How Does Employee Retention Credit Work?

Key Takeaways:

  • The Employee Retention Credit (ERC) was introduced as part of the CARES Act and extended through the third quarter of 2021 for most businesses
  • The ERC is 50% of qualified wages, up to $10,000, for 2020, and 70% of qualified wages, up to $10,000, for 2021
  • Employers can claim up to $5,000 per employee for 2020 and up to $21,000 per employee for 2021, or $7,000 per employee per quarter
  • To qualify, businesses had to have either closed because of a government order or lost 50% in gross receipts in 2020 or 20% of gross receipts in 2021, when compared to the same quarter in 2019

Steps and details to expect when applying for the ERC:

  1. Include accurate calculations for Form 941-X
  2. Provide an explanation
  3. Gather necessary documentation
  4. Apply within the deadline
  5. You’ll get a paper check for your credit
  6. Every employer is subject to the credit limits
  7. You don’t have to pay taxes on the credit but may have to amend your return
  8. The ERC is fully refundable

The government stepped up in early 2020 to provide economic relief to businesses and individuals around the country. Programs like tax credits and disaster relief loans helped many employers stay afloat, even with record layoffs, business closures, and unemployment claims.

The Employee Retention Credit (ERC) was created as part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), passed in March 2020. The goal was to help employers keep their employees on the payroll, and the credit helped offset payroll taxes.

The credit was initially available through the end of 2020 but was then extended by further legislation in 2021. The ERC has ended, but eligible employers can still claim their credit for a limited time.

The ERC became the biggest stimulus program the government has ever released. Businesses may still be eligible to receive up to $26,000 per employee if they saw impacts from the COVID-19 pandemic. This guide walks through how the Employee Retention Credit works and what you can expect throughout the process of filing and getting your credit.

How Does the Employee Retention Credit Work?

The ERC gives employers a major opportunity to get a payroll tax credit to assuage the effects of the pandemic on their business. Businesses that had to close or lost money because of the pandemic can qualify.

The ERC is a fully refundable credit. This means that if you have money left over from the credit after your tax liability is covered, you get that difference as a cash payment.

This credit is 50% of up to $10,000 in wages you paid to each employee for 2020 wages paid between March 12 and Dec. 31. For 2021, the credit is 70% of up to $10,000 in wages paid to each employee per quarter for the first three quarters of 2021. This means that for 2020, you could be eligible for up to $5,000 per employee per year, and for 2021, up to $21,000 per employee per year (or $7,000 per employee per quarter).

The ERC ended for most businesses on Sept. 30, 2021, so you can only count the first three quarters. Recovery startup businesses, however, can also claim the credit for that last quarter. This type of businesses began operating after Feb. 15, 2020, and receive less than $1 million in annual gross receipts.

You could have claimed the ERC on your original Form 941, Employer’s Quarterly Federal Tax Return, when you submitted your quarterly tax returns. You can no longer claim it on this form, however, since the program has ended. You can still claim the ERC retroactively, though, using Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund.

You have three years from the date you filed your original tax return, or when you paid the tax, whichever is later, to claim the ERC for qualifying quarters. You’ll need a separate Form 941-X for each previous quarter for which you’re claiming the credit.

Eligibility Requirements for the ERC

Your first step to claim the ERC is to determine your eligibility and which quarters you can claim. Let’s dig a bit deeper into how to qualify for the ERC:

Business Closure Due to Government Order

The first way to qualify is related to business closure. You can qualify if your business had to close, either partially or fully, because of a government order. This was very common, especially in 2020, since the government put gathering and traveling restrictions in place across the country.

Loss in Gross Receipts

The other way to qualify is to assess your gross receipts for qualifying quarters. You are eligible if you lost at least 50% in gross receipts in 2020 when compared to the same quarter in 2019.

You can also qualify if you lost at least 20% in gross receipts in 2021 when compared to the same quarter in 2019. If you lost 35% of gross receipts in Q1 of 2021 when compared to Q1 of 2019, for example, you would qualify to claim the ERC for that quarter.

Employer Requirements

Your business had to have employed at least one employee in the qualifying quarter to be able to claim the ERC. You also need to know the difference between a small and large employer in regard to this credit.

Small employers had 100 or fewer full-time employees for 2020, and in 2021, they had 500 or fewer full-time employees. Large employers can only claim the ERC for wages paid to employees while they were not providing services.

