Employee Retention Credit (ERC): Complete Guide

When the Employee Retention Credit (ERC) was introduced with the CARES Act 2020, employers were apprehensive about how to file because of the difficulty in understanding whether their businesses qualified. As the IRS has released more clarification on who qualifies and how to file, more companies have taken advantage of the ERC to free up cash flow.

As the government has passed more relief Acts and spending bills, more companies qualify for the ERC and need to know the ins and outs of filing a claim. We’ll cover what the ERC is and how it can benefit your business. We’ll also explain who qualifies and how to calculate your credit.

Table of Contents

What is the Employee Retention Credit?

The Employee Retention Credit, also known as the Employee Retention Tax Credit (ERTC), is a refundable credit that qualifying employers can claim on qualified wages of their employees. It was enacted to provide cash flow relief for employers during the COVID-19 pandemic and lockdowns.

The ERC first came into being during the CARES Act of 2020. As the country continued to struggle from the COVID-19 pandemic, other laws were enacted to extend the ERC but with amended qualifications.

The CARES Act 2020

The Coronavirus Aid, Relief, and Economic Security (CARES) Act introduced the ERC, allowing qualifying employers to claim a credit against 50% of the qualified wages paid between March 13, 2020, through Dec 31, 2020. An employer could claim up to $10,000 per employee annually.

Consolidated Appropriations Act 2021

As the pandemic continued, businesses were still hurting from lost revenue and sporadic lockdowns. To offset these losses, the Federal government passed the Consolidated Appropriations Act 2021 on December 21, 2020.

Under this new spending bill, qualified employers, including PPP recipients, could claim the ERC against 70% of qualified wages paid. This extended the credit for the first two quarters of 2021, where employers could claim up to $10,000 per employee per quarter.

American Rescue Plan Act 2021

As the country struggled to recover and businesses were feeling the pinch from lackluster consumer spending, the Federal government passed the American Rescue Plan Act 2021 on March 11, 2021.

This spending bill extended relief for hard-hit small to medium size businesses. The American Rescue Plan extended the ERC where qualifying companies could claim 70% of qualified wages paid up to $10,000 per employee per quarter until the end of 2021.

The act also included relief for new businesses that started after February 15, 2020, and grossed less than $1 million during 2020. These new startups that didn’t qualify for the ERC could now claim up to $50,000 per quarter.

Would you like help to calculate your ERC? Contact Parachor Consulting to leverage their extensive corporate tax expertise.

Who Qualifies for the Employee Retention Credit in 2021

Because the Consolidated Appropriations Act and American Rescue Plan Act expanded qualifications for the ERC, most employers can qualify. This includes:

Universities
Colleges
Hospitals
501(c) Organizations
Companies who took a Paycheck Protection Program (PPP) loan in the initial round

This is a significant change because companies who originally borrowed under the PPP could not claim the ERC. Now to qualify, employers must meet at least one of three qualifications within the quarter the employer is taking the credit:

1. Business Suspended from Government Order

The business was fully or partially locked down or had reduced business hours because of a government order. In this case, the credit is only for the amount of time the business was suspended and cannot take credit for the entire quarter.

Many employers do not qualify under this criteria because they could continue business operations through remote work or be considered an essential business that could remain open. There is an exception for essential businesses that had their supply chain of goods and materials disrupted enough to affect their business operations can claim the credit.

2. Significant Decline of Gross Receipts

The IRS Revenue Procedure 2021-33 created a safe harbor for employers to exclude the forgiveness amount of the PPP loan from their gross receipts when filing for the ERC. Employers who also received a Shuttered Venue Operators Grant or a Restaurant Revitalization Fund grant do not need to include the grants in the gross receipts when filing an ERC claim. But in order to qualify for the safe harbor, businesses must apply consistently across all entities.

From the Consolidated Appropriations Act, employers have to see more than a 20% drop in gross receipts in the quarter when compared to the same quarter from 2019. The American Rescue Plan Act 2021 also allows businesses to use gross receipts in the preceding calendar quarter to compare with the corresponding quarter in 2019.

3. Recovery Startup Business

Businesses that qualify as a Recovery Startup Business meet these requirements:

Started the business after February 15, 2020.
Have annual gross receipts totaling less than $1 million.
Did not qualify under the other two ERC requirement categories of declining gross receipts or suspension of operations. If the startup qualifies for one of these in the third or fourth quarter, the business would no longer qualify as a Recovery Startup.

IRS Notice 2021-49 states that Recovery Startups can use all qualified employee wages for the credit, regardless of the number of employees. Businesses that qualify as a Recovery Startup should also be aware that they may need to make additional changes to their tax forms to claim the credit.

Employers Utilizing a PEO or CPEO Can Also Claim the ERTC

If you work with a Professional Employer Organization (PEO) or a Certified Professional Employer Organization (CPEO), you can still claim the retention credit. You can report the credit on the PEO aggregate Form 941 and Schedule R.

