The Employee Retention Tax Credit (ERTC) was established as part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) to provide financial relief to employers in response to the COVID-19 pandemic. The ERTC is a refundable tax credit that can be claimed by businesses on qualified wages paid from March 13, 2020 through December 31, 2020. This credit aims to encourage employers to keep their employees on payroll during the pandemic.
The IRS has recently released additional guidance about whether the ERTC is considered taxable income for employees. As with any other type of income, taxes must be withheld from ERTC payments and reported as wages on IRS Forms W-2 and 1099. It is important for employers and employees alike to understand how this credit affects their tax liabilities. This guide provides an overview of the latest information available regarding whether the ERTC constitutes taxable income for individuals.
What is the Employee Retention Tax Credit (ERTC)
The Employee Retention Tax Credit (ERTC) is a refundable tax credit for employers that continue to pay employees during the COVID-19 pandemic. The credit is for employers that have experienced reduced operations due to Coronavirus closures; either because of government orders or due to economic hardship related to the pandemic.
The ERTC allows employers to recoup some of their costs associated with payroll expenses and health insurance premiums they are required to provide under the Families First Coronavirus Relief Act (FFCRA). It also provides employers an incentive not to lay off workers by reimbursing them a portion of their payroll costs through refundable payroll tax credits. The ERTC can be claimed for wages and employee health premiums paid from March 13, 2020, through December 31, 2020.
Eligible employers are in one of two categories: those experiencing full or partial suspension of operations due to government orders limiting commerce, travel or group meetings (for commercial, social, religious purposes); or those with gross receipts which declined by at least 50% compared with the same quarter in 2019. In addition, certain businesses affected by the President’s national emergency declaration regarding Coronavirus are eligible regardless of other qualifying criteria.
In order to qualify for the credit, employers must make certain certifications as well as maintain records substantiating their qualification for the credit. Employers are allowed a credit against its Social Security taxes equal to 50% of qualified wage payments up to $10K per employee/$5K per half year. The wages used for computing the tax credit cannot be taken into account for any other purpose and amounts in excess of employer obligations will be refunded or credited back on Internal Revenue Service (IRS) Form 941 quarterly returns when filed with IRS next year.
The amount received under this program is considered non-taxable income but not all credits may be eligible for exclusion from taxable income as there may be different treatment based on how it was received and other factors including whether it was from federal funds distributed through another program such as EIDL Advance Grants or SEHIP Employer Reimbursement payments which result in an increased liability when filing corporate taxes next year on those respective programs distributions if no eligible exclusion was chosen on initial receipt of funds.
Eligibility Requirements for ERTC
The Employee Retention Tax Credit or ERTC was put in place as part of the Coronavirus Aid, Relief and Economic Security Act, otherwise known as the CARES Act. It is designed to encourage employers to retain their employees during the pandemic. The credit provides a 50% wage reimbursement for up to $10,000 in wages paid during 2020. In order to qualify for the tax credit, employers must meet certain criteria.
Eligibility Requirements for ERTC:
- Employers with operations suspended completely due to a governmental order related to COVID-19 qualify for the tax credit unless they average more than 500 full-time employees when determining the average number of employees during 2019. For employers in operation during 2019 and 2020 but were not subject to a complete suspension, they must have experienced either a 50 percent decline in gross receipts compared to corresponding prior year or have an average number of full-time equivalent employees that are less than 80% of prior year’s levels;
- All wages paid after March 12, 2020 are eligible for reimbursement. Partial wages are excluded;
- Employers cannot both claim credits for wages under the CARES Act (i.e., Paycheck Protection Program loan forgiveness) and payroll tax credits under ERTC;
- Self-employed individuals ineligible for ERTC – Self-employed individuals (including independent contractors or sole proprietors) cannot benefit from this program;
- Wages paid by PEOs qualify under certain conditions: Staffing firms or Professional Employer Organizations (PEOs) may be eligible as long as it can demonstrate that it should receive treatment that is similar to its clients by verifying that its taxable income has decreased substantially due to COVID-19 restrictions. The credit amount will be allocated directly between PEOs and their client companies based on which entity pays qualifying wages;
- Wages paid across multiple territories are eligible: Employers with operations located in multiple territories can still receive one unified credit up to a maximum limit of $10,000 per employee irrespective of how many territories they operate in.
