What is the Employee Retention Tax Credit?
Back in March of 2020, the Federal government passed the CARES Act. As part of the CARES Act, a few different programs were created, including the Paycheck Protection Program (PPP) and the Employee Retention Tax Credit (ERC) program. ERC is a fully refundable payroll tax credit. From the IRS website, “[the ERC] encourages businesses to keep employees on their payroll. The refundable tax credit is 50% of up to $10,000 in wages paid by an eligible employer whose business has been financially impacted by COVID-19.” And while it’s claimed against your payroll taxes, the amount of the ERC may exceed the actual payroll taxes you owe. The 50% tax credit amount applies to each of a business’s employees.
When ERC first rolled out in 2020, many small businesses were ineligible for it if they received a PPP loan. Typically, small businesses found PPP more beneficial and thus elected to participate in the PPP over participating in the ERC. When Congress created the Consolidated Appropriations Act (CAA) they modified the ERC program. CAA retroactively changed the law, allowing employers who had received PPP loans to qualify for ERC if the payroll expenses paid with forgiven PPP proceeds did not duplicate qualified wages used to claim the ERC. Another important change made was the ERC program was extended and expanded. Because of the CAA, many employers who were previously ineligible for the ERC in 2020 are now eligible to claim it.
Who Qualifies for ERC?
To qualify for ERC there are two main factors to consider: did you have a full or partial closure due to the government orders? Or did your business have a significant decline in gross receipts? The decline measurement is different for the 2020 tax year and the 2021 tax year.
- Closure due to government guidelines: If you’re applying for this reason, the credit applies only for the portion of the quarter that the business was closed, not the full quarter. You wouldn’t meet this requirement if you closed your business’ physical location but were able to keep operations going online or through telework.
- A decline in gross receipts: For a decline to be the reason you qualify you must have seen at least a 50% drop in gross receipts when comparing your 2020 numbers to the same quarter the year before (2019). For the 2021 tax year, you must have seen a drop in gross receipts greater than 20% compared to the same quarter in 2019. 2019 is still used as the reference point for comparison as it was the last year most businesses had normal operations unimpacted by the pandemic.
If you still have questions whether your business qualifies, Gusto has some helpful diagrams that may help you. For the 2020 tax year click here; for the 2021 quarters 1 and 2, and quarter 3 and quarter 4. You can also reach out to our team with questions that you might have.
We touched on it briefly above, but there were some changes for 2021. Importantly, the credit was expanded for the first three quarters of the year and the gross receipts were changed to a 20% decline from the same quarter in 2019. The credit was increased to cover 70% of qualified wages, and they changed the limit to $10,00 per quarter rather than for all quarters combined. If you are considered “Severely Financially Distressed” as a large employer in the 3rd quarter of 2021 – meaning you had less than 10% comparable revenue to the 3rd quarter of 2019 – you can count all wages, no matter if employees worked or not.
How to Apply for ERC
To claim the credit there are a few things you can do. Firstly, you’ll calculate the total wages and any related health insurance cost for each quarter then subtract that amount from your deposits on the employer’s quarterly federal tax return (Form 941). If you have already filed your 2020 return you can still claim the credit by filling out Form 941-X. If you qualify as a small employer with 500 or fewer full-time staff, you can request an advance payment of ERC using Form 7200.
Does it Apply to Previous Returns?
Short answer: yes! You may need to go back and amend your 2020 return if you did not subtract the credit amount from your 2020 wage expense when you filed. You might not have since many small businesses filed their returns before they filed for the ERC credit. As mentioned above, you’ll need to fill out Form 941-X to claim the credit retroactively.
Want To Learn More?
We might not have answered all the questions you have about ERC, but hopefully, we covered most of the pressing ones. On the IRS’ website, they cover more of the details of the credit along with more guidelines that we didn’t get into here. You can find that page covering ERC here. Want another breakdown on the new guidelines? Iowa State University has an excellent one on its website here.
Looking for guidance in applying or just fully understanding if it applies to your small business? Reach out to our team! Give us a call at (703) 912-7862, email us or schedule a meeting with one of our team members. We’re here to help you be the most prepared heading into this year’s tax season!