Do you need advice about whether to file an ERTC claim? Find out more about Parachor’s Employee Retention Tax Credit services and how they can help.

What Wages Qualify When Calculating?

When Calculating the Employee Retention Credit, employers can use:

Any wages or compensation subject to FICA taxes paid after March 12, 2020, through December 31, 2021
Qualified health expenses paid after March 12, 2020, through December 31, 2021; you can read more about what qualifies as a health expense on the IRS FAQ. Essentially, this includes the employee and employer pre-tax portion but not any after-tax amounts.

If your company has a PPP loan, credit can only apply to wages not forgiven or expected to be forgiven under PPP.

Want professional help filing your Form 7200 to ensure accuracy and avoid an audit? Contact Parachor Consulting to talk to one of our consultants.

How is the Employee Retention Credit Calculated?

To calculate the ERC, the employer must:

1. Count the number of full-time employees.

To be considered a full-time employee, the person must have worked during 2019 for at least:

30 hours per week
130 hours a month ( equal to 30 hours a week)

For employers that were in business all of 2019 or 2020: Add the number of full-time employees for each month and then divide that number by 12 to find the average.

For businesses that started in 2019 or 2020: Add the number of full-time employees for each month the company was operating that year. Then divide that number by the number of months in business.

Employers should note that this is different from calculating the full-time equivalent (FTE) for the PPP forgiveness report.

2. Add the qualified wages of all the full-time employees.

When adding the qualified wages, remember that there is a cap of $10,000 per employee for each quarter.

3. Apply any rules based on the number of full-time employees.

If your average number of full-time employees during 2019 is more than 100, employers can only count the wages paid to an employee because the business was suspended from the operation or the business had a significant decline of gross receipts for the quarter. These wages cannot be more than the wage amount paid to the employee during the 30 immediately preceding that time.

If your average number of full-time employees during 2019 is less than 100, the employer can count all the wages paid to all employees suspended from the operation or the substantial decline of gross receipts. This includes employees who were not prevented from working during the COVID-19 lockdowns.

There may be other rules that apply depending on the nature of your business, size of the business, and length of the lockdown in your state. It would be wise to talk to an accounting expert who specializes in ERC filing to ensure you’ve calculated the wages according to all the ever-evolving IRS rules.

Once filed correctly, the credit will then pay 50% of the qualified wages in 2020 and 70% of the qualified wages in 2021. This means the maximum a business can receive per employee is $5,000 in 2020 and $7,000 in 2021.

Are Tipped Wages Included in Qualified Wages When Calculating?

According to the IRS Notice 2021-49 that clarifies miscellaneous issues relating to the Employee Retention Credit, tipped wages should be included in qualified wages if the tipped wages were subject to FICA.

So if the employee made over $20 in tips within a calendar month, these tips should be included in the qualified wages for the retention credit. If tips are less than $20 within a month, then these tips are not subject to FICA and wouldn’t qualify for the ERTC.

Can You Still Claim Employee Retention Credit for 2020?

IRS Notice 2021-20 states that a qualified employer can claim the ERTC for qualified wages that were paid between March 12, 2020, through January 1, 2021. If your business qualifies, then you can still submit a claim for a refund within 3 years of filing your quarterly payroll taxes.

How to Retroactively Claim the Retention Tax Credit

IRS Notice 2021-20 explains how employers with a PPP loan can retroactively claim the Employee Retention Tax Credit. To claim past quarters, the employer must submit the following for the applicable quarter(s) when qualified wages were paid:

Form 941-X (also known as Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund)

The IRS provides some instructions on how to file Form 941-X. If this still feels a bit challenging, you can always contact Parachor Consulting for assistance in completing this form accurately.

When Would it be Better to Take the Credit on an Amended Return?

There are a couple of situations where you may want to claim the ERC on your quarterly filed return:

More IRS guidance may be needed to help ascertain if the employer truly qualifies to claim the credit. This may be in relation to PPP forgiveness, overall headcount, or partial shutdown orders from the government. If in doubt, you’re probably better to file your quarterly return rather than apply for the ERC beforehand.
If the employer received a second draw PPP loan, then the employer will need the payroll money for forgiveness, even if there is an extension.

The Employee Retention Credit Can Greatly Help Qualified Employers

If your business qualifies for the ERC, filing for the credit can significantly help your business’s cash flow. But before you claim your credit, you may want to talk to tax professionals to determine if this is a wise decision for your business. Tax professionals can also help you maximize the amount that you qualify for the credit.

Parachor Consulting specializes in tax consulting services for small to medium-size enterprises. With large firm experience, our tax experts will ensure your business receives the best in tax services so that no money is left on the table when filing your ERC.

Want professional help filing your Employee Retention Tax Credit? Contact Parachor Consulting to learn more about corporate tax expertise and how they can help.