Contents
Introduction
The Employer Retention Credit (ERC) is a generous tax credit included in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). It was created to help businesses and non-profits retain employees during the COVID-19 pandemic. Employers qualify for this credit if they suffered a significant decline in gross receipts or had to fully or partially suspend their operations due to government orders limiting commerce, travel, or group meetings due to the coronavirus.
The IRS has provided guidance on how employers can deduct qualified wages paid from 2021 federal income taxes by way of the ERC if future application rules are satisfied. But this begs the question: Is this credit taxable?
The IRS has stated that employers may use the employer retention credit as a deduction against their deduction limitation. In other words, employers will be able to offset up to 50% of their gross wages with the employer retention credit and not pay any taxes on it. This means that employers will see a reduction in income tax liability while still having access to new capital during uncertain economic times. This provides an important source of liquidity for businesses who have had some economic hardship due to coronavirus restrictions.
It’s important for business owners and tax professionals to understand whether or not this employer retention credit is considered taxable income as well as whether or not an employer has one more incentive for retaining employees who would otherwise be laid off due to budget reductions caused by government mandated closures related to COVID-19 pandemic. Knowing these details can help ensure that companies receive all applicable benefits from these credits and deductions.
Overview of the Employer Retention Credit
The employer retention credit is a tax relief measure offered to businesses affected by the COVID-19 pandemic. It is a refundable tax credit for income taxes paid or incurred by an employer for their qualified wages. This credit is meant to provide much needed relief to businesses and can help to offset some of their losses due to the pandemic.
Let’s take a look at the specifics of the credit and whether or not it is taxable:
Eligibility Requirements
The Employer Retention Credit (ERC) is available to employers that experienced revenue losses due to the impact of COVID-19. To be eligible for the credit, employers must meet a number of criteria outlined by the IRS.
- First, an employer’s gross receipts for 2020 must be less than 80% of its gross receipts for 2019. To calculate this, take the sum of its calendar year 2020 quarterly gross receipts and compare it to its sum of calendar year 2019 quarterly gross receipts. If the difference is 20% or more, then an employer may qualify for the ERC credit.
- Second, employers must have been subject to full or partial government shutdown orders due to COVID-19 related health restrictions imposed by states or localities in order for employees to qualify for ERC credit. These orders must mandate that businesses reduce or suspend operations that prevent them from operating as usual due to health concerns related directly or indirectly to COVID-19; in such cases companies are counted as having experienced a “significant decline in gross receipts” on IRS guidance forms 8995 and 941-X.
- Thirdly, employers should have no more than 500 full-time employees during calendar year 2020 – this includes individuals who worked at least 30 hours per week during any given month in 2020 part-time employees are not included in calculating size requirements for eligibility purposes but if an employee was laid off midyear and brought back later then they do apply when counting your company’s total headcount over the course of 2020. Companies with fewer than 500 employees can also qualify if they are part of a larger group considered under aggregation rules determined by common law tests established on IRS Form 8995.
- Finally, employers who received Paycheck Protection Program (PPP) loans are still eligible provided they meet all other criteria – however they will need to account duly record how much PPP funding was used towards salaries/employee benefits before claiming any ERC because only amounts not used towards those expenses may be included as part of their eligible claimable credit amount on IRS Form 941X when filing their taxes (i.e., if $100K was spent on salary costs then you would only claim $50k worth).
Maximum Credit Amount
The maximum amount of Employer Retention Credit available for an eligible employer is 50% of qualified wages up to $10,000 for each employee for 2020. This means that the maximum credit for a single employee is $5,000. The maximum total credit available is limited to $5,000 per employee per calendar quarter ($20,000 over the course of four quarters).
For example, if an eligible employer pays up to $10,000 in qualified wages in a calendar quarter, they could receive a tax credit up to $5,000.
How to Claim the Credit
The employer retention credit is a refundable tax credit intended to help employers retain their current employees. Eligible employers can use the credit to offset their payroll taxes, up to 50% of employee wages paid between March 12, 2020 and January 1, 2021, up to a maximum of $10,000 per employee.
