Is the Employee Retention Credit Tax Exempt?

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Contents

Overview

The Employee Retention Credit (ERC) is a refundable tax credit meant to incentivize businesses to keep their employees on payroll during the COVID-19 pandemic. The credit is available to employers whose businesses have been impacted by the pandemic and is worth up to $5000 per employee.

In this article, we will take a look at the details of the credit to help you understand whether or not it is tax exempt.

Definition of Employee Retention Credit

The Employee Retention Credit is a refundable tax credit available to employers affected by the COVID-19 pandemic. The credit is equal to 50 percent of qualified wages that an employer pays to employees after March 12, 2020 and before Jan. 1, 2021. The maximum amount of wages eligible for the Employee Retention Credit is $5,000 per employee for the entire 2020 calendar year, regardless of when in the year wages are paid. As long as all other eligibility requirements are met, employers may be able to claim this credit on any number of employees on their taxes.

Employers must also meet certain qualification criteria in order to be eligible for the Employee Retention Credit. Eligible employers must have either experienced either a full or partial suspension of business due to a governmental order; or experienced at least a 50-percent reduction in gross receipts during quarter compared with same quarter 2019 gross receipts. Employers may only qualify if they had no more than 100 full-time employees during 2019 or did not take any credits under section 45S(a) Off Payroll Tax Liability for wages paid after March 12 and before Jan 1 2021. The allowable costs do not include wages from which payroll taxes have been abated by participation in Section 2302 Small Business Act (stimulus act) programs such as Public Law 116-136 (CARES act).

If an employer qualifies for its eligibility requirements and payroll costs meet the required criteria, it can apply for its credits when filing taxes at the end of the year. The credits can then offset income tax payments owed by employers up to certain limits and are refundable up to certain limits if exceeded those limits.

Eligibility Requirements

The employee retention credit is available to businesses of any size and certain tax-exempt organizations that carry on a trade or business in 2020, regardless of whether they were closed due to government regulations due to COVID-19. However, there are certain exclusion criteria that must be met in order for employers to qualify.

Eligible businesses must have been operating in 2020 and had:

  • A suspended or reduced operation because of orders from an Appropriate Governmental Authority during the calendar quarter due to COVID-19; or
  • Significant decline in gross receipts compared to the same quarter in 2019. A significant decline means experiencing a 50% or greater reduction in quarterly gross receipts compared to the same calendar quarter in 2019. In addition, businesses that receive funds under the Paycheck Protection Program are not eligible for the Employee Retention Credit.

Eligible tax-exempt organizations must have sustained at least one of the following impacts due to COVID-19:

  • Suspension of operations by order of an Appropriate Governmental Authority; or
  • Significant decline (50% or greater) when compared with same period in 2019. Eligible tax exempt organizations include those described under sections 501(c)(3), 501(c)(8), 501(c)(9), and 401(a).

Tax Exemption

The Employee Retention Credit (ERC) is a credit available to employers who experience financial hardship due to the COVID-19 pandemic. It is designed to provide financial relief to employers, and is available from January 1, 2020 to December 31, 2020. This article will discuss the tax exemption for the Employee Retention Credit.

Qualified Wages

In order to qualify for the Employee Retention Credit (ERC), employers must pay wages to employees between March 13, 2020 and December 31, 2020. To be considered qualified wages and thus be eligible for the ERC, they must have been paid by an employer that:

  • is a trade or business whose operations have been fully or partially suspended due to a governmental order related to COVID-19; or
  • experienced a decline in gross receipts of greater than 50 percent when compared to the same quarter of the previous year.

Up to $10,000 of wages paid per employee are eligible for the credit. Wages do not include remunerations paid for vacation leave, sick leave (regardless of whether the paid sick leave is provided under either the Families First Coronavirus Response Act (FFCRA) or other applicable federal law), medical or family leave; allow allowance for separation pay; payments made in connection with domestic service in a private home; and any compensation paid by an employer that is required by applicable state/local labor/employment law which provides payment to an employee who is absent from work due to coronavirus related reasons.

