How would you describe the year 2020?
Your answer might vary depending on your social, economic and geographic factors.
But suppose you asked a small business owner. In that case, they might describe an unimaginable time with silent streets, halted activities in the busiest areas, and the heartbreaking prospect of closing their doors forever. In fact, over 60% of small businesses experienced a significant financial impact during the pandemic.
In this turmoil, a hand of relief emerged – the Coronavirus Aid, Relief, and Economic Security (CARES) Act – which kept the hopes of millions of small business owners alive.
The US government introduced this act to help businesses stay afloat by retaining their most important resources: their employees.
Curious to know more about this lifesaver?
In this blog, we’ll explore the meaning, origin, benefits, and impact of the Employee Retention Credit, a crucial aspect of this Act.
What is the Employee Retention Credit?
The employee retention credit is a broad-based refundable tax credit that encourages employers to keep employees on their payroll. The credit limit is 50% or up to $10,000 in wages paid by employers whose businesses were completely or partially suspended or whose gross receipts were reduced by 50% due to the impact of COVID-19.
Employee Retention Credit (ERC) is also called Employee Retention Tax Credit (ERTC). The IRS defines this as a “refundable tax credit availed by the eligible employers. This means that the eligible employers may receive payment of the portion of the credit that exceeds certain employment taxes that are due.”
With the meaning of this term clear, let’s explore its key purposes in the next section.
Purpose of ERC
The CARES Act clarifies that the ERC provides financial relief to smaller businesses hit hardest by the pandemic. However, the main purpose of ERC is not limited to this; it serves the following key purposes:
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Financial relief for businesses:
By offering a refundable tax credit, the government helps struggling businesses cover a portion of their employee wages. This alleviates cash flow challenges, enabling them to retain their workforce and continue operations during challenging times.
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Promote workforce stability:
The main aim of ERC is to maintain workforce stability during economic instability by incentivizing employers. Employee retention helps businesses avoid the cost of rehiring and retraining employees during the economic recovery.
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Impact on economic recovery:
ERC promotes economic recovery by ensuring business continuity and reducing layoffs. Providing immediate relief to small businesses helps manage the shock waves of sudden economic change and speeds up recovery once the crisis ends.
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Long-term business implications:
While ERC offers immediate relief to businesses, its long-term implications are debated. Companies should plan for long-term growth post-pandemic by relying on innovation, processes, and customer support. Delaying planning can hinder necessary restructuring for post-pandemic survival.
Let’s discuss a few pros and cons of ERC below.
Pros:
- Provides immediate financial relief to businesses.
- Encourages employee retention.
- Stabilizes business operations during critical times.
- Boosts employee morale and loyalty.
- Fosters economic stability.
Cons:
- May be insufficient for severely affected businesses.
- Temporary relief, not a long-term solution.
- Limited impact on certain industries and geographic locations.
- May lead to misuse or fraud in credit claims.
- May promote employee retention even when downsizing is necessary.
This makes it clear that while the Employee Retention Credit supports crucial businesses during the economic downturn, its effectiveness depends on its ability to navigate challenges and create a broader strategy for long-term recovery and growth.
Let’s discuss how this system works in the next section.
How does Employee Retention Credit work?
Understanding ERC’s basic accounting framework is essential to grasp how it works.
ERC is a refundable payroll tax credit that does not fall under ASC 740, Income Tax. It helps businesses recover from the pandemic’s impact with government assistance.
ERC follows three accounting thresholds that govern business financial operations and assistance:
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IAS 20:
Under IAS 20, ERC is considered an income-related grant. The IRS recognizes ERC when businesses meet all the basic accounting thresholds. Business entities can present government grants as gross or net items in their financial statements.
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ASC 958-605:
Under ASC 958-605, ERC is considered a donor-imposed conditioned grant. The following criteria must be met to be recognized by the IRS: (a) the eligibility barrier is met, or (b) the statute of limitations expires, and the donor is no longer eligible to collect the funds. After meeting these conditions, ERC is recognized as revenue.
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ASC 450-30:
Under ASC 450-30, ERC is recognized only after the contingency meets these two criteria: (a) The IRS affirms the reporting entity’s eligibility, or (b) the statute of limitations that applies to the reporting entity’s eligibility has expired.
This makes the entire ERC accounting framework clear. Let’s look at certain disclosures that must be met.
Disclosure
Under ASC 832, the following disclosures apply to ERC transactions in annual financial statements:
- Information on the transaction, general description, and form of assistance.
- Policies used to account for the transactions.
- The transactions affect line items on the balance sheet and income statement.
