The Employee Retention Credit (ERC) is one of the most lucrative tax credits for small business owners. Fortunately, if you had employees on the payroll during the COVID-19 pandemic, you can still claim it retroactively.
To help you understand how you might qualify, let’s review how the ERC works and walk through some practical examples of eligible businesses.
How Does the Employee Retention Credit Work?
The Coronavirus Aid, Relief, and Economic Security (CARES) Act created the Employee Retention Credit in 2020. Its goal was to provide financial relief to small businesses and encourage them to retain their employees.
The ERC works as a refundable tax credit. You can deduct it from your payroll tax liability and pocket any excess amounts. As a result, it’s even more beneficial than a tax deduction, which can only reduce your taxable income.
To be eligible for the ERC during 2020 or 2021, you must pass the following three tests during the period for which you want to claim the credit:
- Your business was a private sector or tax-exempt organization.
- Your business paid qualified wages to employees.
- Your business experienced hardship in one of the following areas:
- You were forced to suspend your business’ operations, including limiting commerce travel or group meetings, fully or partially due to COVID-19 government orders, or
- You experienced a sufficient decline in gross receipts.
Businesses that pass these tests can claim a tax credit for a portion of each employee’s qualified wages. The 2020 limit is 50% of their first $10,000 that year. The 2021 limit is 70% of their first $10,000 per quarter until September 31, 2021, unless you’re a recovery startup business. That’s a maximum credit of $26,000 per employee.
While you can no longer earn the ERC, you still have time to claim it by filing Form 941-X for each eligible quarter. For quarters in 2020, you have until April 15, 2024. For quarters in 2021, the deadline is April 15, 2025.
What are Qualified Wages?
The definition of qualified wages under the ERC is surprisingly complex and deserves additional clarification. Most notably, your average number of employees in 2019 determines which wages qualify for the credit.
If you had 100 or fewer employees on average during 2019, wages paid to all employees in 2020 are qualified. If you averaged more than 100 employees during 2019, only wages paid to employees who weren’t providing services are qualified.
In 2021, the threshold increased to 500 employees. In other words, if you averaged 500 employees or less in 2019, all wages in each 2021 quarter are qualified. If you averaged more than 500 employees in 2019, only those paid to workers not providing services qualify in 2021 quarters.
What is a Suspension Due to a Government Order?
You must also understand what constitutes a full or partial suspension of operations due to a government order. Let’s look at the suspension of operations aspect first. To pass this test, “more than a nominal portion” of your operations must shut down.
For an aspect of your business to be more than nominal in a given quarter of 2020 or 2021, it must meet one of the following tests in the corresponding 2019 quarter:
- Its gross receipts constituted 10% or more of your total gross receipts.
- Hours worked by the portion’s employees were 10% or more of all hours worked.
Finally, a governmental order refers to official proclamations or decrees from the federal, state, or local government that “limit your commerce, travel, or group meetings due to COVID-19.”
What is a Sufficient Decline in Gross Receipts?
Finally, let’s expand upon what constitutes an eligible decline in gross receipts. Unfortunately, the rules are a little different between 2020 and 2021.
In 2020, you can show a sufficient decline in gross receipts for only one continuous period. It starts in the first calendar quarter that your receipts fall below 50% of receipts in the same quarter of 2019. It ends in the quarter after they first rise to 80% of 2019 receipts.
In 2021, you can test for an eligible decline in gross receipts on a quarterly basis. You can claim the ERC for each quarter that your gross receipts are below 80% of receipts for the same quarter in 2019, even if they’re discontinuous.
Employee Retention Credit Examples
As you can see, the ERC eligibility requirements are complicated. To help you understand them, let’s look at some in-depth examples of eligible employers, explain why they qualify for the ERC, and calculate their credit amounts.
Example 1: Partial Suspension
A restaurant had 20 employees on the payroll in 2019, 2020, and 2021. It paid everyone a $40,000 salary each year, even though half of the workers provided no services between April 1, 2020, and December 31, 2020.
