The Employee Retention Credit (ERC) is a program that was started as a response to the COVID 19 pandemic and the subsequent economic shutdown that followed. It incentivizes any businesses to receive refundable tax credits for maintaining their payroll in 2020 and 2021. It is also a refundable tax credit. This program continues to provide a vast amount of businesses with potentially lucrative refundable tax credits for their payroll’s qualified wages that were paid to employees in 2020 and 2021. It aimed to preserve the infrastructure investment and jobs that the country has always been known for.
What is the Employee Retention Credit?
As part of the Coronavirus Aid, Relief, and Economic Security Act (commonly called the CARES Act) the ERC program was intended by Congress to encourage employers to keep their employees on their payroll during the early stages of 2020 of the pandemic. This was done in addition to the American Rescue Plan Act.
When the program was introduced, the tax credit was for 50% of an employee’s qualified wages. It was limited to $10,000 per employee, so it limited the maximum credit to $5,000 for paid wages from March 13, 2020, to December 31, 2021. The ERC program has since increased its percentage of qualified wages to 70% for 2021. So now the employee wage limit is up to $10,000 per calendar quarter.
This credit is available to any employer deemed eligible. It is not limited to any size of business that paid wages to its employees. However, there are some rules that apply to employers with under 100 employees or under 500 employees for periods of 2020 and 2021.
Those eligible businesses may be granted immediate access to the ERC by reducing the employment tax deposits they are normally required to pay. Additionally, if an employer’s employment tax deposits are insufficient in covering the new credit, that employer may be eligible to receive an advance payment from the IRS.
Who can receive an Employee Retention Credit?
A number of employer categories can receive the ERC, including the following industries:
- Government Contractors
- Healthcare and Life Sciences
- Hospitality and Retail
- Professional Services
- Real Estate and Construction
Recovery startup businesses are subject to different conditions as part of the Disaster Tax Relief Act as there were different rules surrounding the quarterly federal tax return they would file.
To be considered for the retention tax credit, more than a nominal portion of the employer’s business operations must have been suspended.
For the purposes of the employee retention credit, a portion of an employer’s business is considered ‘more than a nominal portion of operations’ if either the gross receipts from that portion of business operations is not less than 10% of gross receipts (determined by same calendar quarter from 2019).
Or alternatively, the hours of service performed by employees is that portion of the business is not less than 10% of the total number of hours of service performed by all employees in the employer’s business.
What would a partial suspension of business operations entail as part of the ERC?
To be deemed ‘partially suspended’, business operations must have been limited due to a federal, state, or local order, proclamation, or decree that affected the employer’s operations.
During the COVID 19 pandemic, this would constitute the lockdowns we saw early on.
For example, a restaurant that had to close its dining room due to a federal government order but continued to ‘make ends meet by offering carry-out and delivery services was considered to have partially suspended operations.
Partial suspension of business operations could occur because an order limited the number of hours a business could be open each day, or some business operations had to be closed and work could not be performed remotely.
Who cannot claim the credit amount?
A recovery startup business would be an example of a business that would not be eligible for the ERC as part of the CARES act. If an employer already receives a Small Business Interruption Loan as part of the Paycheck Protection Program (PPP loan), which was also a part of the CARES Act, then that business would not be eligible to claim the credit.
Qualifying wages for this credit do not include wages for which the employer received a tax credit for paid sick and family leave as part of the Families First Coronavirus Response Act. This act was passed at the beginning of the COVID 19 lockdowns.
Wages counted under this tax credit can’t be used for the credit paid for family and medical leave under section 45S of the Internal Revenue Code, per employee.
Employees are also not counted as eligible for the Employee Retention Credit for employers if that employee is already given a Work Opportunity Tax Credit under section 51 of the Internal Revenue Code in their Federal Tax Return.
What are Qualified Wages in the Employee Retention Credit?
The definition of qualified wages paid is dependent on how the number of full-time employees eligible employers has.
If an employer, on average, had more than 100 full-time employees during 2019 then qualified wages would generally be regarded as those wages paid (including some health insurance costs up to $10,000 per employee) to employees that are not providing services because trade or business was suspended, due to COVID 19.
It may also be when there was a significant decline in annual gross receipts. These employers can only count wages up to the amount that the employee would have been paid for working an equivalent duration during the 30 days immediately preceding the period of economic hardship.
If an employer on average had 100 or fewer full-time employees during any quarter in 2019, qualified wages would be those wages, (including health insurance costs up to $10,000 per employee) paid to any employee during the period trade or business were suspended or the period of the decline in annual gross receipts, regardless of whether or not its employees are providing services.
Employee retention credits are calculated based on the qualifying wages paid per employee during their eligible employer status. For most companies who claim the employee retention credit in this program, the refundable tax credits are often well in excess of the payroll taxes paid by the employers. To claim the ERC benefits means they can be larger than the amounts a company received in PPP funding also.
Are the benefits of the Employee Retention Credit the same for all employers?
Smaller employers receive more benefits under the employee retention credit scheme. More specifically, for the time they are deemed as an Eligible Employer, these businesses can include qualified wages paid to all employees. Large employers may only include qualified wages paid to employees for not providing services.
What defines a small and large employer under the Employee Retention Credit program?
Keep in mind, under the ERC for 2020, an employer with 100 or fewer average full-time employees (as measured against 2019) was defined as a small employer. From 2021 to claim the ERC, an employer needed to have 500 or fewer full-time employees (as measured against 2019) to be deemed a small employer.