Qualified Health Plan Expenses

The Employee Retention Credit (ERC) is a refundable payroll tax credit instituted by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). Its main purpose is to provide financial relief to employers required to partially or fully suspend operations due to the COVID-19 pandemic. The ERC is available for all employers that have operated, at minimum, in 2020.

Qualified healthcare plan expenses incurred by eligible employers who meet certain criteria are tax exempt under the ERC. For example, payments for group health insurance premiums or retirement and welfare benefits are considered qualified expenses.

Eligible employers must meet certain criteria such as:

  • maintaining average full-time employees during 2020 greater than those of 2019;
  • making contributions to qualified health plans in lieu of wages; or
  • operating in an industry that has economic hardship due to COVID-19 restrictions.

Employers must also be able to substantiate the amount of qualified expenses for which a credit may be obtained with appropriate records.

Limitations on Credit

The Employee Retention Credit is available to employers whose operations have been fully or partially suspended due to a governmental order related to COVID-19 or whose gross receipts have decreased by 50% compared to the same quarter in the prior year. The following restrictions apply:

  • The credit is limited to $5,000 per employee, including all wages and health benefits paid on behalf of an employee.
  • The credit cannot exceed the employer’s portion of Social Security taxes paid on all wages during the calendar year.
  • Employers cannot receive both Paycheck Protection Program loans and Employee Retention Credits for the same wages or period.
  • Employees must be employed for the entire quarter for their employer to qualify for the credit.
  • Qualified wages may not include qualified sick leave or family leave wages reimbursed under other payroll tax credits such as those included in The Families First Coronavirus Response Act (FFCRA).
  • Taxpayers claiming credits must retain records that demonstrate that qualified wages were paid and payroll tax returns were filed with respect to such qualified wages.

How to Claim the Credit

If you are an eligible employer, you may be able to claim the Employee Retention Credit for wages paid to employees. This credit is designed to help employers cover costs associated with retaining employees during the COVID-19 pandemic.

In this article, we will discuss the eligibility criteria for the credit and how to claim it:

Filing Form 941

The Employee Retention Credit is a refundable tax credit for employers affected by COVID-19. Employers who are eligible can take the credit against their federal employment taxes that were due beginning after March 12, 2020, and ending before December 31, 2021.

The credit is available on an employers’ quarterly Federal Form 941, Employer’s Quarterly Federal Tax Return. To claim the Employee Retention Credit on Form 941, employers should check box 11 of the form and complete line 17 of the form (credit for qualified wages). The amount of qualified wages and health plan expenses claimed must be reported in lines 14 – 16, respectively.

For more information regarding filing Form 941 to take advantage of the Employee Retention Credit, employers should consult with a tax professional or refer to Publication 5197 – IRS Tax Forms & Instructions Guide.

Claiming the Credit on Form 944

The Employee Retention Credit (ERC) is a tax-exempt refundable credit available to employers affected by COVID-19. It was enacted under the Coronavirus Aid, Relief, and Economic Security (CARES) Act in response to the pandemic. The ERC can help offset part of the costs associated with retaining employees and providing additional employee benefits related to the COVID-19 crisis.

Claiming the credit on Form 944 can be done in two steps:

  1. Calculate qualified wages: Employers must calculate their total eligible wages paid from March 13, 2020 with December 31, 2020 for each employee. This includes any wages paid for family medical leave or sick pay provided under the Families First Coronavirus Response Act (FFCRA).
  2. Calculate the amount of your credit: To claim a credit, employers must determine their average number of full-time employees during 2019, which is used as a baseline against which they are eligible for the employee retention or employment retention credit. The maximum amount of ERC an employer can claim on form 944 is $5,000 per employee ($5,000 times the number of full-time employees) if they have 100 or fewer employees who have not yet been laid off due to COVID-19 related business loss and if they are licensed businesses in all 50 states and D.C.. Failing that requirement, the maximum claim amount is $10,000 for employers with more than 100 full-time employees who were not yet laid off due to COVID-19 related business loss before January 1 2021 depending on their state regulations.. Additionally small self employed businesses without any staff are able to reduce their taxable tax wages up tp $10K as well under this provision depending again on State regulations.

