On March 27, the Treasury Department and the Internal Revenue Service (IRS) established the Employee Retention Credit (ERC) under the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The IRS defines the ERC as a refundable tax credit against various employment taxes equal to 50% of qualified wages an eligible employer pays its employees. For employers suffering from economic hardship due to COVID-19, the ERC incentivizes them to keep employees on the payroll.
Who is considered an eligible employer?
According to the IRS, an eligible employer carries on a trade or business that either:
- Has operations that have been “fully or partially suspended” by government order due to COVID-19. This designation applies if the trade or business operations are fully or partially suspended during any calendar quarter in 2020 due to orders from an appropriate governmental authority as a result of COVID-19.
- Has experienced a significant decline in gross receipts. A significant decline in gross receipts is defined as a reduction of over 50% in quarterly receipts measured year over year.
Government employers and self-employed individuals are not eligible for the ERC. A self-employed individual, however, may claim the credit for eligible wages paid to their employees.
What are qualified wages?
The ERC applies to wages paid to employees after March 12, 2020, and before January 1, 2021, including qualified health plan expenses incurred by the eligible employer.
The applicable credit amount is based on the average number of full-time employees during 2019. An employee is considered to be full time if it, with respect to any calendar month in 2019, averages at least 30 hours a week or 130 hours a month.
- For an eligible employer with less than 100 full-time employees, the credit is based on wages paid to all employees regardless of whether they provided services or not.
- For an eligible employer with more than 100 full-time employees, the credit is allowed only for wages paid to employees for the time when they are not providing services. For example, Employer G, a retailer, closed all of its locations in State B due to a governmental order. Employer G continues to pay its employees their regular salaries. There is not sufficient work while the locations are closed, however, they continue to perform some administrative functions. Employer G has determined, based on the time records, employees are providing 15 percent of their typical work hours. Therefore, 85 percent of wages paid to these employees during the period the locations are closed are qualified wages.
Other components of the ERC
Since the ERC is fully refundable, the eligible employer may get a refund if the amount of the credit exceeds its federal employment tax liability. That is, if for any calendar quarter the amount of the credit the eligible employer is entitled to exceeds the employer’s share of the social security taxes on all wages paid to all employees, then the excess is treated as an overpayment and is available to be refunded to the employer.
How to calculate the ERC
The credit is equal to 50% of qualified wages paid between March 12, 2020, and December 31, 2020, per employee. The maximum amount of qualified wages per employee for all calendar quarters is $10,000, equating to a maximum credit of $5,000 per employee.
How to claim the ERC
Eligible employers report qualified wages and related health insurance costs for each calendar quarter on their federal employment tax returns (usually Form 941, Employer’s Quarterly Federal Tax Return). The ERC may be claimed against the employer’s share of social security taxes.
Employers are permitted to defer the deposit and payment of the employer’s share of social security tax in anticipation of the credit without penalty.
- If the ERC exceeds the payroll deposit, the employer may apply for an advance refund on Form 7200, Advance Payment of Employer Credits Due to COVID-19.
- It’s worth noting that if an employer fully reduces its required deposits of federal employment taxes otherwise due on wages paid in the same calendar quarter to its employees in anticipation of receiving the credits, and it has not paid qualified wages in excess of this amount, it should not file a Form 7200. Otherwise, the employer will need to reconcile this advance credit and its deposits with the qualified wages on Form 941.
Impact of other CARES Act provisions on the ERC
An eligible employer was initially unable to take advantage of the ERC if it had received a loan under the Paycheck Protection Program (PPP) authorized under the CARES Act. However, the PPP Flexibility Act, enacted on June 5, amended this section and allows an employer to receive the benefit of both the ERC and PPP.
Qualified wages for this credit do not include wages for which the employer received a tax credit for paid sick and family leave under the Families First Coronavirus Response Act. Nor can wages counted for this credit be counted for the paid family and medical leave credit.
Employees are not counted for this credit if the eligible employer is allowed a Work Opportunity Tax Credit for the employee.