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Employee Retention Tax Credit: How to Qualify and Apply
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HR + Payroll

Employee Retention Credit: A Valuable Tool During Challenging Times

One-Minute Takeaway

  • The ERC is a business tax credit designed to incentivize businesses to keep employees during COVID.
  • Eligibility for the ERC includes businesses that experienced a significant decline in gross receipts in 2020 & 2021.
  • It’s important that businesses work with organizations that understand the intricacies of claiming the credit.

In times of economic uncertainty, businesses face the challenge of retaining their employees while navigating financial constraints. The Employee Retention Credit (ERC) is a business tax credit designed to provide financial incentives to businesses to keep their employees during challenging times such as the COVID-19 pandemic. By understanding the ERC, business leaders can leverage this valuable tool to stabilize their workforces, encourage business continuity, and maximize growth and stability. As with any federal incentive, understanding its ins and outs can be complicated. So, let’s break it down.

Who is Eligible to Claim the Employee Retention Credit?

The foundation of the Employee Retention Credit (ERC) is to help businesses that have faced economic distress but have shown resilience by retaining their employees. Its goal is to provide relief to businesses that have seen a notable drop in revenue.

  • Government-Initiated Suspensions: If a business was compelled to reduce its hours of operation or shut its doors entirely due to federal, state, or local government mandates (such as health orders related to a pandemic), it’s deemed eligible. This doesn’t just cover complete shutdowns; even partial suspensions of operations, for instance, restrictions on the number of customers allowed indoors, qualify.
  • Significant Decline in Gross Receipts: Here’s the math behind the term “significant decline”: For 2021, if in any quarter your gross receipts were less than 80% of the gross receipts from the same quarter in 2019, you experienced a significant decline for ERC eligibility purposes. This test provides flexibility, allowing businesses that might have had one or two particularly rough quarters to claim the credit, even if the rest of the year was more stable.

It’s also worth noting a special provision for new businesses. If your business started after the benchmark comparison time (e.g., post-2019), then alternate measures are used to determine your eligibility, ensuring that newer enterprises aren’t left out of the relief program.

The size of your business also plays a role. The definition of “qualified wages” can differ based on whether you had more or fewer than a certain number of full-time employees. In 2021, for instance, this threshold was 500 employees.

RELATED: [On-Demand Webinar] 2023 ERC Update – Paycor + Equifax

Unraveling the Math: How is the Credit Amount Calculated under the ERC Program?

Understanding the calculation behind the ERC is crucial, as it directly influences the financial relief your business can expect. The basic premise is a percentage-based credit on qualifying wages, but let’s dissect this further:

  • Percentage of Qualifying Wages: For 2020, the maximum wage per eligible employee was $5,000. For the year 2021, the credit was set at 70% of qualifying wages paid to each employee for Q1–Q3. What this means is that for every dollar you paid an eligible employee under the parameters of the ERC, you can claim 70 cents back as a credit.
  • Maximum Wage Cap:  For 2021, the maximum amount of qualifying wages that could be considered for the ERC was capped at $10,000 per employee for each quarter. Meaning, even if an employee’s qualifying wages for a quarter were $12,000, the ERC will only consider $10,000 of that sum.

Given the 70% rate, this wage cap translates to a maximum credit of $7,000 (70% of $10,000) per employee for each quarter. Over the span of a year, if an employee’s wages qualified in 2020 and in all three quarters of 2021, this could amount to a substantial $26,000 in credits for just that single employee.

  • Cumulative Benefit: The cumulative benefit can be substantial when considering an entire workforce. For a hypothetical business with 10 employees, all earning qualifying wages, the potential credit for 2020–21 could reach up to $260,000 (10 employees x $26,000 maximum annual credit per employee).

