The Employee Retention Tax Credit (ERC) first began in March 2020 under the CARES Act to incentivize employers to keep employees on payroll through the pandemic. Since then, The Relief Act of December 2020, the Consolidated Appropriations Act, the American Rescue Plan Act of 2021 (ARPA), and the Infrastructure Investment and Jobs Act have made several changes to the ERC, some of which were retroactive for 2020, while others apply only to 2021. Here’s everything you should know about the ERC and what to look for in 2023.
How does the Employee Retention Tax Credit work?
Employers eligible for the ERC qualify for a refundable tax credit against their share of the Social Security tax. For most businesses, the credit is only available for wages paid between December 31, 2020, and September 30, 2021, and can’t exceed 70% of the qualified wages per employee.
This is because qualified wages are capped at $10,000 per employee per quarter. The max ERC per employee is $7,000 per quarter or $21,000 for the entire year. If the employer’s share of the Social Security tax for that employee was less than that amount, the excess is awarded as a refund.
Employers were allowed to take advantage of the credit immediately by reducing their employment tax deposits. Small employers were allowed to claim a refund each quarter using Form 7200. This means many of your clients may have already seen the benefit of all or part of the ERC. At the time of tax filing, ERC should be reported on Form 941.
What calendar quarters does the ERC apply to?
The Relief Act initially extended it to June 30, 2021. The ARPA extended it further to the end of 2021, but in November 2021, the Infrastructure Investment and Jobs Act changed the end date to September 30, 2021.
By then, many businesses already reduced tax deposits or filed a Form 7200 for the fourth quarter. The IRS issued guidelines about repayment, making it clear that these employers will not be subject to failure to pay or failure to deposit penalties as long as they have paid their tax liability by the due date of their employment tax returns.
Only a “recovery startup business” – businesses that were started after February 15, 2020, and have fewer than $1 million in annual gross receipts – can still claim up to $50,000 of ERC for the fourth quarter of the year.
To summarize, employers could claim the ERC for 2020 and the first three quarters of 2021.
Which employers qualify for the Employee Retention Tax Credit in 2021?
Eligibility for the ERC changed slightly in 2021, and employers must meet one of the following qualifications to prove that their business was impacted by COVID-19:
- Their business must have sustained a full or partial restriction due to governmental orders surrounding COVID-19 (such as orders that limited travel, group gatherings, and capacity in certain businesses) during 2020 or the first three quarters of 2021(tax-exempt companies and colleges and universities whose principal purpose is to provide medical care qualify), OR
- They must show that their gross receipts during a quarter declined by at least 10% compared to the same quarter in 2019 or the quarter immediately preceding it (employers that didn’t exist in 2019 can use 2020 quarters)
Updates to Qualified Wages
The Relief Act changed the criteria for qualified wages for the 2021 ERC, and the new rules depend largely on the size of the employer.
For employers with over 500 full-time employees in 2019, qualified wages include only those paid to employees not providing services during the relevant quarters due to COVID-19’s impact on the business. In other words, for employers of this size, the credit is only available if they elected to pay employees who were not actively working for them at the time.
For smaller employers with 500 or fewer full-time employees in 2019, qualified wages can include wages paid to any retained employee during the relevant quarters.
“Severely financially distressed employers” may treat all wages as qualified wages during the calendar quarter in which the employer is severely financially distressed.
The ERC and PPP
Initially, an employer could not qualify for both the ERC and Paycheck Protection Program. The Relief Act changed this rule retroactively back to March 27, 2020, allowing employers to claim both if the same wages used to qualify for the ERC are not also used to apply for forgiveness as the PPP loan.
Updates for 2023
The IRS has recently seen marketing that lures ineligible taxpayers to claim this credit. In response, they’ve issued a temporary moratorium for people claiming this credit. Read What the IRS Moratorium on the Employee Retention Credit Means for Your Clients to learn how to spot this scam and how to notify your clients of the scam.