In March 2020, the Employee Retention Credit (ERC) was introduced to provide much-needed financial relief to employers impacted by the COVID-19 pandemic. Part of the Coronavirus Aid, Relief, and Economic Security Act (CARES), the ERC’s goal was to encourage employers to keep employees on the payroll during the peak of the coronavirus pandemic.
This credit, also known as the ERTC, can sometimes get lost in the shuffle. It is sometimes overshadowed by the CARES Act itself, online fraudsters try to dupe business owners, and some employers are simply unaware they may qualify for these payroll tax credits.
The good news is that this credit is real. The deadline for businesses to apply for these 2020 and 2021 credits has been extended several times since the program started, and qualified businesses still have until 2025 to claim them.
But how do you know if the credit applies to your business, and if it does, what are the steps to retroactively claim it? In this employer’s guide, we’ll define what the Employee Retention Credit is, how to know if your business qualifies, and with the deadlines now extended into 2024 and 2025, we’ll cover how you can apply.
Understanding what the Employee Retention Credit is
Simply put, the Employee Retention Credit (ERC) is a refundable payroll tax credit — created by the federal government — to encourage employers to retain and continue paying employees during the COVID-19 pandemic-related economic downturn. It was passed by Congress in early 2020 as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act and the legislation has been amended three times by the following laws:
- Consolidated Appropriations Act 2021
- American Rescue Plan Act (ARPA)
- Infrastructure Investment and Jobs Act
The credit is based on qualified wages and compensation paid to employees, including tips and qualified health expenses paid on behalf of employees.
To better understand how it’s changed since becoming law, let’s take a look at what it started as up until the present day.
ERC at the outset
To start, the ERC credit was calculated using 50% of qualified wages up to $10,000 paid per W-2 employee between the dates of March 12, 2020, and December 31, 2020.
Other provisions of the original version of the ERC stated that the credit was available to businesses that had:
- At least a 50% reduction in gross receipts compared to the same quarter in the previous year
- Operations partially or completely suspended by government order resulting from the pandemic
- Did not already take advantage of or recipients of the Paycheck Protection Program (PPP) funds
The next edition of the ERC
Subsequent versions of the legislation extended the credit period through June 30, 2021, and later through September 30, 2021, where it has remained.
In addition, the gross receipts test changed. This means that employers were able to qualify for the credit with only a 20% drop in gross receipts, using either the current or a preceding quarter for comparison with prior-year gross receipts.
ERC continues to exist
As we fast forward to the present day, the latest version now allows businesses that participated in the PPP loan program to claim a credit against wages that were not used for PPP forgiveness.
And as of this writing, the ERC has undergone even more deadline extensions, providing businesses that were able to keep their staff on the payroll an opportunity to apply. So, what’s in the dollars and cents? The following credits are currently still available for eligible small businesses (and we’ll get into the ins and outs of eligibility a bit later in the article):
- For the period of March 13, 2020 to December 31, 2020, employers can file for a credit of 50% percent of wages paid up to $10,000 per employee, with a maximum credit of $5,000 per employee for each eligible quarter
- For the first three quarters of 2021, the credit goes up to 70 percent of wages paid, up to $10,000 per employee, with a maximum of $7,000 per employee for each eligible quarter
Now that we know how the ERC works, most business owners probably want to know if they are eligible. Let’s find out more about who meets the guidelines for qualifying.
Who is eligible for the ERC credit?
Please avoid getting mad at the messenger: Only some businesses qualify to take the credit, and the IRS uses three factors to determine ERC eligibility based on their definition of a small business. What are they?
- For 2020, the program guidelines stated that a small business was considered to have 100 or fewer full-time employees, with a full-time employee classified as someone working at least 30 hours in a week or 130 hours monthly.
- The definition changed in 2021, with a small business now considered one with fewer than 500 employees. The result? More businesses became eligible for the full credit.
- While larger businesses are also eligible to apply for the ERC, they can only consider wages paid to employees who were not providing services.
Meeting the small business criteria set by Uncle Sam is the first step toward determining your eligibility. From there, your business is eligible to take the credit if one of the following three factors applies to your current situation. Note that If one of these factors does not apply to your business, the ERC is not in the cards. Here they are:
Operation reduction or closed shop
Did your business experience a shutdown or significant reduction in hours of operation as a result of a government order between March 12, 2020, and September 30, 2021? You would be eligible.
Reduction in gross receipts
Your company’s gross receipts experienced a significant decline during any quarter in 2020 and/or the first three quarters of 2021. Keep a couple of caveats in mind though:
- For the tax year 2020, the decline had to be at least 50 percent from the previous year’s receipts for the same quarter. For example, if your business had gross receipts of $50,000 in the second quarter of 2020, and $100,000 in gross receipts in the second quarter of 2019, you would be eligible to apply for the credit.
