How Can I Claim The Employee Retention Credit?

The new law, retroactive to March 27, 2020, now allows employers who received Paycheck Protection Program (PPP) loans to claim the ERC for qualified wages not treated as payroll costs in obtaining forgiveness of the PPP loan.

Claiming The Employee Retention Credit

The updated Employee Retention Credit (ERC) provides a refundable credit of up to $5,000 for each full-time employee you retained between March 13 and Dec. 31, 2020 and up to $14,000 for each retained employee between Jan. 1 and June 30, 2021.

• You qualify as an employer if you were ordered to fully or partially shut down, or if your gross receipts fell below 50% for the same quarter in 2019 (for 2020) and below 80% (for 2021).
• If you weren’t in business in 2019, you can use the corresponding quarters from 2020.
• You can claim your credit immediately by reducing payroll taxes sent to the IRS.
• If your credits exceed payroll taxes, you can request a direct refund from the IRS.

How The Consolidated Appropriations Act (CAA) Changed Employee Retention Credit

If you’re already familiar with the Employee Retention Credit under the CARES Act, here are the changes made by the CAA, 2021.

The CAA includes the following retroactive changes to the ERC. These changes apply to the period from March 13 through Dec. 31, 2020.

• If you received a PPP loan, you may still qualify for the ERC for any wages not paid with proceeds from the forgiven portion of your PPP loan.
• The Consolidated Appropriations Act clarifies how qualifying tax-exempt organizations determine “gross receipts.”
• Group healthcare expenses are considered “qualified wages.” This is true even if no other wages are paid to that employee.

The following elements apply to the ERC for Jan. 1 through June 30, 2021.

• The ERC credit rate per employee is increased to 70% of qualified wages (from 50%). The per-employee wage limit is increased from $10,000 for the year to $10,000 per quarter for 2021.
•  Your eligibility as an employer is based on gross receipts of less than 80% (versus less than 50%) when compared to the same quarter in 2019. So if your gross receipts decline more than 20% in 2021, you’re eligible to take the credit.
• You can elect to use the immediately preceding calendar quarter (i.e., Q4 2020 and Q1 2021) instead of Q1 and Q2, 2021 respectively, compared to the same quarter in 2019 to determine eligibility.
• If your company didn’t exist in 2019, you can compare 2021 quarterly gross receipts to the same 2020 quarters to determine eligibility.
• The 2021 credit is available to public colleges, universities, organizations providing medical or hospital care, and certain organizations chartered by Congress.
• For 2021, because the definition of large employer changes from more than 100 to more than 500 employees, you can use a broader definition of qualified wages if you fall within that threshold. You can count wages paid to both active (working) employees and those not providing services.
• The CAA also removes the limit on qualified wages defined as no more than the employee would have received in the 30 days before the qualifying period. As a result, you can take the Employee Retention Credit if you pay a bonus to an essential worker.
• If you have fewer than 500 full-time employees, you’ll be allowed advance ERC payments during the quarter in which the wages were paid to those employees. This includes seasonal employers and employers not in existence in 2019.

How Can I Qualify As An Eligible Employer?

Whether you qualify as an “Eligible Employer” depends on the time period under discussion. For the period March 13, 2020, through Dec. 31, 2020, you must have carried on a trade or business, or were a tax-exempt organization that:

• Was partially or fully suspended due to COVID-19 orders from an appropriate governmental authority; or
• Experienced a significant decline in gross receipts, defined as less than 50% of gross receipts for the same calendar quarter in 2019.
  Government and state entities and political subdivisions are not eligible for the 2020 ERC.
• If you were self-employed, you’re not eligible for the 2020 ERC for your own wages. But if you employed other people, you can qualify for the ERC wages paid to those employees.

Between January 1, 2021, through June 30, 2021, you must have carried on a trade or business, or were a tax-exempt organization that:

• Was partially or fully suspended due to COVID-19 orders from an appropriate governmental authority; or
• Experienced a significant decline in gross receipts, defined as less than 80% of gross receipts for the same calendar quarter in 2019.
• If you weren’t in business in 2019, you can use 2020 as your comparison year.
• Government and state entities and political subdivisions are not eligible for the 2021 ERC. But tax-exempt public colleges, universities, and hospitals are eligible.
• If you’re self-employed, you’re not eligible for the 2021 ERC for your own wages. But if you employ other people, you can qualify for the ERC wages paid to those employees.

The “significant decline in gross receipts” test for both 2020 and 2021 applies, whether your business was affected by COVID-19 or not.

