Overview of Employee Retention Tax Credit
The Employee Retention Tax Credit (ERTC) is a federal tax credit available to employers who keep their employees employed during the COVID-19 pandemic. The ERTC provides businesses with up to 50% of eligible wages up to $10,000 per employee in the form of a tax credit.
It is important to understand the eligibility criteria to see if your business qualifies for the ERTC. In this article, we will provide an overview of the ERTC, who is eligible, and how to claim.
In order to qualify for the Employee Retention Tax Credit (ERTC), businesses must meet certain eligibility requirements. The most important criteria are:
- The business must have faced full or partial suspension of operation during a period in 2020 due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings due to the coronavirus disease 2019 (COVID-19).
- The business must be operating as of December 31, 2020.
- The business must have fewer than 500 employees with total wages paid during 2020 at or below certain thresholds established by the CARES Act.
- Qualifying wages are those paid to an eligible employee for time worked in which operations were significantly impacted by COVID-19 for any quarter in 2020. This can be determined by comparing gross receipts in a calendar quarter of 2020 with those from 2019.
- Employees not providing services due to a lack of work are also eligible as long as they either receive pay from the employer (and not a related party) or continued health benefits under COBRA for that period, even if their hours were reduced due to insufficient work volume caused by COVID-19 restrictions.
- Businesses are also ineligible if they received government assistance through other funding programs such as PPP loans and any grants provided by the CARES Act’s targeted economic injury disaster loan program (EIDL).
Maximum Credit Amounts
The Employee Retention Tax Credit (ERTC) allows eligible employers to receive a wage-based credit for the wages paid to employees between March 12, 2020, and December 31, 2020. The amount of the credit is 50 percent of qualified wages, up to $5,000 per employee in a calendar quarter. For employers with average annual gross receipts that exceed $10 million and no pandemic-related tax credits used in prior quarters during calendar year 2020, the amount of the credit allowed is limited to 50 percent of qualified wages per employee up to $2,000 in one quarter.
In an effort to encourage businesses to keep workers on their payrolls through 2021 and help businesses dealing with continued impacts from the COVID-19 pandemic, employers with more than 100 full-time employees may be eligible for an enhanced Credit that applies only in 2021. For eligible employers who maintain or increase the number of their full-time employees in 2021 compared to their 2020 numbers (as of March 13), they may be eligible for a 70% payroll tax credit on qualified wages paid up to $10,000 per employee as a maximum for all four quarters combined.
Employers are not required to maintain employment levels throughout all four quarters; however, at least one quarter must have greater hiring levels than their baseline period determined above for any year where enhanced credits are sought after.
How to Claim the Credit
Claiming the 2020 employee retention tax credit requires businesses to provide documentation to the IRS. Paperwork includes Form 941 and Schedule R, Form 5884 and the business’ return (Form 1040, 1120 or the French 1120-C).
Businesses must report employee wages and any other information relevant to calculating the employee retention tax credit on Form 941 or Form 1120-C after filing their payroll forms. Doing so will generate a quarterly report on how many wages of eligible employees were paid by that business for that quarter. This provides proof of wages for each qualifying employee.
On Schedule R, businesses must complete Part II which covers all credits allowed in that quarter for taxes taken from employees based on amounts earned in calendar year 2020, such as Social Security and Medicare taxes. Businesses must also complete Part III which is used to calculate their qualified wages and related health plan expenses from calendar year 2020 if they plan to claim an advance of the employee retention tax credit employer portion in 2021.
Additionally, when filing their business’ return (Form 1040, 1120 or French 1120-C), employers must have proof of qualified wages paid during each quarter as well as a copy of Schedule R completed by the employer. They must also include this information if they are claiming an advance with their 2021 returns.
Finally, businesses seeking more detailed guidance may find help with all applicable tax forms on IRS website here: https://www.irs.gov/help/irslocatedin.
