Overview of Employee Retention Tax Credit
The Employee Retention Tax Credit (ERTC) is a tax incentive provided by the US government to incentivize employers to keep their employees on board despite the economic downturn caused by COVID-19. It is designed to help businesses cover the cost of keeping their employees, and can be claimed on their taxes.
Let’s discuss the journal entry for the ERTC and how businesses can make the most of this tax credit:
Definition of Employee Retention Tax Credit
The Employee Retention Tax Credit (ERTC) is a refundable tax credit that was enacted as part of the Coronavirus Aid, Relief and Economic Security (CARES) Act in response to the effects of the COVID-19 pandemic. The ERTC is available to certain businesses and tax-exempt entities that pay employees’ wages during certain months of 2020. Eligible employers can receive a refundable tax credit equal to 50% of eligible wages paid per employee up to $10,000 total in qualified wages paid by December 31, 2020.
Businesses eligible for this tax credit must have been in operation prior to February 15, 2020 and have seen operations fully or partially suspended due to orders from an appropriate governmental authority limiting commerce or operations due to the COVID-19 crisis. Alternatively, if the business has experienced at least a 50% reduction in gross receipts from one quarter in 2020 compared with the same quarter in 2019, it may also be eligible for ERTC. In order for employers to benefit from this tax credit, they must pay their employee’s wages or salaries regardless of whether employees are working or not working during a shutdown period – or whether their hours were reduced due to economic necessities.
For accounting purposes related to ERTC, employers should begin by determining how much credit they are qualified for and make an appropriate journal entry of this amount when it is received as part of their deductions on Form 941. This journal entry would typically involve debiting ‘retention credits’ under accounts receivable and crediting excess social security/Medicare credits under liabilities along with an effective date. Employers should maintain careful recordkeeping related all relevant transactions including employee payroll records throughout the year along with any other associated documents related to ERTC claims which would include:
- Confirmation statements with IRS Form 7200 information when claiming credits on form 941
- The CARES Act Credit Summary Report upon completion/finalization of ERTC claims via IRS guidelines containing details from forms 940/941 etc.
The Employee Retention Tax Credit (ERTC) is designed to provide relief to employers that have been financially affected by the COVID-19 pandemic. It is a refundable tax credit against applicable taxes and employers are eligible for up to a 50% credit from the Internal Revenue Service (IRS) for qualified wages that were paid after March 12, 2020 and before January 1, 2021.
Eligible employers must meet the following criteria:
- They must have been forced to partially or fully shut down due to government orders or experienced a significant decline in gross receipts of at least 50%.
- Employers with an average number of full-time employees in 2019 of more than 500 are not eligible.
- Employers who received assistance under the Paycheck Protection Program are also ineligible.
Qualified wages will be calculated based on the number of employees at a business before February 15, 2020. Employees include both full-time and part-time staff, but employers may elect one of two methods for calculating qualified wages. The first option allows qualifying amounts based on up to $10,000 per employee and $5,000 per half time employee; while the second option uses average annualized wages per employee determined when they began employment in 2019 as a baseline and applies payroll costs equal to 80% of this amount where applicable.
Maximum Credit Amount
The maximum amount a business may claim under the Employee Retention Tax Credit (ERTC) is 50% of wages paid or $10,000, whichever is less. However, this credit can be higher for certain employers. If a business qualifies for other federal credits available for paid leave under the Families First Coronavirus Response Act, the amount of those credits is limited by reducing the amount of qualifying wages used for ERTC calculation.
The ERTC reduces federal tax deposits according to eligible payroll payments throughout 2020 and allows certain eligible employers to claim a refundable payroll tax credit equal to 100% of their coronavirus-related qualified wages. Qualified wages are limited to $10,000 per employee during 2020 and include health plan costs incurred during that period.
The government defines an “eligible employer” as any trade or business that:
- has been fully or partially suspended due to orders from an appropriate governmental authority limiting commerce; OR
- has experienced at least a 50 percent reduction in quarterly receipts compared to the same quarter in 2019; AND
- has 500 employees or fewer across all locations of its trade or business activities.
