What is the Employee Retention Credit?

The Employee Retention Credit (ERC) is a refundable tax credit provided under the CARES Act for eligible employers that experience a significant decline in gross receipts or certain closures related to COVID-19. This tax credit is equal to 50% of qualified wages that eligible employers pay their employees from March 13, 2020 through December 31, 2020 (up to $10,000 of qualified wages per employee) and 70% of qualified wages that eligible employers pay their employees in 2021 (up to $10,000 of qualified wages per employee per calendar quarter of 2021). The ERC is intended to help business owners keep employees on the payroll and minimize the number of workers filing for unemployment benefits.

Eligible employers can benefit from the ERC in one of three ways.

1. They can reduce the employment tax deposits they are otherwise required to make.
2. If they had an average of 500 or fewer full-time employees in 2019, they can file a claim for an “advance refund” of the credit that is anticipated for a given quarter.
3. When they file their quarterly federal employment tax return (Form 941), they can request a refund of any credit not previously taken as an advance refund or by reducing tax deposits.

For many business owners, this tax credit could be a better fit than some of the relief bill’s more well-known loans and grants. Like the Paycheck Protection Program (PPP), the ERC is designed to keep employees on the payroll and out of the unemployment office. But unlike the PPP, the ERC isn’t a loan. So what is it? Let’s take a closer look.

Why is the ERC important?

Unlike PPP loans and other small business relief options, eligible businesses of all sizes are eligible for the ERC if they were in operation during calendar year 2020 or 2021. And because the ERC is not a loan, recipients will never need to repay or seek forgiveness for ERC funds. Additionally, the ERC is available through December 31, 2021. Each employer can claim a maximum of $5,000 of credits per employee for qualified wages paid for 2020 and a maximum of $7,000 of credits per employee per quarter for qualified wages paid during 2021 (a potential maximum of $28,000 per employee for the calendar year). There is no cap on the total amount of ERC available for a single employer.

Can I qualify for the ERIC if I received a Paycheck Protection Program (PPP) loan?

Under the original CARES Act, the ERC was not available to an employer that received a PPP loan. But Congress has now changed the law so that employers can qualify for both benefits. However, the same wages cannot be used both to qualify for forgiveness of a PPP loan and also to claim the ERC. The employer can choose which wages are used to support PPP loan forgiveness and which are used for the ERC.

How do I qualify for the ERC as an employer?

An eligible employer must carry on a trade or business during calendar year 2020 or 2021 and meet one of two requirements.

1. The employer’s business operations are suspended fully or partially due to orders from a governmental authority limiting commerce, travel, or group meetings due to COVID-19.
2. The employer’s business experiences a quarterly decline in gross receipts:

• For 2020, the business must have a decline of more than 50% in gross receipts for each calendar quarter of 2020 for which ERC is claimed, compared to the same calendar quarter in 2019.
• For 2021, the business must have a decline of more than 20% in gross receipts for each calendar quarter of 2021 for which ERC is claimed, compared to the same calendar quarter in 2019.
• An employer may also elect to qualify for quarters during 2021 by looking back to a 20% decline in gross receipts for the preceding quarter.

For example, let’s say your gross receipts were $210,000 in Q1 of 2019 but $100,000 in Q1 of 2021. You would meet the gross receipts test because your Q1 2021 gross receipts are equal to 48% of the comparable quarter in 2019.

What are qualified wages?

The Internal Revenue Code defines wages as payment for employment, including taxable benefits. The ERC includes as “qualified wages” the portion of group health plan expenses (including employer and pre-tax employee contributions) that is allocable to otherwise qualifying wages. Determining qualified wages in an applicable calendar year depends on the average number of full-time employees the eligible employer had during the year.

Qualified wages for larger employers

The ERC uses different rules for determining qualified wages depending on the size of the employer. For 2020, an employer that had an average of more than 100 full-time employees in 2019 is subject to the following limitations:

1. Qualified wages are only the wages paid to employees who are not providing services due to the employer’s qualifying hardship.
2. Qualifying wages for any given employee may not exceed what the employee would have earned, working an equivalent amount during the 30 days immediately preceding the period of economic hardship.