Here are both qualification tests for 2020 and 2021:

As seen in the table above, based on the “government order test,” your business would qualify for the employee retention credit in the 1st and 2nd quarters of 2020 and in Q1 of 2021. Based on the “gross receipts” test, you’d qualify in the 2nd and 3rd quarters of 2020 and Q2 of 2021. Since either test determines qualification, your business would qualify in Q1, Q2, and Q3 in 2020 and both quarters in 2021. Since neither test would apply in Q4 of 2020, you wouldn’t qualify in that quarter.

Qualifying Wages

Wages/compensation, in general, that are subject to FICA taxes, and qualified health expenses qualify for the retention credit. These must have been paid after March 12, 2020, and they qualify for the credit if paid through June 30, 2021. However, the thresholds on these wages and the percentage of credit increases on 2021.

When determining the qualified health expenses, the IRS has multiple methods of calculation, depending on circumstances. It generally includes the employer and employee pretax portion and not any after-tax amounts.

When determining what qualified wages can be included, you must first determine the number of full-time employees you had in 2019. If you have more than 100 full-time employees (based on the employer shared responsibility provision in the Affordable Care Act), you must use different qualified wages than those with 100 or fewer full-time employees. Under the new law, the employee limit for determining which wages are applicable to the credit increases to 500 in 2021.

A full-time employee is defined as one who in any calendar month in 2019 worked at least 30 hours per week or 130 hours in a month (the monthly equivalent of 30 hours per week); the definition is based on the employer shared responsibility provision in the ACA.

• If you were in business the entire calendar year in 2019, you’d take the sum of the number of full-time employees in each calendar month and divide by 12.
• If you started a business during 2019, you’d determine the number of full-time employees by taking the sum of the number of full-time employees in each full calendar month in 2019 when the business operated and divide by that number of months.
• If you started a business in 2020, you determine the number of full-time employees by taking the sum of the number of full-time employees in each full calendar month in 2020 that the business operated and divides by that number of months

The employee calculation of full-time equivalent (FTE) used for the PPP forgiveness report is not calculated the same way as for a full-time employee regarding the employee retention credit. If you’re an accounting professional, don’t provide your clients with the PPP Forgiveness FTE information. If a client has taken a PPP loan and will be forgiven for it, they may now be eligible for the employee retention credit on certain wages.

Once you determine full-time employees, you’ll will know which qualified wages to use. If you have more than 100 full-time employees (this threshold increases to 500 beginning in 2021), you can only use the qualified wages of employees not providing services because of suspension or decline in business. Any wages paid for vacation, sick or other days off based on the employer’s current policy cannot be included in qualified wages for the larger employers. If you’re an employer, you can only use this credit on employees who are not working.

If you have 100 or fewer full-time employees (this threshold increases to 500 beginning in 2021), you can use all employee wages — those working, as well as any time paid not being at work, with the exception of paid leave provided under the Families First Coronavirus Response Act.

The IRS has erected barriers to prevent wage increases that would count toward the credit, once the employer is eligible for the employee retention credit.

• There is no double-dipping for credits. If you take the employee retention credit, you cannot take credit on those same qualified wages for paid family medical leave.
• If an employee is included for the Work Opportunity Tax Credit, they may not be included for the employee retention credit.

As a result, if you’re considering which credits to take, evaluate which one is better financially to your business.

Other Qualification Standards

Under the CARES Act, you were prohibited from receiving the ERC for:

• Wages for which you received a tax credit for paid sick and family leave under the Families First Coronavirus Response Act (Phase II);
• Any wages you counted as part of the credit for paid family and medical leave under section 45S of the Internal Revenue Code;
• Wages paid to certain related individuals; or
• Any employee for whom you were granted a Work Opportunity Tax Credit under section 51 of the Internal Revenue Code.

Under the CAA, 2021, this prohibition is also extended to wages affected by certain other credits including: the Research Activities Credit, Indian Employment Credit, Credit for Employer Differential Wage, and Empowerment Zone Employment Credit.

Amount of the Credit for 2020

For 2020, the credit is equal to 50% of up to $10,000 in qualified wages (including amounts paid towards health insurance) per full-time employee for all eligible calendar quarters beginning March 13 and ending Dec. 31, 2020. This equates to a maximum credit of $5,000 per employee for the period.

A qualified period begins in any quarter where receipts are less than 50% of receipts in the same quarter in 2019; it ends at the beginning of the first calendar quarter after the first quarter in which gross receipts are greater than 80% of gross receipts for that quarter in 2019.