- For 2021, the reductions in gross receipts required was reduced to 20 percent. If you had gross receipts of $15,000 in the second quarter of 2021, and $22,000 in gross receipts for the second quarter of 2019, you would now be eligible to apply for the credit. For 2021, you can also use the preceding quarter (quarter one of 2019) to determine eligibility.
You have a new or launched startup business after February 15, 2020 (congratulations!) and currently have annual gross receipts of less than $1 million. If your business meets both criteria, you do not have to meet requirements 1 or 2, though you are limited in how much your business will receive in credits for each eligible quarter.
Now that we have broken down how businesses can qualify for the credit, it’s worth understanding which employee wages are considered.
Do all employee wages qualify for ERC?
For 2020, qualified small businesses that averaged 100 full-time employees or less can claim ERC for all employees, whether or not they worked. How is a full-time employee defined?
It’s an employee who works an average of 30 hours in a week.
If you’re keeping score, the definition of a small business changed in 2021 to include businesses that averaged 500 full-time employees, making them eligible to claim the credit whether they worked or not. Keep in mind that part-time employee wages are also eligible to apply towards the credit.
Though the ERC is geared towards small businesses, larger businesses with more than 500 full-time employees can still take advantage of the credit, but only for wages that were paid to employees that did not work.
Cash tips of more than $20 per month are also considered qualified wages, but wages paid to the owner or related family members does not qualify for the credit.
When filing for the ERC, it’s important to remember that you can only use qualified wages for the specific time frame, which is all four quarters of 2020 and the first three quarters of 2021, with eligibility determined per quarter.
For example, if you meet the IRS criteria, you can apply for the credit for each quarter that you remain eligible, even if you’re not eligible for the next quarter.
Businesses are not able to claim wages for the same employees under both the ERC and the Work Opportunity Tax Credit for the same quarter, nor those claiming the employer credit for the Family and Medical Leave Act (FMLA).
As we get through the ins and outs of how the wages work when it comes to the ERTC, business owners are probably wondering how this comes into play when considering PPP loans.
Can I Still Apply for ERC if I’ve received a PPP Loan?
When PPP loans and the ERTC first became options for small businesses, you had to pick one: Applying for both was a “no-no.” Similar to the evolving ERC deadlines, things have changed since those early days.
If you’ve applied for and received a PPP loan, you’re still eligible to apply for the ERC credit. In its original version, the ERC was not available to businesses that had taken a PPP loan. In the updated guidelines issued in late 2020, employers receiving a PPP loan are now allowed to apply for ERC, but cannot use wages used for PPP loan forgiveness when calculating their ERC credit.
We have covered a lot of ground, and — drum roll, please — let’s talk next about the steps to retroactively claim this credit.
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How do employers retroactively claim the employee retention credit?
As we mentioned, the good news is that even if you haven’t claimed the employee retention tax credit yet, time is on your side.
You have until April 15, 2024 to file an amended 941 (using Form 941-X) to:
- Claim a credit for all four quarters of 2020.
- And separately until April 15, 2025 to claim a credit for the first three quarters of 2021.
Are you ready to get the ball rolling on retroactively applying? Here’s the documentation to have ready to go.
- Previously filed 941 forms for the quarters where you are requesting a credit
- Profit and loss statements for all four quarters of 2019, 2020, and 2021
- Payroll reports for 2020 and 2021
- Healthcare costs for 2020 and 2021
- Payroll Protection Program documents, if relevant
Once you have that documentation in place, you’ll need to complete Form 941-X and here are complete instructions on how to fill it out available from the IRS. Before completing Form 941-X, you’ll want to:
- Make sure your business qualifies for the credit
Before downloading Form 941-X or spending time looking over the instructions, make sure that you qualify for the retroactive credit by reviewing the eligibility criteria we touched on earlier in this guide.
- Determine total qualified wages and any related healthcare costs for each eligible quarter
Determined that you qualify for credit? Sounds good! Next, you’ll need to review payroll records to determine your total qualified wages and related healthcare costs for each quarter you’re eligible for the credit.
- Calculate the credit using the allowed percentage for that quarter
Next up is a bit of number crunching. Once you’ve identified the employees and wages that are eligible for the credit, you can calculate it. For example, let’s say your business had 20 full-time employees and five part-time employees in 2020, with all 20 full-time employees paid at least $10,000 in qualified wages for the second quarter of 2020.
Because the 2020 rules state that 50% of wages paid up to $10,000 are eligible for the credit, you would calculate your second quarter credit as follows:
- (20 x $10,000) x 50% = $100,000
However, for your part-time employees, three earned qualified wages of $8,000 for the quarter, and two earned $5,000 for the quarter. Because only 50% of qualified wages is going to be eligible for the credit, you’ll calculate your ERC credit as follows:
- (3 x $8,000) x 50% = $12,000
- (2 x $5,000) x 50% = $5,000
When adding them all up, your total ERC credit for the second quarter of 2020 is:
- $100,000 + $12,000 + $5,000 = $117,000
Let’s look at a second calculation.