For 2021, the second limitation does not apply, and the first limitation applies only to an employer that had an average of more than 500 full-time employees in 2019. In addition, for the third and fourth quarters of 2021, a larger employer is not subject to the first limitation if it experiences a decline in quarterly gross receipts in excess of 90%.

Qualified wages for smaller employers

For an employer that is not subject to the limitations described above for larger employers, qualified wages are generally those paid to all employees during the period of the qualifying hardship, rather than just those related to employees who are not working due to hardship. If the hardship is a full or partial suspension of the employer’s operations due to orders from a governmental authority, then all wages paid during the period of full or partial suspension qualify. If the hardship is a decline in gross receipts, then the qualifying wages are:

• for 2020, those paid beginning with the first quarter for which there was a 50% decline in gross receipts compared to the same quarter of 2019 (but no earlier than March 13, 2020) and ending on the last day of the first quarter in which gross receipts exceed 80% of those for the corresponding quarter of 2019 (but no later than December 31, 2020);
• for 2021, those paid for any quarter for which there was a 20% decline in gross receipts compared to the same calendar quarter in 2019, or that qualifies using the prior-quarter lookback rule.

Wages that do not qualify for the ERC

Qualified sick and family leave wages which an employer takes into account to determine tax credits under the Families First Coronavirus Response Act are not eligible for the ERC. Wages paid to employees for whom the employer is allowed a work opportunity tax credit for a given period cannot also be qualified wages for the ERC. Further, wages for which an employer claims a paid family and medical leave credit under Section 45S of the Internal Revenue Code are not qualified wages for purposes of the ERC.

Wages that an employer uses as a basis for the ERC are not eligible to be treated as payroll costs for purposes of determining the amount or forgiveness of a PPP loan. Employers may elect to exclude from their ERC calculation wages that would otherwise be eligible for the ERC in order count those wages for PPP purposes.

How to calculate the ERC

For calendar year 2020, the tax credit is equal to 50% of qualified wages that eligible employers pay their employees in a calendar quarter. The credit applies to wages paid after March 12, 2020, and before January 1, 2021. Eligible 2020 wages per employee max out at $10,000, so the maximum credit for eligible wages paid to any employee during calendar year 2020 is $5,000.

For calendar year 2021, the tax credit is equal to 70% of qualified wages that eligible employers pay their employees in a calendar quarter. Eligible 2021 wages per employee max out at $10,000 per quarter, so the maximum credit for eligible wages paid to any employee during any calendar quarter of 2021 is $7,000 (and the maximum for the calendar year is $28,000).

The calculations can be tricky. You can estimate your potential tax credit. But you’ll need to know a few things:

• The number of workers you’ve employed in the applicable calendar year.
• Your business revenue in each calendar quarter in 2019.
• Your business revenue for the relevant calendar quarters in 2020 or 2021, as applicable.
• The total qualified wages paid to all employees (which may be limited, as noted above, if you are a larger employer for the applicable period).

How to claim the ERC

Eligible employers can benefit from the ERC in one of three ways.

1. They can reduce the employment tax deposits they are otherwise required to make.
2. If they had an average of 500 or fewer full-time employees in 2019, they can file a claim for an “advance refund” of the credit that is anticipated for a given quarter.
3. When they file their quarterly federal employment tax return (Form 941), they can request a refund of any credit not previously taken as an advance refund or by reducing tax deposits.

Here’s how it works:

• Let’s say you deposit federal employment taxes weekly or semi-weekly. You can reduce the tax deposits by the credit amount that applies to the qualified wages for that pay period.
• Let’s say your credit amount is greater than your total employment tax deposits for the pay period and you had 500 or fewer full-time employees in 2019. You can request an advance refund of the credit using Form 7200. You can file this form multiple times throughout the quarter.
• When you file Form 941 quarterly, you can check your credit amount against the tax deposits already made during the quarter. If there is still credit left, it will be refunded once you file this form.

4 things you can do next

1. Estimate your potential Employee Retention Credit.
2. Learn more about the Employee Retention Credit. Or review the IRS’s ERC FAQs.
3. Find out what you need to know about the ERC from the U.S. Department of the Treasury.
4. Download a quick guide to the ERC from the U.S. Chamber of Commerce.