The ongoing COVID-19 pandemic affected nearly every workplace around the world. Around 60% of temporary business closures that occurred in 2020 eventually became permanent, affecting employers and team members alike.
For many organizations, eliminating employees from the payroll was the only way to reduce expenditures. While many took this route, there were companies who made other adjustments to keep their workforce intact.
The Employee Retention Tax Credit (ERC) was developed under the Coronavirus Aid, Relief, and Economic Security (CARES) Act and enacted on March 27, 2020. The ERC is a tax relief program designed to help employers sustain their current payroll to the greatest extent possible.
Today, we’re sharing how it works and the changes that have occurred since it was first implemented.
What Is the Employee Retention Tax Credit?
When individuals are employed and actively working, the economy is in a stronger place. It sounds like a simple theory, but it can be nearly impossible to put into action, especially in the wake of a global health crisis, like COVID-19.
The ERC is a program designed to encourage employers to keep employees on their payroll, even if they aren’t providing services due to a temporary suspension in operations or a decline in gross receipts.
As you can imagine, this is a costly feat. If employees aren’t producing work, then profits can dip. The ERC helps offset the financial burden of retaining those employees by providing a valuable tax credit for participating companies.
In short, it’s a type of refundable tax credit. Eligible employers can apply the ERC against certain employment taxes equal to 50% of the wages they’ve distributed to their employees after March 12, 2020, and before January 1, 2021.
How to Claim the Credit
To access the credit immediately, those employers will reduce the employment tax deposits they’re required to make quarterly to the IRS.
Companies are required to report their total qualifying wages (as well as related health insurance costs) each time they complete their quarterly employment tax returns. Most companies complete this process using IRS Form 941: Employer’s Quarterly Federal Tax Return.
If you anticipate that you will claim the credit, you’ll calculate the amount of qualifying employment taxes that you can save with the credit. These can include various expenses, such as:
- Federal income tax withholding
- Employees’ share of Social Security and Medicare taxes for all employees
- Employer’s share of Social Security and Medicare taxes for all employees
Then, you will withhold those amounts from your quarterly payments, up to the full amount of the credit. You can do so without penalty, as long as you follow the correct steps. You can contact your local qualified tax attorneys to make sure you’re using the right forms and following the appropriate processes.
If approved, the IRS will apply the credit against your share of Social Security tax. If there is any excess left over, the agency will refund it to you via standard procedures. Note that if you plan to claim the Paid Sick and Family Leave Credit provided under the Families First Coronavirus Response Act (FFCRA), then you will need to take those deposit reductions into account.
What happens if your employment tax deposits aren’t enough to cover the credit? In that case, you can request an advanced payment from the IRS using Form 7200: Advance of Employer Credits Due to COVID-19.
ERC Extensions and Modifications
Since its original inception in 2020, the ERC has undergone multiple extensions and expansions. These changes have been provided under various pieces of legislature, including:
- The Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Relief Act): Enacted on December 27, 2020
- The American Rescue Plan Act of 2021 (ARP Act): Enacted on March 11, 2021
- The Infrastructure Investment and Jobs Act (Infrastructure Act): Enacted on November 15, 2021
The Relief Act amended and extended the ERC, as well as the availability of specific advance tax credit payments. Enacted under Section 2301 of the CARES Act, it applied to the first and second quarters of the 2021 calendar year. Under the Relief Act, eligible employers could claim the ERC against their share of Social Security tax equal to 70% of the qualified wages paid to employees after December 31, 2020, through June 30, 2021.
The $10,000 employee limit did not change, however. This meant that the maximum ERC available changed from $5,000 per employee to $7,000 per employee for each quarter of the calendar year. The ARP Act extended the ERC for the third and fourth quarters of that year.
When the Infrastructure Act went into action, it effectively terminated the ERC for any wages paid in the fourth quarter of 2021. To qualify for the tax credit in that quarter, employers had to provide evidence that their company was classified as a recovery startup business.
What Are Qualified Wages?
Under the ERC, qualified wages can be up to $10,000 for each employee, including some health plan costs. Employers can count these wages to complete their employee retention credit calculation. This can reveal the amount of credit they’re eligible to receive.
If a company claimed the ERC for 2020, the credit was 50% of all qualified wages paid to employees between March 12, 2020, and December 31, 2020. The $10,000 wage limit applies to all employees, for all quarters. Thus, the maximum credit was $5,000 for each employee.
As mentioned, the Relief Act increased these amounts slightly.
For companies claiming the ERC for 2021, the credit was 70% of all qualified wages paid to employees between January 1, 2021, and September 30, 2021. The $10,000 wage limit applies to all employees, for any quarter. Thus, the maximum credit was $7,000 for each employee in every quarter, not to exceed $21,000 per employee, per year.
Adjustments for Small Businesses
The IRS’ definition of “qualified wages” can vary based on the number of employees an eligible employer has. If you qualified for this program and you had more than 100 full-time workers on your payroll during 2019, then those wages will generally qualify.
