Has your small business been dedicated to retaining its workforce throughout the pandemic? Here’s some good news – you might be in line for a tax credit courtesy of the Internal Revenue Service.
The Employee Retention Credit, often abbreviated as ERTC or ERC, debuted during the initial stages of the COVID-19 pandemic as a vital component of the CARES Act relief package. Its primary purpose was to serve as an additional incentive for small businesses to retain their employees, although it somewhat lived in the shadow of the more widely recognized Payment Protection Program. Designed as a refundable tax credit, the ERTC aimed to incentivize employers to retain their workforce during unprecedented challenges. This comprehensive guide will delve into the intricacies of the ERTC, from its eligibility criteria to the calculation of the credit and its potential impact on businesses.
Understanding the ERTC: Key Components
The Employee Retention Tax Credit (ERTC) was introduced to provide financial support to businesses that faced operational disruptions due to the COVID-19 pandemic. Key aspects of the ERTC include:
Availability
The ERTC is accessible to many employers, including tax-exempt organizations. However, there are exceptions for state and local governments and their subsidiaries and small businesses that have availed of Small Business Loans.
Eligibility Tests
Employers must meet one of two alternative tests, calculated quarterly. Their business must be fully or partially suspended by government order due to COVID-19 during the calendar quarter.
Their gross receipts must fall below 50% of the comparable quarter in 2019. If gross receipts recover over 80% of a comparable 2019 quarter, the employer no longer qualifies after that quarter.
Calculation of the Credit
The credit amounts to 50% of qualifying wages, capped at $10,000 per employee. It applies to wages paid after March 13 and before December 31, 2020.
Qualifying Wages
The definition of qualifying wages depends on the average number of employees in 2019.
Less than 100 Employees: For employers with 100 or fewer employees on average in 2019, the credit applies to wages paid to all employees, regardless of their work status.
More than 100 Employees: On average, employers with more than 100 employees in 2019 are eligible for the credit only for wages paid to employees who did not work during the calendar quarter.
Inclusions: Qualifying wages include not only cash payments but also a portion of the cost of employer-provided health care.
Payment and Reimbursement
One of the distinctive features of the ERTC is that employers can receive immediate reimbursement for the credit. This is achieved by reducing the payroll taxes they have withheld from employees’ wages, which they are obligated to deposit with the Treasury.
Ensuring Proper ERTC Claim: A Cautionary Note
While the ERTC has provided significant financial relief to countless businesses, it’s essential to approach the claim process with diligence and compliance. The IRS has processed approximately 3.6 million ERTC claims throughout the program. However, as we move beyond the eligibility date for the program, the IRS has taken steps to bolster safeguards against fraud and revenue loss.
Promoters may advertise ERTC submissions as “risk-free,” but substantial risks are involved as the IRS intensifies its audit and criminal investigation efforts. Improperly claimed ERTC funds must be repaid, potentially incurring penalties and interest. For businesses or tax-exempt groups, repaying the credit could place them in a more challenging financial position than if they had never claimed it in the first place.
Therefore, taxpayers must exercise caution and independently verify their eligibility for the ERTC before applying through a promoter. Promoters can charge a contingency fee of up to 25% of the ERTC refund, making it imperative that businesses take proactive steps to ensure they meet the credit’s requirements.
The Employee Retention Tax Credit (ERTC) has played a pivotal role in supporting businesses during the tumultuous times brought on by the COVID-19 pandemic. Understanding the nuances of this tax credit, from eligibility criteria to payment mechanisms, is essential for businesses looking to leverage this financial resource. However, businesses must tread carefully, as the IRS actively monitors ERTC claims to safeguard against fraud and financial losses. By adhering to the ERTC’s requirements and seeking expert guidance, businesses can navigate this intricate landscape and access the financial support they require to thrive in a post-pandemic world.
How Does the ERC Operate?
The Employee Retention Credit (ERC) is a unique tax credit structured around qualifying employee wages. Unlike traditional income tax credits, the ERC is based on payroll taxes, allowing businesses to benefit even if they have not paid any income taxes in 2020 or 2021.
What sets it apart is its refundable nature, which means you can receive a refund exceeding the amount you initially paid in payroll taxes. To illustrate, if you qualify for a $50,000 ERC credit but have only paid $10,000 in payroll taxes, you’ll still receive the entire $50,000 refund from the IRS. It’s worth noting that a small non-refundable portion of the ERC is limited to the amount of employee Social Security and Medicare taxes you’ve paid.
How Much Can My Small Business Obtain Through the ERC?
For the tax year 2020, eligible small businesses can claim 50% of the first $10,000 in wages per employee via the Employee Retention Credit. This totals a maximum of $5,000 per worker, and it’s worth mentioning that you can apply for this credit in 2023.
Is My Small Business Eligible for the ERC?
While the ERC offers advantages to businesses of all sizes, it particularly favours small businesses over larger counterparts.
Number of Full-Time Employees
In the tax year 2020, a small business is defined as one that averaged 100 or fewer full-time monthly employees in 2019. For the tax year 2021, this definition expands to include businesses that averaged 500 or fewer full-time monthly employees in 2019. Larger employers can also claim the ERC, but it applies only to wages and certain healthcare costs for employees who did not work. In contrast, small businesses can claim the credit for all employees, whether they worked or not.
Government-Mandated Full or Partial Suspension
To qualify for the ERC, your business must have been affected by either a government-mandated lockdown or a decrease in revenue. You can meet the eligibility criteria if your business faces a full or partial suspension of operations due to a government COVID-19 order during any quarter. This includes restrictions on operating hours or capacity. The realm of eligibility in this regard is complex, so it’s advisable to collaborate with a vendor well-versed in government orders, their implications, and the specific timeframes of their enactment. Examples of qualifying businesses encompass those ordered to suspend operations entirely, essential businesses with mandated reduced hours or capacity (like restaurants with fewer available tables), businesses affected by supplier shutdowns impacting deliveries, and those businesses forced to close down a segment of their operations due to government mandates.
Significant Decline in Gross Receipts
Your business can also qualify for the ERC if it experiences a “significant decline” in gross receipts, as defined by the IRS. A significant decline for the tax year 2020 means that quarterly gross receipts are less than 50% compared to the same period in 2019. In the initial three quarters of 2021, quarterly gross receipts are less than 80% compared to the same period in 2019. In the first three quarters of 2021, if your business didn’t witness a 20% decline in gross receipts compared to 2019, you can use the immediately preceding quarter for comparison. If your business’s Q2 of 2021 isn’t eligible compared to Q2 of 2019, you can instead use Q1 of 2021 and compare it to Q1 of 2019 to fulfill the eligibility criteria.
Solutions by Mike Miller, CPA 