- The duration or period of the agreement.
- Any prior commitments made by the business entities.
- Other contingencies.
With the accounting framework and basic rules guiding ERC clearly, let’s move ahead and discuss its working mechanism.
Here is a detailed workflow of how ERC works:
1. Eligibility criteria:
To qualify for ERC, businesses must meet the following conditions:
- Businesses must have been fully or partially suspended or witnessed a significant decline due to COVID-19.
- The rules differ depending on the employee count. For 2020, businesses with 100 or fewer full-time employees can claim credit for all the employees, regardless of whether they are working. For 2021, the threshold has increased to 500 employees.
2. Credit amount:
The ERC provides the following credit against payroll taxes:
- The maximum credit per employee for 2020 was $5,000.
- The amount was increased to $7,000 per quarter in 2021.
3. Qualified wages:
The ERC is claimed against payroll taxes:
- Employees can report the ERC on either their quarterly employment tax returns or against their Social Security taxes using Form 941.
- In case of any anticipated credit excess, businesses can request an advanced payment using Form 7200.
4. Interaction with other relief programs:
Businesses can only claim PPP (Paycheck Protection Program) loans and ERC. They are ineligible to claim benefits from other programs, such as the Work Opportunity Tax Credit or the Family and Medical Leave Act Credit.
5. Documentation and compliance:
Employers must keep records of their eligibility, calculations of the decline in gross receipts, and calculations of qualified wages for at least four years after the tax becomes due.
6. Deadlines and amendments:
Credits are claimed on timely filed quarterly returns, and businesses that later become eligible to claim ERC can amend their tax returns accordingly.
Thus, now that we understand how ERC works and the various rules about its eligibility let’s move on to the next section to learn how business owners can apply for their ERC claims.
How to Apply for the ERC?
Applying for the ERC involves eight key steps: determining eligibility and claiming the credit on tax returns. Let’s discuss these steps below:
1. Determining eligibility:
Check if your business was impacted by COVID-19 or due to an economic downturn resulting from government policies and experienced a significant decline in gross receipts. Next, review your business’s employee headcount to meet the eligibility criteria.
2. Calculating the credit:
The government-mandated credit is 70% of qualified wages up to $10,000 per employee per quarter, equating to a maximum credit of $28,000 per employee annually.
3. Stating qualified wages:
Include the wages paid and the cost of your employees’ health insurance. Consider the accounting thresholds to determine what qualifies as eligible wages.
4. Claiming the credit:
Report the credit on your quarterly federal tax return via Form 941. If your anticipated credit exceeds the employment tax deposits, you can request an advance payment using Form 7200.
5. Documentation:
To justify your credit claim, maintain detailed records of all essential documents, such as payroll records, financial statements, and other documentation.
6. Amending prior returns if needed:
If you did not claim ERC on a previously filed Form 941, you can amend your return by filing Form 941-X. Carefully review your eligibility and maintain payroll records from the previous quarter before filing the form.
7. Retaining key documents:
Retain all critical documents supporting your eligibility claim for at least four years in case of an IRS audit.
Let’s understand this with an example scenario:
Imagine a small family-owned eatery in New York, Delicious Wings and Tenders. Once a flourishing business, it is now struggling to make ends meet. After the government imposed a ban on indoor dining, its revenues crashed. The owners learned about the ERC and decided to apply for it to retain their local staff.
The business owners discovered that as their business was partially suspended, their gross receipts dropped significantly, and they were eligible for the claim. With 25 full-time employees, they calculated the qualified wages and reported the credit on their quarterly tax returns. By filing Form 941 and adjusting their tax deposits, they obtained the much-needed financial assistance to retain their employees.
Thus, it’s clear how businesses can claim their ERC. Let’s discuss the eligibility criteria and what wages qualify for the credit.
Employee Retention Credit Eligibility and Qualification Criteria
With the process of applying for ERC and the working framework of ERC clear, the next thing that pops into your mind is, “What are the eligibility and qualification criteria for claiming ERC?”
Let’s answer it: to claim ERC in any given quarter, businesses must meet at least one of the following criteria:
- Operations should be fully or partially suspended due to governmental restrictions resulting from COVID protocols.
- Organizations must experience a significant decline in their gross receipts from 2019, with a 50% or more decline from the previous quarter.
- For 2021, the gross receipt decline criteria have been significantly reduced from 50% to 20%.
ERC is the credit employers receive on their employee wages. But does every wage qualify for the ERC?
Let’s answer it – “What wages qualify for the ERC?”
