In late 2020, the U.S. federal government extended the deadlines for businesses to retroactively claim the employee retention tax credit (ERTC) to 2024 or 2025, depending on the case. This article covers what employers need to know about the ERTC, how to retroactively claim it, and how it interacts with other credits and funding sources.
What is the Employee Retention Credit?
The Employee Retention Credit is a tax credit designed to incentivize employers to keep their employees on payroll during the pandemic. Originally included in the Coronavirus Aid, Relief, and Economic Security (CARES) Act of April 2020, it was later renewed and extended in December under the Consolidated Appropriations Act. The ERTC provides a tax credit of up to $7,000 against certain wages and $28,000 in certain health care expenses paid or incurred by eligible employers.
Eligible employers are those who have experienced a full or partial suspension of their operations due to a governmental order related to the COVID-19 pandemic, or those who have experienced a significant decline in gross receipts. The credit is available to employers with fewer than 500 employees, and is equal to 50% of qualified wages paid to employees after March 12, 2020 and before January 1, 2021.
The credit is refundable, meaning that employers can receive the full amount of the credit even if they have no tax liability. Employers can also claim the credit against their payroll taxes, reducing the amount of payroll taxes they owe. Additionally, employers can claim the credit for wages paid to employees who are furloughed or laid off, as long as the wages are paid before the end of the year.
How do the credits work?
Employers can claim the Employee Retention Tax Credit for each eligible employee’s covered wages or health care expenses for durations up to one calendar quarter. The credit can be taken as a refundable credit of up to 70% of qualified wages and 25% of qualified health care expenses. To be eligible, employers must suffer a gross receipts reduction of at least 20% compared to the identical quarter in 2019 or must have either laid off employees or cut their hours.
The credit is available for wages paid between March 13, 2020 and December 31, 2020. Employers can claim the credit for wages paid to employees who are not providing services due to the COVID-19 pandemic. The credit is also available for wages paid to employees who are providing services, but whose hours have been reduced due to the pandemic. The credit is not available for wages paid to employees who are not affected by the pandemic.
How does a business claim the employee retention tax credit retroactively?
Eligible businesses who missed their original deadlines but are still within their applicable period can elect to file an original return or amended return. To qualify for retroactive ERTC claims, the employer must have paid eligible wages or provided health care benefits between March 12, 2020 and December 31, 2020, and they must file by the later of December 31, 2021 or the due date (including extensions) for the employer’s 2020 federal tax return.
The employer must also provide documentation to the IRS that shows the wages paid and the health care benefits provided during the applicable period. This documentation should include payroll records, Form W-2s, and Form 1099s. Additionally, employers must provide a statement to the IRS that certifies that the wages and health care benefits were paid or provided during the applicable period and that the employer is eligible for the ERTC.
What employers qualify for the employee retention credit?
The employer must have had an average of fewer than 500 full-time equivalent employees in 2019 to qualify. Self-employed individuals (sole proprietors, independent contractors, self-employed individuals), as well as churches and certain governmental entities, also qualify.
In addition, employers must have experienced a full or partial suspension of operations due to a governmental order related to COVID-19, or have experienced a significant decline in gross receipts. The employer must have been in operation on March 12, 2020, and must have been in operation during the calendar quarter in which the credit is claimed.
What wages qualify when calculating the retention credit?
Qualifying wages are limited to the first $10,000 of compensation, including health benefits, per employee paid between March 12, 2020 and December 31, 2020. This $10,000 limit applies on a per-employee basis within the same calendar quarter: if both Q1 and Q2 are claimed, all wages that contributed to determining an ERTC in Q1 will also be taken into account for Q2.
The retention credit is available to employers whose operations have been fully or partially suspended due to a COVID-19 related governmental order, or whose gross receipts have declined by more than 50% compared to the same quarter in the prior year. Employers must also have fewer than 500 full-time employees in order to qualify for the credit.
The credit is equal to 50% of the qualified wages paid to employees, up to a maximum of $5,000 per employee. This means that employers can receive up to $5,000 in credits for each employee, regardless of the amount of wages paid. The credit is also refundable, meaning that employers can receive a refund for any excess credit amount that exceeds their payroll tax liability.
Are tipped wages included in qualified wages?
No. Tipped wages are not included in qualified wages when calculating the ERTC. However, if an employer provides health benefits to employees who receive tips (such as group health insurance or equivalent employee benefits) for that quarter of the calendar year, then such health benefits will count as qualified wages when calculating the credit.
In addition, employers may also be eligible for the ERTC if they provide paid leave to employees who receive tips. This includes paid sick leave, family and medical leave, and vacation leave. The amount of qualified wages for these employees is calculated by taking the amount of paid leave provided and multiplying it by the average hourly wage of the employee.
What is the interaction with other credits and funding sources?
The ERTC can be taken in addition to—but not in conjunction with—the Work Opportunity Tax Credit and certain Paycheck Protection Program Loans, as well as certain payroll tax credits. Employers must decide: if they want to use both credits/funding sources simultaneously, they should reduce the amount of ERTC that they are claiming by an equal amount. The exact amount of ERTC that an employer is eligible for depends on their gross receipts reduction compared to 2019.
Employers should also be aware that the ERTC is a refundable credit, meaning that if the amount of the credit exceeds the employer’s total tax liability, the employer can receive the difference as a refund. Additionally, employers can carry the credit back one year and forward 20 years, allowing them to use the credit to offset taxes in other years.