Tips for Claiming the Credit

Filing for the employee retention credit can be a complex process. To help business owners and HR departments understand the process and find the best way to submit the credit, there are a few tips worth exploring. Knowing the rules and regulations around the credit is essential to ensuring you get the most from the employee retention credit and make sure it is tax exempt.

Let’s explore the tips for claiming the credit:

Keep Records of Qualified Wages and Qualified Health Plan Expenses

In order to claim the Employee Retention Credit (ERC), employers must provide and retain records of qualified wages and qualified health plan expenses. This includes documents such as copies of Form 941, Employer’s Quarterly Federal Tax Return, and other payroll reports related to wages paid in each calendar quarter of the year. Employers must also provide documents that show their payment of qualified health plan expenses (e.g., invoices, receipts, or other relevant documents). All records used for calculating the amount of the credit should also be retained until after January 31st following the date on which income tax returns for the year in which such amount is claimed are required to be filed.

It is important that employers keep accurate records of their employees’ wages and health care expenses in order to maximize their ERC benefits and remain compliant with governing regulations. The IRS recommends that qualifying employers should keep track of:

  • Gross wages paid on a quarterly basis
  • The number of full-time employees by month for each quarter
  • Qualified wages paid for each employee during each quarter
  • Hours worked by part-time employees during each quarter (as applicable)
  • Any expense allocation methods applied in determining eligible costs.

Confirm Eligibility for the Credit

Before you attempt to claim the employee retention credit, it’s important to check your eligibility. Generally speaking, businesses may be eligible if they meet three criteria:

  1. Their business operations were fully or partially suspended due to an official government order due to COVID-19, or
  2. The business had a significant decline in gross receipts compared to 2019.
  3. The employer’s average number of full-time employees must be fewer than 500 for the calendar quarter in 2020.

If you meet all three criteria, then your business is likely eligible for the employee retention credit. However, other factors and exclusions can apply even with business are eligible. For instance:

  • Businesses that were already exempt from paying payroll taxes in 2019 do not qualify for the credit;
  • Companies that applied for Paycheck Protection Program (PPP) loan only qualify for ERTC after PPP funds have been exhausted;
  • Businesses cannot claim ERTC if they fired employees due to poor performance—they must have been terminated as a result of financial hardship caused by COVID-19; and
  • Workers must meet a minimum amount of hours worked per week (generally an average of 20 during a quarter).

Know the Limitations of the Credit

The Employee Retention Credit (ERC) is a valuable tax relief measure for employers, allowing them to reduce their liability for payroll taxes over the course of 2020 and 2021. However, there are certain limitations to claiming the credit that all employers should be aware of.

Not all types of businesses are eligible for the credit. To qualify, employers must have seen their gross receipts decline by at least 20% as compared to the same quarter in 2019. Additionally, employers receiving Paycheck Protection Program loans are generally ineligible for the ERC. It’s important to remember these key eligibility criteria when researching how you can claim the credit.

In addition, there are several limitations on how much an employer can claim with respect to wages. The limit is $5,000 per employee per quarter or half year depending on filing status. And any wages used in calculating PPP loan forgiveness cannot be used again when calculating the ERC; it’s important to ensure that wages don’t get double counted between these programs.

By understanding and being mindful of these restrictions, employers can take better advantage of this valuable tax incentive program and lower their overall payroll tax burden as they recover from economic hardship incurred during 2020-2021 due to COVID-19 restrictions & shutdowns.