For businesses with more than 500 employees, only wages paid after March 12 and before Jan 1 2021 are eligible for this tax credit.
Journal Entry for Employee Retention Tax Credit
The Employee Retention Tax Credit (ERTC) is a federal tax credit that can benefit employers who have faced losses due to the pandemic. If you’re eligible, you can receive a potential refundable tax credit of up to $5,000 per employee in 2021. To account for this tax credit, you’ll need to make the correct journal entry.
In this article, we’ll explain the journal entry for an Employee Retention Tax Credit and how to best record it in your books:
Debit to Retained Earnings
When a company is eligible for an Employee Retention Tax Credit (ERTC), they need to record an appropriate journal entry. Generally, a company will debit the Tax Expense and credit Retained Earnings. This journal entry is generally made at the end of the period in which the ERTC credit applies.
With the employee retention tax credit, companies can get a dollar-for-dollar tax credit for 50% of qualified wages paid in 2020 and 2021 up to $10,000 per employee per calendar quarter. The ERTC amount can be claimed on Form 941 or Form 943, depending on your entity type and filing frequency. It’s important to note that employers aren’t eligible to claim this credit if they receive a Small Business Interruption Loan under the Paycheck Protection Program (PPP).
The journal entry would be as follows:
- Debit: Retained Earnings – X Amount
- Credit: Tax Expense – X Amount
Credit to Employee Retention Tax Credit
When an employer is eligible for employee retention tax credit, any related tax credits should be recorded with a journal entry. This entry will set up accounts to record the amount of the tax credit that the employer can use to reduce payroll taxes. The entry will contain accounts such as Employee Retention Tax Credit, Accrued Liabilities, Tax Liability, and Repaid Expense Taxes.
The first account to be credited should always be Employee Retention Tax Credit for the amount of the eligible tax credits. Then, businesses need to credit their Accrued Liabilities account for those same amounts (commonly referred to as a “true up”). Finally, two debits must be made: one debit to Tax Liability and another debit to Repaid Expense Taxes.
These entries may vary based on the business’s accounting software and any special complexities that need accounted for; however, this is generally how journal entries should go when recording employee retention tax credits:
- Credit Employee Retention Tax Credit: XX amount
- Credit Accrued Liabilities: XX amount
- Debit Tax Liability: XX amount
- Debit Repaid Expense Taxes: XX amount
The employer is responsible for grossing up payments made to employees who are eligible for the Employee Retention Tax Credit. This means the employer must include an additional amount in the employee’s wage which, when combined with its normal wage, equals the Employee Retention Tax Credit being claimed by the employer. To properly account for this increase in wages and subsequent benefit of credits received by the employer, a journal entry must be recorded.
The journal entry needs to include two components:
- Increase to Salaries Expense Account: The entry should debit an increase in Salaries Expense equal to the amount of compensation paid to employees plus an additional amount that represents the amount of gross-up (equal to half of credit claimable).
- Increase to Tax Credit Account: As a result of recognizing this additional expense, there will also be a corresponding tax credit due from government which will need to be recognized and reported in a separate tax control account. The entry should credit this account for an amount equal to half of credit claimable.
The Employer’s Journal entries will serve as evidence that compensation has been paid with amounts representing gross-up and that a corresponding tax credit has been claimed based on those expenses.
The journal entry for employee retention tax credit is a debit to Sales Tax Payable and a credit to Employee Retention Tax Credit. The amount of the tax credit should be included in the total sales tax payable. The total journal entry should be recorded in the Sales Tax Payable account at the time of filing taxes. This will ensure that the tax credits are properly accounted for and that any tax refunds or credits due to the taxpayer will be provided.
The amount of Employee Retention Tax Credits can vary considerably depending on a variety of factors, such as:
- the size of the business
- number of employees
- type and length of employment, etc.
As such, it is important to consult with a professional tax advisor when calculating these credits, in order to ensure that all eligible costs and expenses are properly accounted for and correctly reported on taxes. Additionally, make sure to review your state’s specific regulations regarding this issue prior to filing your taxes.