Because the credit was raised to $7,000 for the first three quarters of 2021, using the same numbers from our original example above,, you would calculate your 2021 credit for the quarter as follows:
- (20 x $10,000) x 70% = $140,000
- (3 x $8,000) x 70% = $16,800
- (2 x $5,000) x 70% = $7,000
So, your total for the 2021 quarter would be:
- $140,000 + $16,800 + $7,000 = $163,800
It’s important to follow the rules for the quarter in which you’re applying for the credit. What does this mean?
For instance, let’s say you’re applying for a credit for 2020, your eligible full-time employees are going to be capped at 100, with the cap increasing to 500 in 2021.
And if you’re a startup business, the maximum you can receive in credits is $50,000 per quarter for both 2020 and 2021.
- Download and Complete Form 941-X with the appropriate documentation
It can be a good idea to familiarize yourself with Form 941-X before filling it out. Fortunately, the IRS has included a detailed worksheet that can help simplify the task.
Remember, a separate 941X has to be filed for each quarter that you are requesting a refund, and filing online or electronically is not an available option. What should you do when it’s completed? You’ll have to send your completed Form 941-X form to the nearest IRS office, either in Cincinnati, Ohio, or Ogden, Utah.
For further reference, the IRS provides a resource with specific mailing addresses and breaks down who should mail the form and which office to use.
- Sit back and wait for the refund
If you have enough payroll taxes to offset the credit, you’ll be able to use the credit immediately against the deposit. However, if the credit exceeds the amount of tax that’s owed, you’ll be eligible for a refund, which can take several months.
Originally, the IRS used Form 7200, which allowed businesses to apply for an advanced refund. But it was officially sunsetted on January 31, 2022, leaving businesses with the option to wait for a refund or apply for an ERC advance loan.
As we wrap up, let’s find out how small businesses can stay up to date on the status of their refund and avoid bad actors who are trying to use the ERC to take advantage of small business owners.
Additional information about the ERC
One of the reasons the ERC is getting more attention is that it’s not a loan, and business owners are under no obligation to repay it. Having said that, while you may be happy to be receiving a refund, patience is key because there are many people in the same boat. Refunds are currently taking between four months to a year to receive, but the IRS has said that refund times are improving.
For business owners who want to check on the status of their refund, the IRS has a hotline for updates, which can be reached at (800) 829-4933.
Look out for ERC charlatans
When money enters the equation, there are bound to be those looking to spread misinformation to make a quick buck. As a CPA with over a decade of accounting experience, Noel Lorenzana of Lorenzana Tax has come across scammers trying to take advantage of small business owners applying for the ERTC.
“Though Employee Retention Tax Credits are a valuable financial resource for businesses, but the space is unfortunately rife with fraud and abuse.”
— Noel Lorezana, CPA and tax expert
The IRS even keeps a page on its website with tax scams and alerts so consumers can stay two steps ahead of those who are up to no good. For business owners taking a closer look into the ERC, it’s wise to keep an eye out for evil-doers such as “ERC mills” that are springing up as more and more businesses apply.
Furthermore, IRS Commissioner Danny Werfel recently issued warnings to businesses regarding the use of aggressive ERC marketing tactics and con artists to pull a fast one. There’s no shame in being suspicious if you experience any of the following:
- Unsolicited or aggressive calls mentioning an ‘easy application process’
- Large, upfront fees
- Claims that the company can determine ERC eligibility in minutes
- Fees that are based on a percentage of the refund you’ll receive
- Letters claiming to be from The Department of Employee Retention Credit
- Leaving out key parts of the program and the eligibility process
All of this being said, it’s important to point out that there are plenty of legitimate businesses offering assistance with ERC filings, as well. It’s just a good idea to keep your guard up.
We asked Lorenzana if there are any specific things to keep an eye out for. Here’s what he shared:
If you’re unsure how to do this on your own, you can always ask your CPA or payroll provider for assistance when filing the ERC claim.
“It’s always a good idea to consult with your CPA or trusted tax professional for accurate information,” says Lorenzana. “By exercising caution and leveraging professional guidance, businesses can successfully apply for ERC without falling victim to scams.”
Take a closer look at the ERC
Though retroactively claiming ERC credit means that you need to have all your ducks in a row, it could be a boon for your bottom line. Designed for employers that were able to keep their employees on staff while the pandemic created economic uncertainty, if you failed to take the ERC credit in 2020 and 2021, there is still time to do so.
With an expiration date of April 15, 2024, to file 2020 claims and an April 15, 2025 expiration date for 2021 claims approaching, it’s worth spending some time to determine if you fit the eligibility requirements for retroactively applying for the ERC.