 13, 2020 and December 31, 2020 (or before June 30 2021, in certain circumstances), these eligible wages can include both cash remuneration paid to the employee and health plan expenses allocable to such remuneration but excluding allocated tips and third-party sick pay payments.
- Are there other limitations? Other restrictions or qualifications may apply in certain situations—generally where a business has already received other forms of aid (through loan programs such as Paycheck Protection Program), whether claims are available beyond 2021 or after certain events have occurred.
Most importantly, employers should make sure they obtain additional guidance from their tax professional before deciding whether or not they should claim any type of government relief measure.
What other factors should be taken into account when making this decision?
When deciding whether to take advantage of the Employee Retention Tax Credit, employers should consider the potential tax implications of their choice. The full reimbursement of wages used to qualify for the credit is typically considered taxable income, however, any additional benefits such as bonuses or additional non-wage expense reimbursements are not.
In addition, employers will need to assess their financial situation and the impact that the credit may have on cash flow, as well as their ability to pay back any advances previously disbursed from other relief measures. Furthermore, when calculating taxes owed on wages taken into consideration for eligibility for the ERTC program, an employer must also consider any state-specific taxation regulations that apply in addition to federal guidelines.
Finally, employers should be aware that if they choose not to claim the credit but later wish to do so in a future quarter, they may need to make adjustments accordingly. For example, employers who originally claimed other available relief programs such as PPP and EIDL prior to taking ERTC could potentially experience overfunding if both were claimed without making appropriate amendments once determining which option best suits their individual business need.