Qualified Wages

You can use both part-time and full-time wages to calculate your credit. Wages are any wages, tips, or compensation an employer paid to its employees and can include qualified health plan expenses.

PPP Loan Recipients

Employers originally couldn’t claim the ERC if they also received a Paycheck Protection Program (PPP) loan. You can now qualify for the ERC even if you received a PPP loan.

You just can’t use the same wages when calculating your ERC that were paid for by your PPP loan. There can’t be any overlap.

Make sure you fully understand all of these qualification requirements before you claim the ERC. Most businesses likely qualify, since everyone was impacted by the COVID-19 pandemic.

Just make sure you apply for the credit only in quarters where you meet these requirements. Talk to an ERC expert if you have questions about how to qualify.

Eight Things to Expect When Applying for the ERC

It’s time to take steps to claim the credit once you’ve determined your eligibility for the ERC. This is a significant credit that can positively impact your business, so make sure you don’t delay in applying. Let’s walk through the steps you can expect to complete process:

1. Include Accurate Calculations on Form 941-X

Form 941-X is used for more than just the ERC, so you’ll see a few other line items when you fill it out, like other tax credits. Find the line for the ERC. You will need to have calculated your credit based on the quarter you’re claiming it for and the wages you’re using.

2. Provide an Explanation

Form 941-X also requires you provide an explanation since it’s technically a form to correct your original Form 941. The IRS states on the form, “You must give us a detailed explanation of how you determined your corrections.” Your explanation needs to include the line numbers impacted, the date you discovered your error (or learned you qualified for the ERC), the amount of the error, and the cause of the error.

3. Gather Necessary Documentation

Collect all of your information and ensure it’s accurate before you apply. You’ll need to have your original tax returns you’re amending and records about how much you paid employees and when. You will also need documentation about the quarters for which you had to suspend operations or lost gross receipts.

4. Apply by the Deadline

You don’t have forever to claim the ERC. You need to apply with Form 941-X within three years from the date you originally filed your payroll tax return, or two years from when you paid the tax, whichever is later. You won’t be able to get your credit if you miss this deadline, so it’s best to apply as soon as possible.

5. You’ll Get a Check After the IRS Has Processed Your Credit

The ERC isn’t distributed via direct deposit, so you’ll receive your credit in paper check form. The IRS has been pretty delayed since the pandemic, so the timeline for receiving your check will vary.

6. Every Employer Is Subject to the Credit Limits

You may have experienced significant losses because of the pandemic. There is, however, a limit to how much you can claim across the board, and that applies to every employer.

You can only claim up to $5,000 per employee for 2020, and up to $21,000 per employee for 2021, which is $7,000 per employee per quarter, for the first three quarters. Make sure you understand these limits for the quarters you’re applying for.

7. You Don’t Have to Pay Taxes on the ERC but May Need to Amend Your Return

Another area employers don’t always understand is how the ERC impacts taxes. You don’t have to pay taxes on the ERC funds you receive.

This is because the IRS considers it a refund, not income. Your credit will, however, lower the amount you pay for employer taxes.

That means you’ll see a reduced total wage expense for that year. This may increase your profits or lower your losses. You may need to amend your tax return for the applicable year based on this information.

8. The ERC Is Fully Refundable

There are certain nonrefundable credits out there, which means that anything not used to cover your tax liability isn’t refunded to you. The ERC is fully refundable, which means you’ll get back whatever isn’t used to cover what you owe in taxes. This is a big plus, as you’ll receive your full credit amount from the IRS, even if you owe money in taxes.

Navigating the ERC application process isn’t always easy, even when you’re sure you have everything calculated correctly. That’s why working with an ERC professional can be a game-changer for getting your credit in a timely manner. You don’t want to have to deal with unnecessary delays or issues that you could easily avoid.

Contact the Experts at ERC Today for Help

Some great news about the ERC is that you don’t have to calculate your credit or start the application process completely on your own.

Tax credit experts are available to help you understand which quarters you qualify for, how much you will receive from the IRS, how long you have to file, and how to ensure the process goes smoothly. Claiming the ERC can be complicated when you’re doing it retroactively, and you have to be sure you keep up with the latest regulations and guidelines.

The team at ERC Today is available to help you through it all. Our experts understand tax laws, deadlines, and best practices to ensure you get the credit you’re owed as soon as possible. Contact ERC Today for more information about your Employee Retention Credit options.