Benefits of the Employee Retention Tax Credit

This article, which was originally published in the Winter 2021/22 issue of New Jersey CPA, has been updated to reflect changes from the Infrastructure Investment and Jobs Act, which was signed into law on Nov. 15.

The Employee Retention Credit (ERC), a fully refundable IRS payroll tax credit for employers, is now available to a broad cross section of businesses and has the potential for millions in savings on federal payroll taxes. The ERC had been originally overshadowed by the Paycheck Protection Program (PPP) due to a prohibition on businesses from obtaining both the ERC and PPP funds. Retroactive to 2020, the Consolidated and Appropriations Act allowed businesses that received PPP funds to still qualify for the ERC. The recently enacted Infrastructure Investment and Jobs Act eliminated the ERC for the fourth quarter of 2021, except for recovery start-up businesses (RSBs). Eligible employers can still claim the ERC for calendar quarters prior to Q4 2021.

Benefits

The maximum payroll tax credit under the ERC program is:

• Tax year 2020: $5,000 per employee per annum (50 percent of the first $10,000 of eligible wages)
• Q1, Q2 and Q3 of 2021: $7,000 per employee per quarter, which translates into a maximum credit of $21,000 per employee for 2021 (70 percent of the first $10,000 of eligible wages per quarter, per employee, assuming a business qualifies for the first three quarters of 2021)

For example, if a small business with 50 employees is deemed eligible for the first three quarters of 2021, it could potentially receive a $1,050,000 IRS payroll tax credit (50 employees x $21,000).

Eligibility

In order to qualify for the ERC, a business must experience either a government-man­dated full/partial suspension of operations or a significant decline in gross receipts.

• Tax year 2020: A “significant decline” in gross receipts is if an employer’s gross receipts for a given quarter are less than 50 percent of their gross receipts for the same calendar quarter in 2019
• Q1, Q2 and Q3 of 2021: A “significant decline” in gross receipts is if an employer’s gross receipts for a given quarter are less than 80 percent of their gross receipts for the same calendar quarter in 2019

For the first three quarters of 2021 quarters, an optional election is available which allows a look­back to the prior quarter if there hasn’t been a 20-percent decline in gross receipts. The election allows a lookback at gross receipts of the immediately preceding calendar quarter. For instance, if in Q1 2021, a taxpayer doesn’t experience a 20-percent decline in gross receipts, they can elect to compare Q4 2020 gross receipts to Q4 2019 gross receipts in order to determine eligibility for Q1 2021.

Start-Up Businesses

For Q3 and Q4 of 2021, if a business does not meet the requirement of either suspended operations or a significant decline in gross receipts, it may still be eligible for the ERC. The American Rescue Plan Act of 2021 created a new tax provision for “recovery start-up businesses” (RSBs). An RSB is an employer that began carrying on a trade or business after Feb.15, 2020, and had average annual gross receipts of not more than $1 million. The ERC is limited to $50,000 per quarter for RSBs.

Employee Count

Businesses of any size may potentially benefit from the ERC. However, there are limitations on the ERC for “large employers.” If a business is deemed to be a large employer, it can only claim the ERC for wages paid to employees not to work or employer-paid health insurance premiums for furloughed employees. A large employer for purposes of the ERC is defined as:

• Tax year 2020: a business that had averaged more than 100 full-time monthly employees in 2019
• Tax year 2021: a business that had averaged more than 500 full-time monthly employees in 2019

If a business is not deemed to be a large employer, it may potentially claim the credit for all eligible employees, whether working or not.

For Q3 of 2021, if a large employer’s gross receipts for a given quarter are less than 10 percent of their gross receipts for the same calendar quarter in 2019, the limitation would not apply. Therefore, a “severely financially distressed employer” may claim the ERC for all eligi­ble employees, whether working or not.

Interplay Between the ERC and PPP

Eligible businesses can claim the ERC on wages that are not used toward payroll costs when applying for PPP forgiveness. Businesses should analyze their payroll costs in order to obtain 100-percent PPP loan forgiveness and maximize their ERC. The PPP loan forgiveness program allows businesses to report up to 40 percent of qualified non-payroll costs (e.g., utilities, rent) on its application.

The ERC is claimed on IRS Form 941. An eligible business may reduce its federal employment tax deposits by the allowable ERC amount. If the ERC exceeds the remaining federal employment tax deposits for that quarter, the business may file Form 7200 to claim an advance refund. In order to claim the ERC for previously filed quarters, a form 941-X must be filed.