The employee retention credit (ERC) is an incentive set up by the Coronavirus Aid, Relief, and Economic Security (CARES) Act to help employers offset the costs of keeping staff on their payrolls during the 2020 and 2021 tax years. Establishing when and how to calculate the ERC is important for businesses to make sure that they receive the full amount of credit to which they’re eligible. In this article, we will cover the basics of the credit, how to calculate the credit amount, claim the credit, navigation points while filling out Form 7200, and finally the maximum tax credit availability.
Employee Retention Credit: What is It?
The employee retention credit is a refundable payroll tax credit available to employers who retain employees on their payrolls and pay “qualifying wages.” The credit, which was increased from 50% to 70% in the American Rescue Plan Act of 2021, covers a period lasting from March 12, 2020 to June 30, 2021. The credit is available to businesses affected by coronavirus-related shutdowns, as well as businesses that still have to pay taxes related to worker wages, regardless of any government closure orders.
The credit is available to employers with fewer than 500 employees, and the amount of the credit is based on the amount of wages paid to employees. The credit is also available to employers who have experienced a significant decline in gross receipts. Employers can claim the credit for wages paid after March 12, 2020 and before January 1, 2021.
Calculating the Credit Amount
The ERC is calculated as a percentage of an employer’s “qualified wages” for each employee in a calendar quarter. In 2021, employers are eligible for a 70% of employee wages up to a maximum of $7000 per employee. Employers can use the following formula to arrive at the total ERC:
ERC = 0.7 x (qualified wages x Employment period)
Qualified wages are wages paid to an employee for services performed during the calendar quarter. The wages must be paid to an employee who is not a highly compensated employee, and must be paid for services performed in the United States. The wages must also be paid to an employee whose principal place of residence is in the United States.
How Does the ERC Credit Calculation Work?
Employers first need to get an understanding of what qualifies for wages for purposes of the ERC. Qualified wages include payments for employee sick leave, vacations, and holidays that are related to the coronavirus pandemic but do not include certain amounts paid under a cafeteria plan. Additionally, employers must keep track of total employee wages received by each employee.
As stated previously, the ERC is calculated as a percentage of an employer’s qualified wages paid to an employee per quarter. The calculation works by multiplying 0.7 by the total amount of qualified wages paid by an employer to a single employee in one quarter. This amount is then compared to a maximum tax credit of $7000 per employee; whichever is lower is applied.
Employers must also keep in mind that the ERC is only available for wages paid between March 13, 2020 and December 31, 2020. Additionally, employers must also be aware that the ERC is not available for wages paid to employees who have already received wages of more than $10,000 in a quarter.
What are the Ways to Claim the ERC?
There are two ways for employers to claim the ERC. First, employers can claim the credit against payroll taxes when filing for quarterly deposits of their federal withholdings, FICA and FUTA taxes. Alternatively, since the ERC is refundable, employers can also claim for it as a refund in their quarterly or annual income tax return.
Employers must provide the IRS with the necessary information to claim the ERC, including the employee’s name, Social Security number, and the amount of the credit. Employers must also provide the IRS with the total wages paid to the employee during the quarter, as well as the total amount of the ERC claimed.
In order to claim the ERC, employers must also provide the IRS with a copy of the employee’s Form W-2, which must be filed with the IRS by the end of January of the following year. Employers must also provide the IRS with a copy of the employee’s Form 1040, which must be filed with the IRS by April 15th of the following year.
What are the Points to Consider While Filling Out Form 7200?
Form 7200 is required if employers choose to claim their ERC in their quarterly or annual income tax return. If claiming in their quarterly return, Form 7200 must be filled out and filed with their 941 forms. If claiming in their annual tax return, Form 7200 must be filled out and filed with their 940 or 944 forms. It’s important to note that Form 7200 should be filed before the end of the quarter that employers receive the credit.
When filling out Form 7200, employers should make sure to include all relevant information, such as the amount of the ERC they are claiming, the period for which the credit is being claimed, and the total amount of wages paid during the period. Employers should also make sure to include any other relevant information that may be required by the IRS.
It is also important to note that employers must keep records of their ERC claims for at least four years. This includes any documents that support the claim, such as payroll records, invoices, and other relevant documents. This is to ensure that the IRS can verify the accuracy of the claim if necessary.
What is the Maximum Per Employee Credit Under ERC?
The maximum available per employee tax credit under ERC is $7000 for wages paid for a calendar quarter. This means that employers will receive a credit up to 70% of $7000 spent on an employee’s qualified wages for a single quarter. For example, if an employer spends $6000 on an employee’s wages in one quarter, the employer would be eligible for a maximum tax credit under ERC of $4200 (70% x $6000).
The ERC is a refundable tax credit, meaning that employers can receive a refund for any unused credits. This is beneficial for employers who may not have enough tax liability to use the full credit amount. Additionally, employers can use the ERC to offset payroll taxes, which can help to reduce their overall payroll tax burden.
The ERC is available for wages paid between March 12, 2020 and December 31, 2020. Employers must apply for the credit through the IRS and must provide documentation to prove that the wages were paid to employees. Employers must also provide proof that the wages were paid for qualified wages, such as a copy of the employee’s pay stub.
Is an Eligible Employer Who Paid Wages After February 1, 2021, Qualified for the Retention Credit?
Yes, employers who paid employee wages after February 1, 2021 are eligible for ERC if other criteria are met. In order to be eligible, employers must pass all three tests outlined in the CARES Act: (1) business operations need to be fully or partially suspended due to a governmental shutdown order related to COVID-19; (2) a significant reduction in gross receipts; or (3) fully or partially suspended operations due to lack of available resources.
In addition, employers must have paid wages to employees during the period of February 1, 2021 through June 30, 2021. The wages must have been paid for services performed during the period of February 1, 2021 through June 30, 2021. Employers must also have paid wages to employees for whom the employer is not claiming the Work Opportunity Tax Credit.
Employers need to very mindful and understand how and when to claim the employee retention credit. While preparing for tax returns, employers should keep track of qualified wages from each enrolled employee and pay close attention to all applicable government orders, rules and regulations. Remember that employers are eligible for a maximum tax credit under ERC of $7000 for every enrolled employee per quarter.
It is important to note that the ERC is a refundable credit, meaning that employers can receive a refund for any amount of the credit that exceeds their total payroll tax liability. Additionally, employers should be aware that the ERC is not available to employers who receive a loan under the Paycheck Protection Program. Employers should consult with their tax advisors to ensure they are taking full advantage of the ERC.