The restaurant closed dine-in services to comply with federal social distancing mandates on March 15, 2020, but remained open for take-out. The government order ended on March 30, 2021. Throughout 2019, dine-in services generated 65% of the restaurant’s gross receipts.
As a for-profit business that operated in 2020 and 2021, the restaurant passed the first test for the ERC in both years. Because it continued to pay its workers during the pandemic, it also cleared the second.
Dine-in services generated 65% of the restaurant’s gross receipts in 2019, making it a more than nominal portion of operations. Because the social distancing mandate came from the federal government, it was a qualified government order. That means the restaurant passed the hardship test from March 15, 2020, until March 30, 2021.
Now we can calculate the restaurant’s ERC amount. Because it averaged less than 100 employees in 2019, all wages were qualified in 2020. Since everyone had a $40,000 salary, each earned more than $10,000 during the eligible period.
With the ERC limit being 50% of their first $10,000, the restaurant’s 2020 ERC is $5,000 for 20 employees, which equals $100,000.
Now, let’s calculate the amount for 2021. Since the restaurant averaged less than 500 employees in 2019, all employee wages qualified in 2021. However, the 2021 ERC limit is 70% of the first $10,000 per eligible quarter. Because the government order ended on March 31, 2021, only the first quarter is eligible in 2021.
With $40,000 salaries, each worker earned $10,000 per quarter, so they all reached the cap during the first quarter of 2021. As a result, the restaurant could claim 70% of $10,000 for 20 workers for that year, giving it a $140,000 credit.
Ultimately, the restaurant could claim a $240,000 ERC.
Example 2: Significant Decline in Gross Receipts
A 501(c)(3) charitable organization had 550 employees on the payroll from 2019 to 2021. Each employee had a $60,000 annual salary for all three years.
The charity had 250 employees stop providing services from April 1, 2020, to the end of the year. It put 125 of them back to work on January 1, 2021. The rest resumed working on March 31, 2021.
The organization received the following donations during that three-year period, which were its only gross receipts:
|Year||Quarter 1||Quarter 2||Quarter 3||Quarter 4||Total|
As a nonprofit organization that continued to operate during 2020 and 2021, this charity satisfied the first requirement for both years. Because it continued to pay wages to its full-time employees in 2020 and 2021, it also met the second one.
The charity also passed the hardship test in both years. It experienced a significant decline in gross receipts starting in the second quarter of 2020. $12 million in gross receipts is less than 50% of the $25 million received in the equivalent quarter of 2019.
The decline continued through 2020 because gross receipts in the remaining quarters never exceeded 80% of the gross receipts in the corresponding 2019 quarters.
In 2021, the charity saw a decline in gross receipts in the first and third quarters. $18.5 million and $19.5 million are less than 80% of the $25 million received each quarter in 2019.
Now we can calculate the ERC amount, starting with 2020. Because the charity averaged more than 100 employees in 2019, only wages paid to workers not providing services were qualified.
The 2020 eligible period was the second quarter through the end of the year. During that time, 250 workers were not providing services. With $60,000 annual salaries, they all earned $10,000 in that period. As a result, the charity could claim $5,000 for each of them, equaling a $1.25 million ERC in 2020.
In 2021, the first and third quarters were eligible for the ERC. However, 125 workers resumed working on January 1, 2021, and everyone else did so by March 31, 2021. Because the charity averaged more than 500 employees in 2019, only wages paid to those not providing services were qualified for the year.
As a result, the charity can claim the ERC for only 70% of the first $10,000 paid to the 125 employees not working in the first quarter. Since they all earned more than $10,000 during that time, the charity’s ERC for the year would be 70% of $10,000 for 125 employees, which equals $875,000.
That puts the charity’s total ERC at $2,125,000.
Apply For the Employee Retention Credit
As you can see, the ERC can be incredibly lucrative. If you qualify but fail to claim your tax credit, you could leave thousands of dollars on the table. Fortunately, it’s not too late to apply, and our easy-to-use application tool can guide you through the process from start to finish. Give it a try today.
Learn More: If you have further questions about the ERC due to unusual business circumstances, our other ERC resources may be able to help:
See If You Qualify For The ERC
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