Many businesses may be eligible to receive the employee retention tax credit implemented by the Coronavirus Aid, Relief, and Economic Security (CARES) Act. Eligibility is based on several factors, such as gross receipts, size of workforce, and overall financial stability at the time of the credit.
Let’s take a closer look at the criteria for qualifying businesses:
Businesses Who Experienced a Significant Decline in Gross Receipts
Businesses who experienced a significant decline in their gross receipts due to coronavirus are eligible for employee retention tax credits (ERTC). According to the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) signed into law in March 2020, business owners can take advantage of this refundable tax credit of up to $10,000 per employee per quarter.
Under the ERTC rules, businesses may qualify if they meet all of the following criteria:
- Experienced a significant decline in gross receipts compared to the same quarter in the prior year. The significant decline threshold is 50 percent. This means that gross receipts must have declined by at least 50 percent before businesses can apply.
- Did not receive a Paycheck Protection Program (PPP) loan or Small Business Interruption Loan (EIDL). Eligibility for ERTC is still available even if you received PPP or EIDL loans as long as you have not used any portion of those loans for wages that are used to calculate ERTC credit. Note: You cannot claim both the PPP loan forgiveness and separately claim an employer retention credit under this provision; however, you can apply for both programs and choose which one best suits your needs after accounting for any double dipping penalties.
- Employed no more than 500 employees on average during 2019. This includes full-time and part-time employees but does not include independent contractors or sole proprietors who are not covered by type A wages. Related entities are also included in this calculation.
Businesses who satisfy all of these criteria may be eligible for tax credits up to $10K/quarter when wages paid exceed an applicable threshold amount based on certain changes in net annual income or drop year over year by 50%. Eligible wages must be paid between March 13th 2020 – December 31st 2021 and businesses should review their current taxable year figures before applying.
Businesses Who Experienced a Full or Partial Shutdown
Businesses who qualify for the Employee Retention Tax Credit and experienced either a full or partial shutdown due to governments ordering them to cease operations as a result of the COVID-19 pandemic are eligible for the Employee Retention Tax Credit. This includes businesses who require customers and employees to follow special safety protocols.
Eligible businesses that experienced a full or partial shutdown due to government orders must have had:
- Operations that were fully or partially suspended during any calendar quarter between March 12, 2020 and December 31, 2021 due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings due to COVID-19; OR
- A significant decline in gross receipts during the taxable year in which the calendar quarter began compared with the same quarter in 2019 – where gross receipts declined by more than 50% could meet this criterion by comparing their quarterly 2020 gross receipts with their quarterly 2019 gross receipts.
Further eligibility requirements include proof of more than 100 full-time employees on average during 2019 and providing proof of wages paid during periods within which an employer was eligible for the credit. The employer must also not have received Payroll Protection Program loans prior.
Under the Employee Retention Tax Credit (ERTC), businesses can receive tax credits for keeping employees of their business on the payroll. To qualify for the tax credit, businesses must meet certain criteria such as:
- Having to have been significantly affected by Covid-19
- Not have received a Paycheck Protection Program loan
- And more.
In this section, we’ll go into detail about what qualifies as a qualifying employee.
Employees Who Worked for the Business During the Crisis
Employers who qualify for the Employee Retention Tax Credit (ERTC) must have been in business in either 2019 or 2020, had fully or partially suspended operations due to an order from an appropriate governmental authority due to COVID-19, or a significant decline in gross receipts. In addition, employers who qualify must have encountered some of the following:
- Employees who Worked for the Business During the Crisis:
- Employees who had worked for the business during any calendar quarter through December 31, 2020 and can demonstrate a reduction of services during that time compared to those offered prior to January 1, 2020.
- Employees who continued employment through December 31, 2020 but had wages reduced by more than 20%, compared to wages paid prior to January 1, 2020.
- Employees that received health care benefits from their employer in effect as of December 31 of both 2019 and 2020.