How ERTC is Calculated
The Employee Retention Tax Credit (ERTC) is a provision under the CARES Act that provides employers with a refundable tax credit for wages paid or incurred after March 12, 2020, and before January 1, 2021. The amount of the credit is based on a formula involving qualified wages paid to employees who are not working due to circumstances related to COVID-19.
The ERTC calculation can be broken down into two components: wages used to determine the rate of the credit and wages used to calculate the maximum amount of the credit. The rate of the ERTC is 70% of qualified wages up to $10,000 per employee or $7,000 per employee. This means that employers will receive a tax credit per employee up to a maximum number equal to 70% multiplied by $10,000 for each employee for whom qualified wages have been paid or incurred during the time period.
For example, if an employer paid an employee $2,000 in qualified wages from March 12 – December 31 then they would receive $1,400 ($2,000 x .7) in ERTC on that employee’s wages alone as long as all other eligibility requirements are met. If an additional six employees received similar amounts during this period then this employer would receive an estimated total maximum amount of $8,400 in ERTC credits ($1,400 x 6).
If the employer had nine qualifying employees then they would be able to claim no more than $9,000 ($10k x 9) per employer even if they had paid more than this in qualified wages during this time period since 70% of total qualified wage payments can not exceed $10k per qualifying employee under current regulations.
Is ERTC Taxable Income
The Employee Retention Tax Credit (ERTC) was created to help businesses affected by the COVID-19 pandemic. It is a payroll tax credit for qualified wages paid to an employee or contractor that employers can take advantage of. But the big question many employers have is whether or not the ERTC is taxable income.
Let’s explore the answer to this question:
IRS Guidance on ERTC
In general, the Employee Retention Tax Credit (ERTC) received by businesses is excluded from gross income as a refund. This reflects the Internal Revenue Service’s (IRS) point of view that ERTC credit is not taxable income to the business. The Internal Revenue Code provides that a reimbursement or refund of an amount paid will not be deemed taxable income, and this applies to ERTC payments received.
The IRS provided guidance on the taxation of ERTC payments in Revenue Ruling 2021-17, released on April 5th, 2021. According to this ruling, ERTC payments recouped through credits against payroll taxes are deferred and do not need to be recognized in the same year when they are earned by employers who receive them. In addition, if an employer elects to claim the 2020 or 2021 ERTC as an offset against payroll taxes instead of cash repayment from either credits or refunds from prior year liabilities then prior year withholding amounts would be part of deferred credits, which would be reported on Form 941.
Employers who have elected to take the alternative approach of having their tax liability reduced instead of claiming cash refunds for those tax years must analyze their eligibility for 2019 and later before claiming the credit for any period after December 31st, 2020.
Ultimately, businesses should consult with their tax professionals or legal advisors to determine how best to treat and document these credits as it relates to their respective taxation situation.
Tax Treatment of ERTC
The Employee Retention Tax Credit (ERTC) is a refundable tax credit created by the Coronavirus Aid, Relief and Economic Security Act (CARES Act) aimed at helping businesses retain employees due to disruption caused by the COVID-19 pandemic. This tax credit is administered by the Internal Revenue Service and takes into account wages paid after March 12, 2020 and before December 31, 2020. Employers must also have experienced either a partial or full suspension of business as a result of government orders related to COVID-19 or have a significant decline in gross receipts.
When it comes to understanding the tax treatment of ERTC income, it’s important to note that the ERTC is considered an employer paid expenses so it does not get reported as income on Form W-2 for an individual employee’s wages. For example, if an employer claims a $10,000 ERTC, none of that $10,000 would be reported as taxable wages or withheld from employees on Form W-2. The $10,000 is also not included in the employer’s gross income separately from employee wages – rather it simply replaces those same employee wages for purposes of reducing taxable earnings for both employer and employee. Furthermore, neither employers nor employees will be required to pay taxes on the ERTC amount received and there is no obligation to report this amount in any other part of their individual income tax return.
In conclusion, the Employee Retention Tax Credit (ERTC) is not taxable income. The credit is available to employers who continue to pay wages to employees even as their businesses have been impacted by COVID-19. As a dollar-for-dollar reduction of payroll taxes paid by employers, the ERTC is excluded from gross income and not included in an employee’s wages.
This tax relief is only available until December 31, 2020 so it is important for employers to take advantage of this tax credit while it lasts.