The credit is applied to your portion of the employee's Social Security taxes, and it’s fully refundable. Thus, the credit will serve as an overpayment and be refunded to you after subtracting your share of those taxes. The table below illustrates your payroll costs for one full-time employee for 2020 based on three qualified quarters. The table only includes FICA taxes as a cost, since other costs would not be affected.

As the table shows, your regular payroll costs for this employee for 2020 would have been $20,668.800. With the Employee Retention Credit, your payroll costs drop to $15,668.80. Your credit for this employee for Q1 and Q2 exceeds the amount you pay in Social Security taxes, which is not the case in Q3.

Amount of the Credit for 2021

For 2021, the credit is equal to 70% of up to $10,000 in qualified wages (including amounts paid towards health insurance) per full-time employee for each eligible calendar quarter beginning Jan. 1 and ending June 30, 2021. This equates to a maximum credit of $14,000 per employee ($7,000 per quarter) for the period.

The credit is applied to your portion of the employee's Social Security taxes, and it’s fully refundable. Consequently, the credit will serve as an overpayment and be refunded to you after subtracting your share of those taxes. The table below shows your payroll costs for one full-time employee for the first half of 2021, based on two qualified quarters. The table only includes FICA taxes as a cost, since other costs would not be affected. 

As the table demonstrates, your regular payroll costs for this employee for the first half of 2021 would’ve been $11,068.80. With the Employee Retention Credit, your payroll costs drop to $5,534.40. Your credit for this employee for Q1 and Q2 exceeds the amount you pay in Social Security taxes. in the next section, you’ll learn how to get your credit.

Getting the Employee Retention Credit for Wages Paid in Q4 2020

You file for the ERC for Q4 2020 wages by essentially following the same process you followed for all of 2020. Calculate the amount of your credit for Q4 2020, and reduce your Form 941, Employer's Quarterly Federal Tax Return deposit by that amount.

For example: If your credit for Q4 2020 was $10,000 and the amount you’re scheduled to deposit is $15,000, reduce the deposit by $10,000 and deposit $5,000. You’ll account for this credit on Form 941, which you must file by Jan. 31, 2021. 

You can claim your credit by deducting it from any withholding amount, including federal income taxes, employee FICA taxes, and your share of FICA taxes for all employees up to the amount of the credit.

Getting the ERC for Unforgiven PPP Loan Proceeds

If you received a PPP loan in 2020, it doesn’t prevent you from claiming the ERC for qualified wages not counted as payroll costs to obtain forgiveness of all or part of your PPP loan. And if you included wages paid in Q2 and/or Q3, 2020 on your forgiveness request and your request was denied, you can claim those wages on your Q4 2020 Form 941 due Jan. 31, 2021. 

You can also report on your 4th quarter Form 941 any ERC attributable to health expenses that are qualified wages that you didn't include on your 2nd and/or 3rd quarter Form 941.

If you choose to use this procedure, add the appropriate ERC attributable to Q2 and/or Q3 qualified wages and health expenses on line 11c or line 13d of your original Q4 2020 Form 941, along with qualified wages paid in Q4. You can find complete detailed instructions on the IRS website.

Otherwise, you can file an adjusted return or claim for refund for the appropriate quarter to which the additional ERC relates using Form 941-X.

Getting the ERC for Wages Paid in 2021

You obtain the Employee Retention Credit for 2021 using a similar process to that outlined for 2020 above. Be certain to take into account changes enacted by the CAA and outlined above.

Just like in 2020, you can obtain your ERC for Q1 and Q2 2021 by reducing your employment tax deposits. If you qualify as a small employer (500 or fewer full-time employees in 2019), you may request advance payment of the credit using Form 7200, Advance of Employer Credits Due to COVID-19. In 2021, advances aren’t available for employers with more than 500 employees.

How Does a PEO Client Employer Reconcile?

If you’re an employer utilizing a Professional Employer Organization (PEO) or Certified Professional Employer Organization (CPEO), you don’t have an individual 941 filed on your behalf. Therefore, you have to understand how you’d reconcile this information and receive the credit. The IRS posted guidance to clarify how it would work.

If an eligible employer uses a PEO or CPEO, the retention credit is reported on the PEO/CPEO aggerate Form 941 and Schedule R.

For help or more information about the Employee Retention Credit, please contact us or visit our COVID-19 Stimulus Resource Center.