However, these must be employees who were not providing services due to operational suspensions or drops in gross receipts. Keep in mind that you can only count wages up to the amount that the employee would have received for working an average, equivalent amount in the 30 days that preceded the period of hardship.
If you are at the helm of a small business, wage qualification works a little differently.
If employers had fewer than 100 employees on their payroll during 2019, their wages will qualify for the ERC just as a larger company’s would. However, the difference is that all wages will qualify in this case, regardless of whether or not the employees are providing services.
Adjustments for Severely Financially Distressed Employers
The IRS categorizes companies as severely financially distressed employers if their gross receipts fell more than 90% in 2020 compared to that same calendar quarter in 2019.
If this applies to your business, then you can treat all wages that you’ve paid during the third quarter of 2021 as qualified wages.
Adjustments for Recovery Startup Businesses
A recovery startup business includes any employer that began conducting trade or business after February 15, 2020. To qualify under the ERC, this business must also:
- Have average annual gross receipts that do not exceed $1 million for the taxable three-year period, ending with the taxable year preceding the calendar quarter for which the credit is determined
- Not qualify as an eligible employer due to a full or partial operational suspension
- Not qualify as an eligible employer due to a decline in gross receipts
If your organization falls under this category, then your total ERC is limited to $50,000 per calendar quarter. Any wages paid through December 31, 2021, are eligible to receive the credit and are not limited to the September 30, 2021 deadline.
Which Businesses Qualify for the ERC?
When it was first enacted, the eligibility for ERC was based on a business’s 2019 tax records.
If your company had 100 or fewer full-time employees that year, then it may qualify for an employee wage credit worth up to 100%. This would be applicable whether your business was operable during the pandemic or was required to close due to a shutdown order.
For all other businesses, there are two ways to claim eligibility:
- Show a decline in sales via the Gross Receipt Test
- Show that your operations fully or partially shut down due to a pandemic-driven mandate delivered by a government authority
The Gross Receipt Test
If you had 500 or fewer employees on the payroll, you could qualify for the credit by providing evidence that the pandemic directly affected your gross receipts. Specifically, you had to show that your gross receipts in 2020 or 2021 were lower per quarter than they were in that same quarter of 2019.
To claim eligibility based on a decline in gross receipts in 2020, you had to show evidence that your gross receipts were less than 50% of the amount you earned in the same quarter of the previous year. Based on changes enacted through the Relief Act and other legislation, companies that choose to claim eligibility this way now have to show a reduction of only 20% in gross receipts. You can show this decline via a process known as the Gross Receipts Test.
Full or Partial Shutdown
In lieu of the Gross Receipts Test, organizations could also qualify for the credit by showing that they fully or partially suspended their operations during the quarter in which they are claiming the ERC. This total or partial shutdown must have occurred due to an order from a government authority that limited:
- Group meetings
For instance, a restaurant can claim eligibility by showing that it was forced to close indoor dining and move to a takeout-only model during the qualifying quarters. This would be an example of a partial shutdown. If you had to temporarily close all aspects of your organization for a period of time, that would be classified as a full suspension.
When it was first released, the ERC was designed to only apply to private sector businesses or tax-exempt organizations. In the years since its enaction, there have been several changes to the way the IRS defines a qualifying employer.
Now, it can include government agencies that serve as colleges or universities, as well as organizations that provide hospital or medical care. Yet, governmental employers and self-employed individuals are still ineligible to apply for this credit.
Can I Still Qualify?
With all of the ERC changes that have occurred, you might be wondering if your organization still qualifies for this tax credit. It becomes especially confusing when you consider that the Infrastructure Act retroactively ended the Employee Retention Credit (ERC) in November 2021.
However, you can still claim this credit on your 2022 tax return. However, it’s important to note that based on the latest legislature, the credit is now limited to the third quarter of 2021 only. This means that any employee wages your company paid before September 30, 2021, are ineligible for the ERC.
Note that recovery startup businesses have slightly different rules. As mentioned, these businesses have a total credit limit that’s limited to $50,000 per calendar quarter. This rule applies to wages paid through December 31, 2021. If you’re interested in claiming the ERC in 2022 for wages paid in the third quarter of 2021, then it’s best to work with a team of experienced tax attorneys.
These experts can help you report your qualified wages and related credits for each calendar quarter. Depending on your circumstance you may do so via one of two forms. These include IRS Form 941-X: Adjusted Employer’s Quarterly Federal Tax Return or IRS Form 843: Claim for Refund and Request for Abatement.
Learn More About the Employee Retention Tax Credit
Tax forms and regulations can be challenging to navigate. They become especially cumbersome when there are lots of updates, adjustments, and revisions to understand.
If you believe that your company could still qualify for the Employee Retention Tax Credit, get in touch with us today. This is a technical process that requires completing the right forms and providing the right financial data and information. When done correctly, it can provide valuable relief and operational support.
Don’t stay in the dark. Contact Silver Tax Group today to discuss your tax-related questions!