What is the Employee Retention Tax Credit?
As part of the tax relief measures included in the CARES Act passed into law in March 2020, the Employee Retention Tax Credit is a refundable payroll tax credit that was made available to qualified employers. The federal government designed this tax credit to help businesses continue to pay their employees while they were partially or completely shut down due to the pandemic if they remained open but suffered significant revenue decreases between March 13, 2020 and December 31, 2020, or if they suffered a decline in gross receipts during the first three quarters of 2021. Businesses that qualify as recovery startup businesses could also potentially claim the ERTC for the fourth quarter of 2021.
Qualified employers could claim a credit of 50% of qualifying wages and payroll costs paid in 2020 to keep eligible employees on the payroll, up to a total of $10,000 for the year. The credit was amended for the 2021 tax year, allowing for a credit of up to 70% of qualifying wages paid, up to $10,000 per quarter for the first two calendar quarters of the year.
The ERTC was amended several times, including by the Taxpayer Certainty and Disaster Relief Act of 2020, which expanded eligibility for the credit to include employers that received Paycheck Protection Program (PPP) loans. Originally, PPP loan recipients were excluded from being able to claim the ERTC. Employers, however, are not permitted to claim the same wages for calculating the ERTC and for PPP loan forgiveness. If you are unsure about whether you qualify, ask your tax professional.
What programs extended the ERTC?
The Employee Retention Tax Credit has been amended three times since being enacted. The Taxpayer Relief Act, passed by Congress later in 2020, expanded the maximum credit percentage and dollar amounts as described previously. The American Rescue Plan Act (ARPA) of 2021 added eligibility requirements for businesses classified as recovery startup businesses. Finally, the Infrastructure Investment and Jobs Act (IIJA) of 2021 further clarified eligibility and requirements for recovery startup businesses.
What is a recovery startup business?
Section 3134(c)(5) of the Internal Revenue Code (IRC) defines a recovery startup business as one which began after February 15, 2020, has annual gross receipts of $1 million or less, and is not considered an eligible employer for the ERTC due to a full or partial pandemic-related closure or a decline in gross receipts because the business was new. Employers that qualify as recovery startup businesses may be eligible to claim the ERTC for the third and fourth quarters of 2021.
Businesses that meet these qualifications may be able to claim up to $50,000 per quarter in employee retention credits for the third and fourth quarters of 2021.
It is important to note that a business that qualifies as a recovery startup business for the third quarter of 2021 is not automatically deemed a recovery startup business for the fourth quarter of 2021. The determination is made on a quarter-by-quarter basis.
Who is an eligible employer?
For ERTC purposes, an eligible employer can be a business with employees of any size, as long as the business was operating in 2020 or 2021. This includes tax-exempt organizations as well as for-profit companies. In 2020, governments, agencies, and instrumentalities were specifically excluded from eligibility for the ERTC. Eligibility was expanded for tax quarters in 2021 to include 501(c)(1) organizations, which are tax-exempt under 501(a) of the tax code, as well as colleges or universities whose primary purpose was providing medical or hospital care.
If your business meets this threshold test, the next requirement for eligibility is having had to either partially or fully suspend business operations in any calendar quarter in 2020 due to COVID-19 government-ordered business closures. Alternatively, your business may be eligible if it was not subject to shutdowns due to the pandemic but suffered a significant decline in gross receipts in 2020, meaning that your gross receipts for a calendar quarter were less than 50% of your gross receipts for the same calendar quarter in 2019. A business is no longer considered eligible if its gross receipts for a quarter were at least 80% of its gross receipts for the same calendar quarter of 2019.
For 2021, employers could also take advantage of an alternative quarter election rule. Businesses not operating in 2019 are allowed to compare their 2021 quarterly gross receipts to the same calendar quarters in 2020.
What are qualified wages?
Eligibility for the ERTC also requires that your business paid qualified wages during one or more of the 2020 or 2021 calendar quarters. Note that self-employed persons cannot claim the credit for their own wages but may be eligible for the ERTC if they paid qualified wages to employees in 2020 or 2021.
Generally, qualified wages are employee wages paid between March 12, 2020, and September 30, 2021 or December 31, 2021 for qualified startup businesses, which are subject to FICA tax, as well as certain healthcare expenses which may be part of employee compensation packages. Wages or health insurance expenses that were forgiven (or which you expect to be forgiven) under PPP loan forgiveness are not eligible for ERTC calculations. There are some important differences in what counts as qualified wages for 2020 and 2021 for ERTC purposes:
- For 2020, if you had 100 or fewer full-time employees in 2019, qualified wages include those paid to employees whether those employees were working or not during your business’s period(s) of economic hardship in 2020. If you averaged more than 100 full-time employees in 2019, you can only claim the ERTC for wages paid to employees who were not working because of the pandemic.
- For 2021, employers with an average of 500 or fewer full-time workers in 2019 could claim the ERTC for wages paid to employees who provided services as well as those who were not working due to the pandemic, while employers with more than 500 employees in 2019 could claim the credit based on wages paid to employees who were not providing services.
The American Rescue Plan Act of 2021 and the Infrastructure Investment and Jobs Act added and clarified further provisions wages paid by severely financially distressed employers.
What does the tax credit apply toward?
For applicable quarters in both the 2020 and 2021 calendar years, employers claiming the ERTC could apply the credit to the employer portion of employment taxes paid. As a fully refundable credit, the Employee Retention Tax Credit can be refunded if it resulted in an overpayment when calculating and filing the business’s tax return. The American Rescue Plan Act of 2021 changed the tax offset so it is against the employer’s portion of Medicare taxes paid.
What are the deadlines for the ERTC?
The Employee Retention Tax Credit ended on December 31, 2021. However, eligible employers can still claim unused credits for 2020 or 2021 and reduce their tax liability by amending their previously filed tax returns. In fact, retroactive filing for these credits is permitted through April 15, 2024, for 2020 credits and through April 15, 2025, for 2021 credits.
Because it may take up to a year (or potentially longer) to receive the credits after you claim them, it generally makes sense to file for this tax relief sooner rather than later. The IRS issued guidance in October 2022 urging employers to beware of potential ERTC scams and to let them know that claims for the credits are scrutinized carefully. Of course, as is the case with any type of tax filing, your amended tax returns are potentially subject to audit by the IRS.
How can an employer apply for the credit?
If you previously filed IRS Form 941, Employer’s Quarterly Federal Tax Return to report your quarterly tax return information, use IRS Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund for the appropriate quarter(s). If you use a third-party payroll provider, be sure to coordinate with that company as you amend your previously reported information.
In addition to exploring your eligibility for the Employee Retention Tax Credit, ask your attorney, CPA, or other tax professional to help you confirm whether your business is eligible for other tax relief, such as the Qualified Business Income Deduction (QBID) or the Work Opportunity Tax Credit. By taking control of your company’s taxes and maximizing available deductions and credits, you can dedicate more resources to reaching your business goals.
If you believe your business was eligible and that you paid qualified wages to eligible employees, but you did not originally claim the ERC, it is not too late to file for tax relief. Work with your tax professional to help you confirm eligibility and file your amended employment tax returns. If you have more questions, reach out to a Rocket Lawyer network attorney for affordable legal advice.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.