To be eligible for the employer retention credit, employers must meet certain requirements. These requirements include:
- Having operations fully or partially suspended due to governmental orders limiting commerce or operations during the quarter in which they are claiming the credit, or
- Having a significant decline in gross receipts compared to the same calendar quarter in 2019.
Additionally, employers must have fewer than 500 employees and have not received a PPP Loan.
Once eligibility is determined, employers must gather essential information before claiming the employer retention credit. This includes collecting various payroll documents including but not limited to W2s for each qualifying employee and proof of decreased gross receipts if applicable. The IRS Form 941 should also be prepared prior to submitting an application for the credit. Finally, a completed IRS Form 941-X will be necessary along with Form 7200 (Advance Payment of Employer Credits Due To COVID-19) in order to receive any advanced payments from the IRS related to this program before filing business tax returns for 2020. Once these documents are assembled and filled out properly employers may submit their claim via mail or through an authorized third-party provider such as TaxAct or H&R Block.
Taxability of the Employer Retention Credit
The Employer Retention Credit (ERC) is a tax credit available to employers to encourage them to keep employees on payroll and retain wages during the COVID-19 pandemic. Employers may be eligible for the ERC, depending on their size and gross receipts. The question now is, is the ERC taxable? Let’s take a look at how this credit is treated for tax purposes.
IRS Guidance
The Internal Revenue Service (IRS) has provided guidance on the taxation of employer retention credits. The IRS issued Notice 2020-23 on May 6, 2020, stating that taxpayers can reduce their tax liabilities with an employer retention credit (ERC) and that no portion of the credit is includable in gross income.
The Notice defines an ERC as a fully refundable credit allowed under the Coronavirus Aid, Relief and Economic Security Act (CARES Act) for employers whose operations were partially or fully suspended in 2020 due to orders from a governmental authority limiting commerce, travel or group meetings due to COVID-19.
The Notice clarifies that any amount allowed as a credit by way of the ERC is not included in gross income and is not subject to income tax withholding or employment taxes. This means the full value of an ERC can be used to reduce current year taxable income without any reduction for taxes paid on those amounts. However, taxpayers must report their reductions in gross income resulting from taking an ERC on their federal tax returns for the respective year of claim.
The taxpayer also must track and monitor information about any claims it makes for an ERC, including all supporting calculations relating to credit eligibility and amount claimed each quarter throughout its given fiscal year ending Dec. 31, 2020 if applicable. The IRS also provides that taxpayers who are members of affiliated groups filing consolidated returns may claim and use ERCs – but they must document the contributions made by each member separately based upon the IRC Section 15 statements submitted on Form 1120-W or other similar documents when required.
Tax Treatment for Employers
Under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), employers of all sizes may be eligible for an employer retention credit equal to 50% of qualifying wages paid to employees from March 13, 2020 through December 31, 2020. The employer retention credit is generally a dollar-for-dollar nonrefundable tax credit applied against an employer’s employment taxes on a quarterly basis in the same manner as other deposits and payments related to those taxes.
The following are qualified wages eligible for the employer retention credit:
- Qualified wages paid after March 12, 2020, and before January 1, 2021
- Wages paid to employees unable to work due to governmental orders relating to COVID-19; provided such employees were in place prior to February 15th of this year
- Wages paid by businesses with fewer than 500 full time equivalent employees
- Wages increased by 50% or less over calendar year 2019 for an employee income level not exceeding $100K annually
Tax treatment for employers differs depending upon each particular situation. Individuals should consult with a qualified tax professional regarding the circumstances surrounding their particular situation related to the Employer Retention Credit, so that they can understand how this affect their taxes.
Conclusion
Based on the analysis of the tax code provision, the Employer Retention Credit is not taxable. This credit serves as an important component of the CARES Act and is intended to help businesses retain employees, maintain operations, and provide financial relief for struggling employers during difficult times.
The amount of credit taken must reduce other current year deductions to prevent double benefit from the same expenditure. Further, generally, taxpayers cannot currently deduct any wages paid with proceeds from credits taken under this provision which helps ensure businesses get a financial benefit rather than a tax break. Unless Congress amends the provision in future legislation, taxpayers can expect this favorable treatment to continue in 2021 and beyond.