The global economic landscape has seen significant challenges in the wake of the COVID-19 pandemic. In response, the U.S. government introduced several measures, including the Employee Retention Credit (ERC), which was designed to support businesses and incentivize employers to retain their employees during periods of economic hardship.
The task of understanding the ERC and how to claim it can be complex, particularly given the numerous updates since its inception. Fortunately, you don't have to go it alone. This guide will help you understand and navigate the ERC process in 2023, simplifying each step of this critical aspect of pandemic relief. So, let's get started.
Understanding the Evolution of the ERC
The ERC was established in March 2020 as part of the CARES Act, aimed at encouraging employers to maintain their workforce during the pandemic. Initially, the credit was calculated on eligible wages paid within specified dates in 2020, offering a 50% credit on up to $10,000 of qualified wages per employee.
There were substantial updates made to this legislation with the Consolidated Appropriations Act (CAA) in December 2020 and the American Rescue Plan Act of 2021 (ARPA) in March 2021. These updates increased the credit value, redefined “large employer” and introduced provisions for specific startup businesses and severely financially distressed employers (SFDEs).
Determining Your Eligibility for the ERC
The eligibility criteria for the ERC have evolved since its inception in March of 2020. Below, we've distilled these requirements for different time periods:
March 12, 2020 to December 31, 2020
Eligibility included any entity operating a trade, business or tax-exempt organization, with some exclusions. Employers needed to experience either a full or partial suspension of operations due to a government order related to COVID-19 or a significant decline in gross receipts during any quarter.
January 1, 2021 to June 30, 2021
Eligibility was extended to include specific governmental employers, colleges or universities, and organizations providing medical or hospital care. The “recovery startup businesses,” or businesses that began operations after February 15, 2020 and had average annual gross receipts under $1,000,000, were also included.
July 1, 2021 to December 31, 2021
The ERC was primarily available to recovery startup businesses, with changes to the requirement for a recovery startup business to be an eligible employer due to operational restrictions or a decline in gross receipts for the fourth calendar quarter.
Calculating Your Employee Retention Credit
To make the most of the ERC, you not only need to understand the legislative updates and your eligibility, but you also need to calculate the precise credit your business is due. Let's break down this process:
Identifying Qualified Wages
The term “qualified wages” refers to the wages you can count towards the ERC. The definition of qualified wages has been revised throughout the various legislative updates.
In 2020, for businesses with over 100 full-time employees, only wages paid to employees not working due to a COVID-19 related shutdown or significant decline in gross receipts qualified for the ERC. However, for businesses with 100 or fewer full-time employees, all employee wages qualified, regardless of the business's operational status.
By 2021, the employee threshold was raised to 500 full-time workers. For businesses with over 500 employees, only wages paid during their idle time qualified. In contrast, for businesses with 500 or fewer employees, all employee wages qualified, irrespective of the business's operational status.
Determining the Credit Amount
Once you've identified the qualified wages, you can begin calculating your ERC. For 2020, the ERC equals 50% of up to $10,000 in qualified wages per employee, capping the maximum credit at $5,000 per employee.
For 2021, the ERC was upped to 70% of up to $10,000 in qualified wages per employee per quarter. Hence, the maximum credit for 2021 stands at $7,000 per employee per quarter, or up to $28,000 per employee for the year.
Note that qualified health plan expenses can also be included as qualified wages, potentially increasing your credit significantly.
Claiming the ERC Using Form 941
To claim the ERC, you need to accurately report the credit on your federal employment tax returns. This is typically done through Form 941, Employer's Quarterly Federal Tax Return. If your credit exceeds the total employment taxes due, the excess is refunded to you.
Here's how to use Form 941 in the ERC process:
- Calculating the Credit: Begin by tallying the total amount of qualified wages for the given quarter, which may include certain healthcare costs. The credit is then computed as a percentage of these qualified wages, depending on the year (50% for 2020, 70% for 2021).
- Reporting the Credit: Report the calculated credit on Form 941. Before filing Form 941, you can reduce your employment tax deposits by the anticipated credit amount.
- Claiming the Credit: When it's time to file Form 941 for the quarter, you'll reconcile the reduced employment tax deposits with the actual calculated credit. If the credit surpasses the employer portion of social security tax, the excess is refunded.
The ERC and PPP Loans
One of the most common questions businesses have is whether they can qualify for the ERC if they received a Paycheck Protection Program (PPP) loan. The answer is yes, but with certain conditions.
The Consolidated Appropriations Act, 2021, made a significant change that allows businesses that received PPP loans to also claim the ERC. However, it's important to note that you cannot “double-dip” by using the same wages for both programs. In other words, the wages that are used in calculating forgiveness of the PPP loan cannot be used in calculating the ERC.
For example, if you received a PPP loan and used 60% of it on payroll costs, you can only claim the ERC on the remaining 40% of wages that were not counted towards PPP loan forgiveness. This requires careful tracking and calculation to ensure you are not overlapping the use of funds.
Moreover, if you received a PPP loan and are eligible for the ERC, you can claim the credit on any qualified wages that are not counted as payroll costs in obtaining PPP loan forgiveness. This allows businesses to benefit from both programs while adhering to the rules set by the IRS.
The Critical Role of Documentation in the ERC Process
Keeping accurate and comprehensive documentation is key when claiming the Employee Retention Credit (ERC). If the IRS requests to review your records to verify your claim, organized documentation can expedite this process and prevent potential complications.
Ensure you maintain the following records:
- Payroll records
- Quarterly financial statements
- Records demonstrating how you calculated the credit
- Copy of the government order that affected operations (if applicable)
- Documentation proving the significant decline in gross receipts (if applicable)
- Records of health insurance costs included in the qualified wages
- Copies of submitted employment tax returns, such as Form 941
Leveraging Professional Guidance
While it's important to understand the basics of the ERC, its complexity and frequent legislative changes can make professional guidance necessary. Tax professionals or legal advisors can provide updated information, guide you through the complexities of the ERC and ensure you're maximizing your credit while staying compliant with the law.
These professionals can assist in determining your eligibility, calculating the credit amount, preparing the necessary forms and documentation, and offering advice if the IRS requests additional information or audits your claim.
Every business is unique, and the specifics of the ERC can vary based on your situation. A professional can provide customized guidance tailored to your business's needs. To learn more, we invite you to contact Engineered Tax Services today.
Your Next Steps in Navigating the Employee Retention Credit in 2023
Though the process of navigating the Employee Retention Credit can be complex, with the right resources and knowledge, this tax incentive can serve as a valuable tool for businesses seeking financial relief after the COVID-19 pandemic. Understanding the history and eligibility criteria of the ERC and knowing how to calculate and claim the credit are vital steps in maximizing your benefits while staying law-compliant.
Remember, thorough and accurate documentation is essential for a smooth process, and professional guidance can be a game-changer when navigating the intricacies of the ERC. As every business is unique, a professional can provide guidance personalized to your business's needs.
Finally, we recommend using our Eligibility Calculator to estimate your potential Employee Retention Credit amount. This tool can give you a clearer picture of the potential financial relief available to your business through the ERC.
