It is no secret that many businesses have been negatively impacted by the COVID-19 pandemic these past few years. A powerful tool for business owners to ease some of their financial burden has emerged: the Employee Retention Credit (ERC). This tax credit was initiated when President Trump signed the CARES Act into law in March 2020. Since then, it has been amended three separate times under President Biden with the passages of the Relief Act of 2021, the American Rescue Plan Act, and the Infrastructures Investment and Jobs Act. ERC rules have changed significantly as a result; the purpose of this article is to provide general information about the ERC, how it benefits you, and how you could qualify.
The purpose of the original ERC provision was to encourage business owners to keep W-2 employees on payroll and reduce the number of people seeking unemployment benefits. If you have a business that has kept several employees on your payroll during 2020 and 2021, you could be eligible to benefit from this credit. The eligibility is determined on a quarterly basis based on the number of W-2 employees you have; you could potentially get a total of up to $26,000 per employee refunded back to you in cash for both 2020 and 2021 combined. If you qualify as a “Recovery Startup Business” (RSB), you can get up to $50,000 per quarter for the last two quarters of 2021. The criteria for RSB status are as follows: you started your business after February 15, 2020, average annual gross receipts are determined not to exceed $1,000,000, and you employ one or more employees. To qualify for 2020, you must meet one of two alternative tests set forth by the IRS: 1) Your business was partially or fully shut down by government order due to COVID-19; or 2) There was a significant decline in gross receipts compared to the same quarter in 2019. It is important to note that 1099 workers do not count when you are computing whether you qualify. If you received a First or Second Draw Paycheck Protection Program loan, you could still qualify, but the credit will only be applied to the wages that are not forgiven. A “significant decline in gross receipts” is defined differently for 2020 and 2021. For 2020, your business must have seen a 50% drop in gross receipts when you compared a quarter in 2020 with the equivalent quarter in 2019.
For 2021, the rules became easier, and you could qualify in more ways. One of the most common ways to qualify is if for the first three calendar quarters in 2021, there was decline in gross receipts of 20% lower than the same quarter in 2019.
Once you have determined that you are in fact eligible, you must know how to calculate the credit. Starting with 2020 tax year, you can potentially receive a credit of up to 50% of each employee’s qualified wages paid, up to $10,000 in wages per employee, with a credit cap of $5,000 per employee for the year. For the 2021 tax year, you could receive a credit of up to 70% of each employee’s qualified wages, capped at $10,000 per quarter for the first three quarters, resulting in a credit of up to $7,000 per quarter per employee, maxing out at $21,000 per employee for 2021.
An example for both years would help illustrate. For the 2020 tax year, assume Employee A had $2,000 of wages in one quarter and $12,000 in another. This $14,000 total would be capped at $10,000 for the year and the 50% credit would be worth $5,000. In 2021, the credit would be calculated on a quarterly basis, capped at $10,000 in wages per employee per quarter. The same total credit would thus be $8,400, calculated as follows: $2,000 x 70% = $1,400 and $10,000 x 70% = $7,000.
To claim the ERC, you will need to file Form 941-X. There is still time to file these for 2020 and 2021. For 2020, the deadline is April 15, 2024, for and for 2021, the deadline is April 15, 2025. It should be noted that with the passage of the Infrastructure Bill under President Biden, the ERC program expired on September 30, 2021. This limits the availability of the ERC in the fourth quarter of 2021 to only business owners who qualify as a Recovery Startup Business and match the criteria listed earlier. You are not allowed to pay current wages to claim the ERC, but you can retroactively claim it by filing the amended tax return.
It is also important to point out that the eligibility rules may differ if you have more than 500 employees. Most majority owners with living relatives cannot claim their wages. Unlike the PPP loans, if the ERC is taken, you must reduce your deduction for wages by the amount of the credit. This may mean that tax returns will have to be amended for both years. As it may be apparent, there are many rules that apply to the ERC credit that go beyond the scope of this article.
In matters like these, it is always best to seek guidance from a CPA that knows these rules well and can properly advise you. The ERC rules are constantly changing and may even have changed further by the time you are reading this article. CPAs in the profession have noticed an increase in audits related to incorrectly filed ERC forms or credits exceeding $200,000. You would not want to engage with an IRS audit on your own and would be better off avoiding it entirely. It is best to work with a CPA in the profession who monitors this topic and other tax savings opportunities closely. Hopefully you will consider this major tax benefit and use it to your advantage.
Bryce Kahler and Melinda Bucknam are CPA’s at Bucknam & Conley Tax Advisory & CPA Firm. Visit them at: Saratogacpa.com