- Employees whose hours were reduced between February 15th and April 26th of 2021 regardless if other employees not covered under ERTC were working fewer hours.
Employees Who Were Not Working During the Crisis
Employers may qualify for the Employee Retention Tax Credit if they have employees who were not working during certain periods of the pandemic. These periods are called “covered periods” and refer to any period between 1 March 2020 and 31 December 2021. An employee is considered to not be working during a covered period if they did not provide services to the business or any related person, organization, or affiliated individual during the period.
In order to qualify for the tax credit, employers must demonstrate certain criteria such as:
- How their gross receipts declined during either 2020 or 2021 compared to the same quarter in 2019.
- How they were affected by government regulations due to COVID-19 that led to either full or partial closure of their business’ operations or services.
- How their average number of full time employees declined from March 13, 2020 through present day.
Once these criteria are met and approved by a qualified auditor, then employers may seek reimbursement for taking care of their employees throughout these times through a tax credit.
Calculating the Credit
The Employee Retention Tax Credit (ERTC) is aimed at helping businesses keep their workforce employed during the economic downturn caused by the COVID-19 pandemic. Businesses can qualify for the ERTC if they have suffered a significant decline in gross receipts or have been affected by government shutdown orders due to COVID-19.
This section will discuss the calculation of the credit.
Calculating the Amount of the Credit
Calculating the amount of the credit is an important step in filing your taxes. The amount of the credit you can claim depends on several factors, including income, marital status, and filing status. It also may be affected by other credits or deductions you are eligible to take.
To calculate the credit, you will need to know your filing status and total taxable income. Most individuals will use their tax return from the prior year for these calculations. If you have made any significant changes to your tax filing status since last year, this should be taken into account when calculating your credit.
Once you have calculated your taxable income and determined whether or not adjustments have been made since last year’s return, it’s time to determine which credits you can claim for this tax year. This includes credits such as those for college expenses and energy-related purchases as well as any other applicable credits listed on your tax return form.
Once all applicable credits have been applied, subtract this amount from the total taxable income to arrive at the taxpayer’s net taxable income – also referred to as modified adjusted gross income (MAGI). This number is used in conjunction with IRS Publication 17 to determine what percentage of refundable credits a taxpayer may qualify for based on their MAGI and filing status combination. Use this percentage along with the net taxable income number calculated previously to arrive at an estimate of how much refundable credit a taxpayer can expect on their return this year.
Calculating the Number of Qualifying Employees
The Employee Retention Tax Credit (ERTC) provides eligible employers with a refundable tax credit against their employment taxes for the wages paid to certain employees during the COVID-19 pandemic. Employers qualify for the ERTC if either full or partial operations of their business have been suspended due to a government order related to COVID-19, or if their gross receipts for any quarter are below a certain threshold.
To determine the amount of credit available, it is necessary to calculate the number of qualifying employees. The number of qualifying employees is based on the average number of employees per pay period in 2019 and in 2020. Employees are considered “qualifying” if they are not engaging in work activities with respect to the employer and are considered full-time by Internal Revenue Service (IRS) standards. This includes both full-time and part-time employees who were not engaged in work activities during any calendar quarter in 2020 due to circumstances resulting from COVID-19 pandemic; however, there are special considerations if an employee was furloughed or had hours reduced but still received wages over $10,000 under an election made by that employer.
In addition, all eligible employers must first check their average employee count for 2020 against 2019’s employee count before submitting a claim for ERTC benefits. Only those employers with 50 or fewer employees who can show that there was a decrease from 2019’s average number of pay periods will be eligible for ERTC credits on wages paid after March 12, 2020 and before January 1, 2021.
Claiming the Credit
Businesses that qualify for the employee retention tax credit can significantly reduce their tax burden and benefit from other financial benefits. The credit is available to employers who have seen a significant drop in their gross receipts due to COVID-19. To take advantage of this credit, businesses need to understand how to properly claim it.