Understanding Qualifying Wages for the ERC

At the heart of the ERC is the concept of “qualifying wages.” These wages determine the credit’s magnitude, making it essential for businesses to grasp what can be included under this umbrella. While it’s easy to think of wages as merely the numbers on an employee’s paycheck, in the context of the ERC, the scope is broader:

  • Salaries and Hourly Wages: The most straightforward component, salaries and hourly wages refer to the basic compensation an employee receives. Whether your employees are salaried or paid by the hour, these amounts form the foundation of the qualifying wage calculation.
  • Health Benefits: Beyond the basic pay, many businesses contribute towards their employees’ health insurance premiums. These employer-provided health benefits, often a significant component of an employee’s compensation package, count as qualifying wages for the ERC. This inclusion recognizes the ongoing costs businesses bear even when their operations may be partially or fully suspended.
  • Wages to Furloughed Employees: The basis for the ERC was its aim to support businesses that kept their employees on payroll, even when active work wasn’t available. Wages paid to employees not performing services due to operational disruptions (often termed as being “furloughed”) still qualify.
  • Exclusions: While the ERC’s scope for qualifying wages is broad, not everything is included. For instance, wages used for the purposes of other credits, such as the Work Opportunity Credit (WOTC) or Paid Family and Medical Leave Credit, can’t be double-counted for the ERC.
  • Impact of Business Size: The number of employees you have can influence the definition of qualifying wages. In 2021, for businesses with more than 500 employees, only wages paid to employees for the time they were prevented from working due to operational disruptions qualify. Conversely, for smaller businesses (those with fewer than 500), all wages paid, irrespective of whether the employee worked or not, can qualify.

Can Businesses Combine the ERC with PPP?

The economic landscape of recent times presented multiple financial relief options to businesses, with the ERC and the Paycheck Protection Program (PPP) being two primary pillars. However, juggling benefits from both programs requires a careful balancing act.

At the outset, it’s important to understand that while both ERC and PPP aimed to provide financial relief to businesses, they serve different purposes. The ERC is a tax credit meant to alleviate payroll tax burdens for businesses that kept their workforce on the payroll, while the PPP provided loans to businesses that may be forgivable if used primarily for payroll expenses.

The guiding principle when combining ERC and PPP benefits is to avoid double-dipping meaning, you can’t use the same set of wages to both qualify for ERC and receive PPP loan forgiveness. This ensures that businesses don’t receive an unfair or exaggerated advantage by overlapping the two program’s benefits.

Given the double-dipping restriction, if a business received a PPP loan and used it to cover payroll expenses for an 8-week period, the wages during this period can’t be used to claim the ERC. However, wages outside this period can be used for the ERC, provided they meet program criteria.

A forgiven PPP loan essentially translates to a grant, covering costs without repayment. On the other hand, the ERC offers a direct credit against payroll taxes, potentially offering a dollar-for-dollar reduction in tax liability. Businesses should consider their financial situations, the loan amount, and the potential tax credit to determine the optimal route they take.

Remember that use of either (or both) programs requires impeccable record-keeping. Businesses should maintain separate records for wages and expenses used to claim the ERC and achieve PPP loan forgiveness. This not only helps ensure compliance but will be invaluable in the face of any audits or reviews.

As with many relief programs, guidelines evolve. The IRS and the Small Business Administration (SBA) have periodically issued clarifications on the interplay between ERC and PPP. You should stay updated to ensure you receive the maximum benefits while remaining compliant.

The Application Process and Documentation for the ERC

Securing the ERC can provide significant relief for businesses facing economic hardships. But the process of applying for the credit and ensuring you have the right documentation in place can be extremely challenging. Here’s a step-by-step guide to help navigate this landscape:

  • Application: Unlike some relief programs that require a separate application form, the ERC is claimed directly on your business’s federal employment tax returns. Specifically, this is done using Form 941, Employer’s Quarterly Federal Tax Return, where you report the total qualified wages for the credit.
  • Documentation Essentials: Exceptional documentation is the backbone of your ERC claim. Ensuring you have detailed and accurate records will not only bolster your claim but also protect your business in the event of any audits or queries. Essential documentation includes:
  • Eligibility Evidence: Documentation showing that the business experienced a shutdown or significant decline in gross receipts. This can be in the form of financial statements, sales records, or any government-mandated shutdown orders relevant to your business.
  • Employee Wage Data: Detailed payroll records showing wages paid to each employee during the claim period. This should also break down the components of the wage, such as base pay, bonuses, and health benefits.
  • Health Insurance Costs: If the business claims health benefits as part of the qualifying wage, detailed records of the insurance premiums paid on behalf of the employees are required.
  • Employee Count: Records indicating the average number of full-time employees are crucial as the credit calculation varies based on the size of the business.
  • Consider Electronic Record Keeping: Given the number of documents and the need for easy retrieval, consider maintaining electronic records. Tools and software that enable accurate payroll tracking, digital storage of financial statements, and easy retrieval of insurance premium documents can be invaluable.

Don’t Be Taken by ERC Scams

Remember, while the Employee Retention Credit (ERC) has expired, you still have until April 2024 to do a lookback, claim the credit, and file amended returns. Online scammers, promising to quickly get businesses these credits, are prevalent. So prevalent, in fact, that the IRS added ERC credit scams to its 2023 Dirty Dozen list of tax scams.  

If you used a marketing group that pressured you into filing for a refund and haven’t yet received it, the IRS has a way for you to withdraw your claim without being penalized and you can refile using a trusted provider like Paycor.

The stakes are too high for you to use an organization that doesn’t have the legal or tax credit expertise you need to maximize your relief. Paycor’s Audit Defense, adds an extra layer of protection at no cost to you.

The Consequences of Inaccuracies in Claiming the ERC

It’s important to ensure accuracy and transparency when filing for ERC relief. Missteps, whether unintentional oversights or deliberate misrepresentations, can have consequences. Here’s a comprehensive look at the potential pitfalls and penalties businesses might face:

  • Accuracy-Related Penalty: This penalty can be levied if you fail an IRS audit of your claim. One of the repercussions of claiming excessive credits is the obligation to repay the excess amounts. And this isn’t a mere “give back what you took” situation. Repayments come attached with 20% interest, adding to the financial burden. So, for example, if you fail an audit and your tax bill is increased by $20,000, you’ll be levied an additional $4,000 penalty.
  • Tax Fraud Penalty: The penalty for civil tax fraud is 75% of the unreported tax. So, using the previous example, you’d be fined an additional $15,000 if you’re hit with a tax fraud penalty.
  • Criminal Charges: In extreme cases, where the inaccuracies are a result of deliberate fraud or misrepresentation, businesses and even individuals within the organization can face criminal charges. Convictions here might lead to hefty fines and, in some instances, imprisonment.
  • Reputational Damage: Beyond the tangible financial consequences, there’s the intangible yet very real risk of reputational damage. In the age of information, news about businesses facing penalties or legal action spreads fast. This can erode trust with customer, partners, and even employees, potentially hindering future business prospects.
  • Operational Disruptions: Addressing inaccuracies, especially if they catch the attention of the IRS, can lead to operational disruptions. Audits, reviews, and internal investigations can divert essential resources from core business functions, leading to lost opportunities and reduced productivity.

Proactive Measures to Avoid Penalties

While the penalties can seem daunting, you can take proactive steps to mitigate the risks.

  • Detailed Record-Keeping: Ensure that all calculations, rationales, and relevant data are meticulously documented.
  • Stay Updated: Regularly check for updates or clarifications to the ERC guidelines to ensure compliance with the latest standards.
  • Seek Expertise: Consider consulting with tax professionals or other experts when preparing claims. Their insights can pinpoint potential issues and provide guidance.
  • Internal Audits: Periodically review your claims internally or via third-party auditors to ensure accuracy and compliance.

How Paycor Helps

The Employee Retention Credit is a testament to the importance of sustaining businesses and their workforces during tough times. Yet, like any federal program, it requires a keen understanding and careful management to maximize its benefits. Remember, when in doubt, always consult with a professional.