The Employee Retention Credit (ERC) is a refundable tax credit of up to $5,000 per employee. It was created by the CARES Act and is designed to help and encourage employers whose businesses are negatively affected by COVID-19 to keep employees on their payroll.
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Who Qualifies for the Credit
The ERC is available to businesses, including nonprofit organizations, who are adversely affected by COVID-19 during a calendar quarter in one of two ways:
- Business is fully or partially suspended by government order during the quarter.
- Business 2020 gross receipts fall below 50% of the same quarter in 2019.
Fully or Partially Suspended by Government Order
A business may be partially suspended when a government authority imposes restrictions limiting commerce, travel, or group meetings due to COVID-19. While a business may still be allowed to operate, it may not be at its normal capacity due to the imposed restrictions.
For Example
Restaurants who may only provide services on a drive-thru basis due to executive order would be considered to have business partially suspended because full operations would include sit-down services.
Gross Receipts Business Test
In relation to the gross receipts test, once business 2020 gross receipts rebound to 80% or more when compared to the same quarter in 2019, the business will no longer qualify for the ERC after the end of such quarter.
For Example
Assume a business’s 2020 gross receipts by quarter when compared to 2019 are as follows: 35% for Q2, 89% for Q3, and 94% for Q4. The business is eligible for the ERC for quarters two and three only.
Who Does Not Qualify
The ERC is not available for businesses who:
- Have utilized the new SBA 7(a) Paycheck Protection Program loan
- Are state and local governments or their instrumentalities
- Operate as a self-employed individual (with no employees)
How the Credit is Calculated
Credit amounts are based on 50% of qualifying wages paid to employees from March 13, 2020, through December 31, 2020. Up to $10,000 in qualifying wages may be used towards the credit, for ALL quarters combined. Qualifying wages include not only cash compensation but the allocable portion of health care to an employee during the period.
For Example
Sam Co, an eligible employer, pays employee Eric $12,000 in wages and allocable healthcare during Q2. Sam Co may take only $10,000 into consideration for Eric in calculating Q2’s ERC. Sam Co may not use any further wages attributable to Eric in a future quarter to compute the ERC.
Instead, assume Eric’s qualifying wages for Q2 were $8,000. If Sam Co still qualifies for the ERC in Q3, it may potentially use up to $2,000 of Eric’s wages for a credit in Q3.
While there is no company size restriction to qualifying for the ERC, special rules apply if the number of full-time employees (as defined in IRC section 4980H) in 2019, on average, exceeds 100. Those businesses may only use the credit for wages paid to employees not working during an eligible 2020 calendar quarter because of COVID-19. If the 2019 average employee count is 100 or fewer, the credit is based on wages paid to all employees, whether they were working or not.
For the purposes of determining the 100-employee count, aggregation rules apply under IRC section 52(a) controlled group of corporations, 52(b) employees of partnerships, proprietorships, etc. under common control, 414(m) employees of an affiliated service group, or 414(o) related regulations.
No double benefit may be had in claiming credits based on the same wages. Wages used in calculating paid sick and family leave credits under the Families First Coronavirus Response Act (FFCRA) or the Paid FMLA credit under IRC section 45S may not also be considered qualifying wages for the ERC. In addition, eligible wages do not include those of an employee allowing the employer to take the Work Opportunity Tax Credit and qualifying wages may not be considered for certain related parties to the employer as defined under IRC sections 51(i)(1) and 280C(a).
The IRS has provided further clarification related to employee retention credits.
How the Credit Is Claimed
Qualifying businesses do not need to wait until filing a 2020 income tax return, rather the credit is taken by reducing a quarter’s required payroll tax deposits.
There are two parts to the ERC: current and refundable. The current portion is the lesser of qualifying credits and the 6.2% employer’s share of Social Security taxes (due on all wages paid to all employees for the quarter). If a credit due is more than such an amount, it will be allowed to offset the rest of tax liabilities on the employment tax return for the period.
For Example
Sam Co paid $10,000 in eligible wages during an eligible quarter and is due a credit of $5,000. Sam Co has payroll tax deposit requirements of $8,000 for the quarter on all its employee wages. Sam Co may keep $5,000 of the $8,000 taxes it would normally deposit for the quarter and will not owe a penalty for only depositing $3,000 on the appropriate due date for the period. The activity will be recorded and reconciled on the quarter’s Form 941, Employer’s Quarterly Federal Tax Return.
If qualifying wages exist from March 12, 2020, through March 31, 2020 (calendar Q1), the resulting credit will be added to the calendar Q2 payroll tax filing.
The CARES Act states the ERC is taken against payroll taxes after any credits allowed for IRC section 3111 for Vets and R&D, and paid sick and family leave of the Families First Coronavirus Response Act.
In cases where an eligible employer needs funds to pay employees that is in excess of employment taxes available for use, a refund may be obtained by filing Form 7200, Advance Payment of Employer Credits Due to COVID-19. Employers should first reduce federal employment tax deposits for wages paid during the quarter by the maximum amount allowable. If Form 7200 is used, an employer will need to reconcile the advance credit and its deposits with qualified wages reported on Form 941 for the quarter.
For Example
Sam Co paid $10,000 of eligible wages and is due a credit of $5,000 for the quarter. Sam Co has $3,000 of employment taxes due for the period and may keep such amount that it otherwise would be required to deposit. Sam Co may file Form 7200 for the remaining $2,000 due as an advance credit.
When to Consider Using the Employee Retention Credit
The Employee Retention Credit may prove valuable for those employers not eligible for or opting out of the Paycheck Protection Program (PPP) loan. An analysis should be done to determine the best outcome considering all factors of your unique circumstances. If the PPP loan is ultimately utilized and the ERC has been taken for a quarter, recapture of the withholding taxes not deposited as a result of taking the ERC will be required.
The Employee Retention Credit can help your organization during a time of immense change.
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