In this section we will discuss how to claim the employee retention tax credit:
How to Claim the Credit
Employers that qualify for the Employee Retention Tax Credit (ERTC) can claim the credit when filing their quarterly or annual payroll tax return using Form 941. In order to do so, employers must check block 18 of their payroll tax forms, indicating the number of eligible employees for which the credit is determined.
The amount of eligible wages for the ERTC is calculated by subtracting any qualified health plan expenses from net taxable wages paid in a calendar quarter. If there are no qualified health plan expenses, then employers must use all taxable wages paid in a calendar quarter to determine qualifying wages for ERTC purposes.
Employers should be aware that only payments made during any calendar quarter starting after March 12, 2020 and before January 1, 2021 will be credited towards employee retention. For example, if an employer spends money in April but those payments are posted to June’s payroll return due to accounting processes, those payable amounts will not be allowed as part of the calculation. Furthermore, employers cannot double dip nor receive both credits at once on eligible wages; any excess taxes should be reported on Form 8845 upon filing their quarterly or annual payroll tax returns if they have elected both credits at once on eligible wages.
How to File Form 941
If your business is eligible for the Employee Retention Tax Credit, you must use Form 941, Employer’s Quarterly Federal Tax Return, to file a claim and receive the credit. Form 941 must be filed on a quarterly basis with the IRS in order to receive the credit. To properly complete Form 941 and determine your tax liability, you will need to provide information such as the number of employees employed and wages paid during each quarter.
On page one of Form 941, enter your name and address, Social Security Number or Employer Identification Number along with general business information. On page two of Form 941, fill in line 22f with the amount of employee retention credits for which you’re claiming during this quarter. In order to receive the full credit amount, you’ll need to add any wages paid or credited prior to March 13, 2020 (up to ten thousand dollars) that are included in this quarter’s filing period; otherwise only post-March 13 wages can be included for credit consideration for this quarter.
Additionally on page two of Form 941 enter line 34b with any taxable Social Security Wages paid in excess of $1 million (total YTD) plus any wages subject to Medicare taxes shown on line 14; any amount entered will be subtracted from the credits claimed on line 22f. Note that there are special rules governing how much tax can be offset by credits depending upon when they become effective; verify it is necessary with your accountant or financial advisor prior to filing. Finally put biographical information as requested at bottom right part of form (Page 3). After entering all pertinent information accurately and completely submit form as instructed by associated instructions document.
How to File Form 943
To qualify for the employee retention tax credit, you must file Form 943, Employer’s Annual Federal Tax Return for Agricultural Employees. To complete this form, you’ll need to know information on your total wages paid and total federal income tax withheld from all your employees during the 2018 or 2019 calendar year.
First, fill out general business information at the top of Form 943 including your Employer Identification Number (EIN), business name and address. You’ll also need to fill out the beginning and ending dates of your payroll tax period and the total wages paid in that pay period.
Next, enter shareholder or partner information for any incorporated businesses—also provide other ownership information if applicable. Now you can break down all employee wages earned by state—the employee’s gross wages should be reported on line 7. If any wages you pay are exempt from Social Security and Medicare taxes due to a foreign employment exemption code provided by an F-1 or J-1 visa holder, then they must be reported on line 8 instead of line 7.
When all personal details have been filled in, you can proceed to calculating both Social Security taxes (in boxes 4 and 5) as well as Medicare taxes (boxes 6 through 10). Additional calculations are necessary when claiming credits related to federal unemployment contributions made throughout that year; however not all businesses will require this additional step.
Finally, remember to sign and date the form along with supplying a contact person’s name in case further action is required by IRS agents in the future. For a full guide on how to file Form 943 correctly for Employee Retention Tax Credit qualification please refer to IRS Publication 5137: “Use of Form 943 To Claim The Employee Retention Credit For 2021 And 2020” which can be found here: https://www.irs.gov/pub/irs-pdf/p5137.pdf.