Economic uncertainty tends to have a cascading effect. First, business owners get worried about the future and lay off employees. Then lost income forces employees to cut spending, and businesses lose more revenues.
That’s the scenario Congress wanted to prevent (or at least minimize) when the pandemic forced shutdowns and partial suspensions of business operations in 2020.
In response, they created the Employee Retention Credit (ERC), which was an invaluable lifeline for many small businesses that struggled during the pandemic.
The ERC is a refundable credit that employers can claim on certain payroll taxes. Businesses don’t have to wait to file a payroll tax return to claim the credit. They can get immediate access by reducing their payroll tax deposits or by requesting an advance payment from the IRS. Best of all, the ERC doesn’t have to be paid back.
While the ERC officially ended in 2021, businesses can retroactively claim the credit. The IRS usually gives three years from when you file your return (or two years from when you pay the tax) to make changes. So, if you think you qualify and want to claim the ERC tax credit, you just need to file amended payroll tax returns using Form 941X. Once the IRS processes your amended return, it will mail a refund check to the address on file.
Read on to learn the ins and outs of the Employee Retention Credit, including how it works and who qualifies for it.
Employee Retention Credit Overview
The ERC is a refundable tax credit created by Congress as part of the Coronavirus Aid, Relief, and Economic Security Act of 2020, also known as the CARES Act. It went through several expansions, extensions, and changes before it ended in late 2021. Unlike some other pandemic relief programs, the ERC is not a loan, and does not have to be paid back.
Here’s what it was worth to eligible employers:
- 50 percent of qualified wages (up to $10,000 in wages) paid to each employee for a maximum tax credit of $5,000 per employee
- 70 percent of qualified wages (up to $10,000 in wages) paid to each employee per quarter for Q1-Q3, for a maximum credit of $21,000 per employee
Below, we’ll dive into what makes an employer eligible and what counts as qualified wages, and look at an example of how to calculate the ERC.
What are Qualified Wages for the ERC?
Qualifying wages include any salary or wages paid to employees during the quarter. It also includes qualified health plan expenses paid to those employees, even if the business didn’t pay the employee any other wages.
How to Calculate your ERC Amount
The easiest way to understand how to calculate your ERC is by looking at a quick example.
Let’s say Cassie’s Cleaning Co has five employees, each of which earns $40,000 per year. The company was eligible for the ERC in 2020 and the first three quarters of 2021.
Each quarter, Cassie’s employees make $10,000 each, for a total of $50,000 combined. The ERC in 2020 paid 50 percent of their wages. So…
For 2020, Cassie’s tax credit would be:
$50,000 x 50% = $25,000
Note: The ERC only paid up to $5,000 per employee PER YEAR in 2020. So, the max Cassie could get for 2020 was $25,000.
For 2021, her employees get 70 percent of their wages paid to them per quarter. That’s a big step up from 2020.
So, the ERC would be:
$50,000 x 70% = $35,000 x 3 = $105,000
Clearly, the ERC could be very valuable for employers who meet the eligibility requirements.
Who Qualifies for the Employee Retention Credit?
To qualify for the credit, your business or nonprofit organization must meet at least one of the following requirements in the calendar quarter they want to use the credit:
- The business was fully or partially closed due to a government order stemming from the COVID-19 pandemic, or
- The business had a significant decline in gross receipts
The definition of a “significant decline in gross receipts” was different for 2020 than for the 2021 calendar year.
For the 2020 tax year, the business must have seen a 50 percent drop in gross receipts for the quarter compared to the corresponding quarter in 2019. The business must also have 100 or fewer full-time employees, excluding the owners.
For 2021, the business must have had a 20 percent or greater drop in gross receipts for the quarter compared to the same quarter in 2019. The business must also have between 1 and 500 full-time W-2 employees, excluding the owners.
For the ERC, a full-time employee is one that works at least 30 hours per week or 130 hours in a month.
IRS rules allow new businesses—those who weren’t around in 2019—to use the gross receipts for the quarter they started business as a reference point for any quarter in which they don’t have 2019 figures.
How to Claim the ERC
Unlike many other tax credits available to small business owners, the ERC doesn’t offset income taxes. Instead, it’s a credit to reduce the employer’s portion of Social Security tax.
Taxpayers had two options for claiming the credit:
- Reduce employment tax deposits by the amount of their expected credit. If the expected credit was more than their payroll tax deposits, taxpayers could request an advance payment by filing Form 7200.
- Claim the Employee Retention Credit on Form 941, Employer’s Quarterly Federal Tax Return, and receive a refund of previously paid tax deposits.
Since the ERC expired at the end of 2021, the only way to apply for the ERC going forward is to file an amended Form 941X for a previous quarter in which you were eligible for the payroll tax credit but didn’t claim it.
Employee Retention Tax Credit FAQs
Here are answers to some of the most frequently asked questions about the Employee Retention Credit.
Am I eligible for the ERC if I received a PPP loan?
Yes. Businesses that received a Paycheck Protection Program loan still qualify for the ERC. However, you can’t apply the credit to wages that were forgiven or expected to be forgiven under the PPP loan program.
For example, if you used PPP loan funds to pay for $50,000 of wages, and expect to qualify for PPP loan forgiveness, you can’t use those wages to calculate your ERC.
Is there a deadline to claim the ERC?
The Employee Retention Tax Credit was set to expire on January 1, 2022. However, the Infrastructure Investment and Jobs Act passed in November of 2021 retroactively moved up the expiration date to October 1, 2021 for most businesses.
For October through December of 2021, the credit is only available to recovery startup businesses.
A recovery startup business, as defined by the American Rescue Plan Act, is a new business that:
- Began operations on or after February 15, 2020, and
- Has average annual gross receipts of $1 million or less
If you qualified for the ERC during 2020 or 2021, you can file an amended Form 941X to retroactively claim the credit. The IRS generally gives you three years from the date you filed your original return or two years from the date you paid the tax to file an amended federal employment tax return.
Does the Employee Retention Credit have to be paid back?
No. The ERC is not a loan like the Paycheck Protection Program. It’s a fully refundable tax credit that employers can claim against applicable employment taxes.
Are the benefits of the Employee Retention Credit the same for large and small employers?
Businesses of any size can claim the ERC. However, large employers can only claim the ERC for employee wages and health care insurance premiums paid while employees weren’t working due to a pandemic-related shutdown.
For the ERC, a large employer is:
- 2020 Tax Year: an organization with more than 100 full-time employees
- 2021 Tax Year: an organization with more than 500 full-time employees
What are considered gross receipts for the ERC?
Gross receipts are the organization’s total revenue before subtracting returns, discounts, or operating expenses. You should calculate your gross receipts using the same accounting method you use when filing your tax return.
Do I take the ERC into income when I receive it?
The ERC is not taxable income. However, you should reduce your wages expense by your ERC credit amount. Remember to do that for the year the wages were actually paid.
For example, if you claim a $10,000 employee retention credit for 2021, you should reduce your deductible wages expense by $10,000 for 2021, even if you don’t actually receive the refund until 2022.
How long does it take for the IRS to provide a refund after filing an amended Form 941X?
The IRS is working through a huge backlog of amended 941 returns as a result of the ERC. For that reason, it may take anywhere from six to 16 months to receive a refund once you file Form 941X.
Send in Your Amended 941X for a Refund
All that’s left to do now is send in your amended Form 941X and wait for your refund. It might take a while to receive a check from the IRS, but the ERC can be a valuable tax credit for businesses that qualify. If you’re one of them, it’s worth the wait.