Employee Retention Credit: Can Your Small Business Benefit?
The Employee Retention Credit is one of the most important new tax credits to help small businesses suffering in the wake of the coronavirus pandemic. It provides a dollar-for-dollar reduction in an eligible company’s payroll tax liability that owners could take advantage of immediately. However, there are limitations on who qualifies for the tax credit and how much you could receive. Small business owners also must decide between claiming the tax credit or accepting a Paycheck Protection Program loan.
What is the Employee Retention Credit?
The Employee Retention Credit (ERC) is a refundable tax credit equal to 50% of qualified wages that eligible employers pay their employees. The Coronavirus Aid, Relief, and Economic Security (CARES) Act established the ERC as an incentive for employers to maintain their payroll while business is partially or fully suspended due to COVID-19 restrictions. The ERC is one of three new credits created by the CARES Act and an earlier relief measure known as the Families First Coronavirus Response Act.
New legislation could increase the tax credit to 80% of qualified wages. The credit would also apply to the first $15,000 in eligible wages, $5,000 more than the current threshold. However, the HEROES (Health and Economic Recovery Omnibus Emergency Solutions) Act passed by the U.S. House faces opposition in the U.S. Senate.
Here’s how it works now
The ERC applies to wages paid after March 12, 2020 and before Jan. 1, 2021. The credit applies to the first $10,000 in wages for each eligible employee, meaning employers may receive a maximum credit of $5,000 per employee. Employers may get a cash refund if the amount of the credit exceeds the amount of employment taxes owed. The credit would not only limit your business’s tax liability, but could provide an immediate reimbursement of funds, said Linda Farinola, president of Princeton Financial Group in New Jersey.
“To some extent it’s reducing your taxes, and to some extent they’re giving the business money to put toward salaries,” she said.
ABC Supply pays Employee X $100,000 of salary in 2020. The employer would typically be required to pay the federal government 6.2% of that, or $6,200 in Social Security payroll taxes. The ERC may reduce that liability to half that amount, or $3,200.
How to apply: Eligible employers must file IRS Form 7200 to request an offset in advance of their tax credit when reporting their quarterly payroll tax. You would submit the request along with Form 941, the quarterly federal tax return for employers.
Private-sector businesses and tax-exempt organizations, such as nonprofits, may qualify for the tax credit, regardless of size. To be eligible for the ERC, businesses must pass one of two tests:
- Operations have been fully or partially suspended under government orders related to the COVID-19 pandemic during any quarter of 2020.
- The business has experienced a significant decrease in revenue during any quarter of 2020. The IRS defines a significant decrease as a 50% or greater drop in gross receipts as compared with the same quarter in 2019. The decline would end when gross receipts are at least 80% of what the business earned in the same quarter last year, or when the first quarter of 2021 begins.
The tests are calculated each calendar quarter because businesses file employment taxes on a quarterly basis, Farinola said. If your business did not qualify during the first quarter of 2020, you may be able to qualify in the second quarter, or any quarter through the rest of the year, should your business circumstances change.
The tax credit may only be applied to certain employees’ wages, depending on the size of your workforce:
- More than 100 employees: Only wages of full-time employees who are earning a paycheck but not providing a service because the business is closed or is experiencing a significant drop in revenue would count toward eligibility.
- Fewer than 100 full-time employees: Wages of all employees earning a paycheck would count toward eligibility, regardless of whether or not they are providing a service.
Businesses with a large number of full-time employees who earn relatively low wages may be able to get the most out of the tax credit, Farinola said.
“This would be an avenue where they would at least be able to pay their employees and at least get some money back from the government in the form of that refundable credit to keep the employees on the payroll,” she said.
Businesses ineligible for the Employee Retention Credit
Household employers and self-employed people are not eligible for the ERC. However, if you are self-employed but you employ others and meet the requirements, you may be eligible with respect to the wages paid to your employees, not your own earnings.
Additionally, any business owners who have received a loan through the Paycheck Protection Program (PPP) — an emergency federal funding program also established through the CARES Act — would not be eligible for the tax credit. The HEROES Act would allow business owners to receive both, but for now, you cannot take advantage of forgivable PPP loans and the ERC.
Another option: Even if you are not eligible for the credit, the CARES Act also allows all employers to defer payment of Social Security tax and certain self-employment taxes in 2020. You’d owe 50% of the deferred amount by Dec. 31, 2021, and the remaining 50% by Dec. 31, 2022.
Employee Retention Credit vs. PPP loans
The ERC and PPP loans both aim to provide federally funded relief for small businesses struggling to survive the coronavirus pandemic. Because you may only receive one or the other, consider these key points when deciding which option to pursue.
|Employee Retention Credit vs. Paycheck Protection Program|
|Amount||Up to $5,000 per employee||Up to $10 million|
|Eligibility||Businesses of any size experiencing a decrease in revenue or suspended operations||Generally, businesses with no more than 500 employees|
|Deadline||Available for wages paid before Jan. 1, 2021||Applications close June 30, 2020, or when funding runs out|
|Repayment||Not required||Any amount not forgiven: 5-year repayment terms with 1% interest after 10 months of deferred payments|
Though the ERC may not provide as much money as a PPP loan, it would offer some reprieve for your small business, especially if you were unable to get a PPP loan, Farinola said.
“It would help get you through this difficult period and help keep those people on the payroll for a couple of months,” she said.
The ERC also has a wider window during which employers could take advantage of the program. The credit may be applied to any qualified wages paid through the remainder of 2020. On the other hand, PPP loans will no longer be available once the pool of funds is depleted, which happened once already. If you have yet to apply for a PPP loan, consider doing so as your first move — the program has about $120 billion remaining — and keep the ERC as your backup plan.
Can I get the Employee Retention Credit and a PPP loan?
No, you are not eligible for the ERC if you received a PPP loan. However, if you return your PPP loan by the SBA’s safe harbor deadline on May 14, you would be able to claim the tax credit.
What are qualified wages?
Qualified wages encompass compensation, including health plan expenses, paid to part-time and full-time employees between March 12, 2020, and Jan. 1, 2021. If you have more than 100 full-time employees, only wages paid while employees were not providing a service would qualify. If you have fewer than 100 full-time employees, wages paid to any employee would qualify, regardless of whether they were providing a service.
Do I need to provide documentation to the IRS after receiving the Employee Retention Credit?
The IRS has not indicated business owners need to provide additional documentation after receiving the tax credit. However, you should document your payroll and employment information from 2020 and 2019 in the event there is a question. “That could always happen. It’s best practice to keep those records to make sure you qualify,” Farinola said.
Is my business eligible for additional tax credits?
Businesses can claim tax credits to cover qualified leave wages for employees who take paid sick, family or medical leave for reasons related to COVID-19. Employers may receive both the ERC and the paid family and medical leave credit, but not for the same wages. You cannot apply both credits to the same wage payments.
These credits are available in addition to expanded tax credits for net operating losses (NOLs) and donations made by corporations to charitable organizations.