Many business owners are quickly running to apply for the Employee Retention Credit (ERC) mistakenly believing that any disruption of business during the pandemic will qualify a business for the credit. However, simply being affected by the pandemic may not be sufficient to qualify a business for the refundable credit.
Most employers are familiar with the Paycheck Protection Program (PPP). The ERC was the lesser known employer assistance program enacted under the same Coronavirus Aid, Relief, and Economic Security Act (CARES Act) as the PPP. The ERC is a refundable tax credit, designed to reward employers who were negatively impacted by the COVID-19 pandemic but continued to retain employees despite the financial difficulties.
Unfortunately, many ineligible business owners are being told that they qualify for the ERC and are put at risk of an audit that may result in paying back the credit amount plus penalties, interest, and opening up to other liabilities. There are also many eligible employers who are informed that they do not qualify and are missing out on this valuable credit.
In 2022, the IRS issued Notice IR-2022-183 encouraging employers to be cautious and report faulty ERC claims to help the IRS protect taxpayers from fraud. With increasing scrutiny, it is important to accurately understand the qualifications to receive the ERC refund.
What Is the Employee Retention Credit?
The Employee Retention Credit (ERC) is a refundable tax credit for eligible employers, designed in the wake of the COVID-19 pandemic. Qualifying employers can receive a credit of 50% of the qualifying wages paid to eligible employees – as much as $5,000 per employee in 2020. In 2021, qualifying employers can receive a credit of 70% of the qualifying wage – up to $7,000 per employee per quarter in quarters 1, 2, and/or 3. Quarter 4 of 2021 is available to Recovery Startup Businesses that started its business during the pandemic.
ERC rules are very technical and can be confusing to many business owners and accountants. If employers are not well-versed in the technicalities of the ERC, stay alert – there are increasing numbers of ERC scams trying to profit by convincing unqualified companies to apply for the ERC.
The bottom line is that employers should only apply for this credit if the business clearly qualifies based on the negative effect of COVID-19 on the business operations. Employers are expected to see more ERC audits in the near future, and any company that falsely filed for the ERC might soon face difficult consequences.
Who Qualifies for the ERC?
To qualify for the Employee Retention Credit, an employer must meet the following criteria:
- The employer must be an eligible employer. This includes businesses with operations that were fully or partially suspended due to government orders related to COVID-19, or businesses that experienced a significant decline in gross receipts compared to the same quarter in 2019.
- The employer must have eligible wages. This means, for example, employers that received PPP loans cannot double dip their employee wages – wages used to apply for PPP forgiveness cannot be used to receive the ERC. Owners wages are also ineligible.
- The employer must meet the full-time (or equivalent) employee limitation. This means the employer must have a total of 100 or fewer full-time employees on average in 2019 for credit in 2020 or 500 or fewer full-time employees on average for credit in 2021. Otherwise, the employer will be considered a large employer for ERC purposes and the qualifying wages are limited to those wages paid to employees for time that employees were not providing service.
The employer size and eligibility may depend on whether the business must be aggregated as a single employer for ERC purposes. Certain businesses with common ownership must be aggregated as a single employer. This means the gross receipts and employees among the related entities must be combined to determine if the businesses are eligible for the ERC.
If an employer meets the eligibility criterias, it may be entitled to receive a maximum tax credit of $26,000 per employee.
Who Does Not Qualify for the ERC?
Some employers are ineligible to receive the ERC. These include:
- Government entities, such as federal, state, local, and tribal government organizations
- Public colleges, universities, and medical providers
- Owner employees
As mentioned earlier, audits for business owners claiming the ERC are expected to increase in frequency. Employers planning to apply should ensure that it is even eligible to apply for the ERC.
When Is the Qualifying Period for the ERC?
The qualifying period for the Employee Retention Credit starts March 13, 2020 and ends in the third quarter of 2021. Fourth quarter of 2021 is only available to Recovery Startup Businesses.
Whether an employer qualifies is determined quarter by quarter. In order to qualify under significant decline, the employer must compare its quarterly gross receipts from 2019 to the respective quarter in 2020 or 2021. To qualify under suspension of operations, the business must have fully or partially suspended its operations during that specified period due to a COVID-19 mandate from a governmental authority.
The credit is then claimed by amending the employer’s quarterly payroll tax return by filing Form 941X.
Calculating the ERC
1. Determine Employer Eligibility
The employer’s eligibility must consider aggregation with other related businesses. Once the single employer group is determined, the group must experience a significant decline in gross receipts or suspension of operations, whether full or partial.
2. Determine the Eligible Wages
Eligible wages are limited to $10,000 per employee for the entire year in 2020. For 2021, the eligible wages are limited to $10,000 per quarter per employee. Owner employee wages are not eligible for the ERC. Wages used to apply for other government assistance programs, such as PPP forgiveness are not eligible.
3. Calculate the Credit
The ERC is equal to 50% of the eligible wages for 2020 and 70% of the eligible wages for 2021.
Under the CARES Act, the Employee Retention Credit (ERC) was designed to assist businesses that were negatively impacted by the coronavirus pandemic. For many business owners, this tax credit is a lifeline – but not all business owners qualify.
Even now, many businesses are not fully aware of their eligibility for the ERC or even how to apply. If you’re not sure if you qualify, or if you’re still confused as to what wages qualify, seek ERC guidance immediately. Navigating through the technical rules to determine ERC eligibility is difficult. Employers should seek legal advice from a tax professional or tax attorney before applying for the credit.