This answer lies on the size of the organization and its employee count. If a large organization is eligible for the ERC, it can claim ERC for wages paid to employees when they are not providing their services. Similarly, smaller organizations can claim credit for all wages paid to employees irrespective of whether they provide their services.
Organizations can claim ERC for the health care expenses of their furloughed employees, as they alone qualify as wages!
With all these doubts surrounding qualified wages clear, let’s delve deeper into ERC calculations in the next section.
Employee Retention Credit Calculations
As we know, the ERC was established under the CARES Act to protect businesses from the economic downturn caused by COVID-19. This Act underwent significant changes in 2021, so let’s look at the calculation breakdown of both instances.
Steps to Calculate ERC:
- Determine Qualified Wages: Include the wages paid when the business experienced complete or partial suspension of operations.
- Calculate the Credit: Apply the respective credit percentages to the qualified wages.
- Apply the Cap: Ensure the credit does not exceed the maximum allowable amount per employee.
Let’s understand this with two examples.
Example for 2020:
Let’s assume ABC Industries paid an employee $18,000 in qualified wages in 2020. How much ERC can they claim?
- Qualified wages = The cap for 2020 is $10,000, so we use $10,000 even though the company paid $18,000.
- Credit = 50% of $10,000 = $5,000
So, the company can claim $5,000 as the ERC for the employee.
Example for 2021:
Suppose ABC Industries paid the same employee $18,000 in qualified wages in Q1 2021.
- Qualified wages = The cap for 2021 is $10,000, so we will use $10,000 even though the company paid $18,000.
- Credit = 70% of $10,000 = $7,000
So, the company can claim $7,000 as the ERC for the employee.
Hence, the above example clearly illustrates how ERC is calculated. Now, let’s move on to the next section and see the changes the ERC act has undergone over the past years.
Evolution of ERC
The ERC under the CARES Act has undergone significant changes since 2020. In 2020, if an eligible employer had 100 or fewer employees, wages and healthcare expenses were covered under qualified wages. In 2021, the employee count was increased to 500, allowing employers with 500 or fewer full-time employees to be eligible.
Let’s discuss other changes in the ERC from 2020 to 2021 below.
| Criteria | 2020 | 2021 |
| Qualified wages | Up to $10,000 paid after March 12, 2020, and before January 1, 2021. | Up to $10,000 paid after March 12, 2020, and before July 1, 2021. |
| Suspension of services | Partial or full suspension due to COVID-19 or governmental orders. | Partial or full suspension due to COVID-19 or governmental orders.
(OR) 20% decline in gross receipts from the same quarter in 2019. |
| Credit | 50% of qualified wages, with an annual cap of $5,000. | 70% of qualified wages, with an annual cap of $7,000. |
| Total credit | $5,000 for the entire year | $14,000 for Q1 and Q2 of 2021 |
With the evolution of the Act clear, let’s find out the ERC deadline for the year 2024 in the next section.
Employee Retention Credit Deadline
According to the IRS, the current deadline to file ERC claims is April 15, 2024, for the 2020 tax year and April 15, 2025, for the 2021 tax year. New ERC claims are prohibited after January 31, 2024. The Act could undergo another amendment to extend the filing period as the deadline has passed.
Wrapping it Up
The ERC is a vital tax claim that helps businesses stay afloat in the tumultuous post-pandemic times. Understanding its meaning, calculation, and compliance rules allows enterprises to benefit fully from this Act. It supports economic recovery, helps retain employees, and reduces the impact of economic downturns. Knowledge of the ERC and other relief measures enables organizations to continue operations without major changes, restructuring, or layoffs.
Frequently Asked Questions (FAQs)
1. Is every business eligible for Employee Retention Credit?
No, only businesses that experienced a decline in gross receipts or were subjected to partial or full suspension of operations due to government orders are eligible for ERC.
2. Who is not eligible to claim Employee retention credit?
- The following are not eligible to claim ERC:
- Businesses that use PPP loans for loan forgiveness.
- Governmental employers.
- Certain self-employed individuals.
3. What is the deadline for employee retention credit in 2024?
The deadline to claim the ERC for 2024 is April 15, 2025, when filing payroll tax returns for 2021 through Form 941-X.
4. How does Employee retention credit affect tax returns?
The ERC reduces payroll tax liability via a refundable tax credit, lowering the employer’s tax burden on their federal tax return.
5. Is Employee Retention Credit taxable?
The Employee Retention Credit is not taxable but may increase the employer’s taxable income.
6. Is there any nonrefundable portion of the Employee Retention Credit?
The nonrefundable portion of ERC is the employer’s share of Social Security Tax, and its excess is treated as refundable overpayment.
