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 updates to the ERC for 2021.
How does the Employee Retention Tax Credit work in 2021?
Employers who are 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. 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 simply by reducing their employment tax deposits. Small employers were allowed to claim the 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 extension of the Employee Retention Credit has been one of its most confusing aspects. 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 this time, many businesses had 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 “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.
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 two qualifications to prove that their business has been impacted by COVID-19:
- Their business must have been fully or partially restricted because of governmental orders surrounding COVID-19 (such as orders that limited travel, group gatherings, and capacity in certain businesses), OR
- They must show that their gross receipts during a quarter declined by at least 20% compared to the same quarter in 2019 or the quarter immediately preceding it (employers that didn’t exist in 2019 can use 2020 quarters).
This differs from the 2020 eligibility rules, which required gross receipts to be less than 50% of their 2019 values.
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 more than 500 full-time employees in 2019, qualified wages include only the wages that were paid to employees who were 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.
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 all the way back to March 27, 2020, allowing employers to claim both as long as the same wages used to qualify for the ERC are not also used to apply for forgiveness as the PPP loan.