And what defines a ‘full-time employee’ in the program?
This term refers to an employee who, in any calendar month in 2019, gave an average minimum of 30 hours of service per week, or 130 hours in the month. 130 hours of service in a month is treated as the monthly equivalent of at least 30 hours of service per week, as determined in accordance with Section 4980 H of the Code. Any employer who operated their business for the entirety of 2019 determines their number of full-time employees by getting the total number of full-time employees from each calendar month in 2019 and then dividing it by 12.
Special rules may apply to employers who were not operating for the whole of 2019.
Is the Employee Retention Credit only apply to full-time employees?
The good news is no! An employer may include qualified wages paid to part and full-time employees in the calculation of their ERC. The only limitation on this calculation of the credit is if an employer only calculates the credits on the first $10,000 of wages and health plan expenses paid to each employee during each credit-generating period.
How can I apply for the ERC?
From this point on, the only method of application for the program involves filing an amended Form 941 X (the Quarterly Federal Payroll Tax Return) for the quarters in which the business was deemed an ‘eligible employer’.
When will the ERC expire?
On August 4, 2021, the IRS released Notice 2021-49 that gave additional guidance regarding claiming the Employee Retention Credit for employers who pay qualified wages after June 30, 2021, and before January 1, 2022. The ERC was due to set to expire on December 31, 2020. However, the Consolidated Appropriations Act (CAA) 2021, extended the ERC through June 30, 2021. The CAA also expanded the ERC credit rate from 50% to 70% of qualified wages. The ERC was extended again to December 31st, 2021, and then retroactively ended as of 9/20/21.
Are businesses doing the Decline in Gross Receipts Test or the Government Mandate Test to receive eligibility for the Employee Retention Credit?
In terms of the 2020 version of the ERC, many companies qualified as eligible employers under the Government Mandate Test. For the 2021 employee retention credit, companies instead were qualifying as eligible employers via the Gross Receipts Test, which looked for a significant decline in gross receipts.
What would be deemed Gross Receipts under the ERC?
- For taxable entities:
- Total sales (net of returns and allowances) and all amounts received for services.
- Includes any income from the following investments:
- Royalties and annuities (regardless of if the amounts came from ordinary taxpayer trade or business)
- Reduced by the taxpayer’s adjusted status for certain property used in a trade and business or capital assets sold.
- The tax return method for income recognition applies.
- For tax-exempt organizations:
- Gross Receipts indicate the gross receipts of the taxable year and likely include all other receipts.
- The tax return method for income recognition applies.
- Includes proceeds from investments and grants.
- Not reduced by a taxpayer’s adjusted status for some properties used in a trade or business or when capital assets are sold.
If I qualified for the ERC according to the Government Mandate Test, do I automatically qualify as an ‘eligible employer’ per quarter?
Generally yes. However, you can only pay ‘qualified wages’ during mandates and when they were having more than the nominal impact on the business.
Does my Employee Retention Credit factor into my income?
No, your employer must reduce the deductions they take from wages on their income tax return for the tax year in which they are deemed an ‘eligible employer’ under ERC program.
Do I have to pay back what I receive under the Employee Retention Credit program?
Also no! The Employee Retention Credit is a fully refundable tax credit that eligible employers claim against certain employment taxes, like payroll tax. It is not like a loan and never needs to be paid back. For many taxpayers, the refundable credit is going to be higher than the usual payroll tax they would pay during credit-generating periods.
What’s the timeline for the IRS in providing refunds once I have filed an amended Form 941 X?
In most cases, it appears to be taking approximately 9 months to get a refund back from the IRS after filing Form 941 X in an amended manner.
My business has already received a PPP loan. Can I also file and receive the Employee Retention Credit?
Yes, you can! While an employer cannot include wages that are funded by PPP loans in their ERC calculations, PPP loan funds only provided for 8 – 10 weeks of wages. The ERC’s eligibility periods are much longer and PPP loans may also fund expenses outside of wages.
With regard to the ERC, it is important to maintain and retain evidence of PPP funding allocations across the entire 24-week Covered Period.
PPP funding can also be allocated to wages that would not generate any ERC.
Should I file for PPP loan forgiveness before filing for the ERC?
No, you should shift the maximum number of non-wage allowable costs to your PPP that is being forgiven.
Would PPP loan forgiveness also be included with gross receipts under the ERC program?
Again, no. Based on guidance from the IRS (released in August 2021), it has been confirmed that PPP forgiveness does not generate gross receipts in the amount of the forgiveness. This also applies to any Shuttered Venue Grant proceeds received and any Restaurant Revitalization Program funds received.
Could churches or other religiously affiliated organizations qualify for the ERC?
Yes. The Employee Retention Credit program is open to churches or other religious organizations that were impacted by government-mandated capacity restrictions on mass gatherings or if they experienced significant declines in gross receipts (like from donations and grants).
Would a company own by a Private Equity Fund need to aggregate its gross receipts and employee counts together to determine its ‘eligible employer status?
In most cases no. Brother-sister-styled portfolio companies under the private equity fund would likely be seen as distinct trade or businesses when determining their eligible employer status. This would be due to the fact that the Fund owning the portfolio companies is not an active trade or business. Instead, it’s seen as a passive investment vehicle.
If I use a PEO in place of traditional payroll tax providers, can I claim the ERC?
Yes. Employers using a PEO are still able to claim under the Employee Retention Credit program.