What is the Employee Retention Credit (ERC)?
The Employee Retention Credit (ERC) was included as part of the CARES Act relief program that was passed by Congress back in March of 2020 under the Trump Administration to combat the coronavirus pandemic. The purposes of the ERC were twofold. First, it was designed to encourage employers across the United States who had been negatively impacted by the pandemic to keep their employees on the payroll. Secondly, it was designed to help relieve the tax burden on small businesses across the nation struggling under the weight of the pandemic.
The initial credit itself offered eligible employers a refundable tax credit that was 50% of up to $10,000 in wages. As we will discuss, this has changed and increased.
Since its inclusion in the CARES Act, the ERC has been modified two times by two separate bills: the Taxpayer Certainty and Disaster Tax Relief Act of 2020, enacted December 27, 2020, the American Rescue Plan Act of 2021, enacted March 11, 2021. According to the Internal Revenue Service (IRS), “The Relief act amended and extended the employee retention credit (and the availability of certain advance payments of the tax credits) under section 2301 of the CARES Act for the first and second calendar quarters of 2021. The ARP Act modified and extended the employee retention credit for the third and fourth quarters of 2021.”
This has been a lot for small business owners to digest, and quite confusing. As such, in this article we’ll cover the current state of the ERC and discuss who is eligible under the most recent IRS guidelines.
What Is the Actual Tax Credit Being Offered by the ERC?
At this time, the ERC is a refundable tax credit of 70% on up to $10,000 in qualified wages paid per quarter for eligible employers. This means that eligible employers can receive a maximum tax credit of $7,000 per employee for each of the quarters of 2021 – a total of $28,000 per employee for the year.
How Can a Business Qualify for the ERC?
The American Rescue Plan Act of 2021 altered the eligibility guidelines for receiving the ERC.
Guidelines for 2021:
Under the current guidelines as issued by the IRS, there are two ways a business can qualify for the ERC.
- The first way to qualify is based on your business’s revenues. If your business has experienced a decline in revenue on account of the COVID-19 pandemic in any quarter, then you are eligible to receive the ERC for that quarter. To show this, businesses must be able to prove that their gross receipts in the quarter or for the immediately preceding quarter were less than 80% of the gross receipts for the matching quarter of 2019.
- The second way to qualify is if you have had to fully or partially suspend any of your business’s regular operations on account of a government order. The government has issued many orders throughout the pandemic limiting travel, commerce, group meetings, and more to slow the spread of the virus. If your operations were suspended in any way on account of any of these orders, your business is eligible for the ERC regardless of gross receipts.
Guidelines for 2020:
The guidelines for the 2020 tax year were nearly identical to those for 2021 except for a few changes. The biggest change was regarding how much of a decline in gross receipts business’s need to have experienced in order to be eligible for the ERC. To be eligible for the 2020 credit, businesses must have experienced a decline in gross receipts of 50% when compared to the same quarter in 2019.
What are “Qualified Wages”?
Under the current IRS guidelines, qualified wages are different based on whether you are a “small employer” or a “large employer.” The IRS guidelines on who is considered a “small employer” and who is considered a “large employer” are fairly detailed, and they change depending on what you are trying to qualify for (for example, the difference between a “small employer” and a “large employer” under the IRS Affordable Care Act (ACA) guidelines is different than under the ERC guidelines – so make sure you are looking at the right information).
At this point in time, the distinction between a large and small employer is based on the number of full-time employees the business had in 2019. In general, the guidelines are as follows, though your classification may be slightly different based on the individual nature of your business:
Guidelines for 2021:
For 2021, businesses that had 500 or fewer full-time employees in 2019 are being considered “small employers.” Businesses that had more than 500 full-time employees are considered “large employers.”
Guidelines for 2020:
For 2020, businesses that had 100 or fewer full-time employees in 2019 are considered as “small employers.” Businesses that had more than 100 full-time employees in 2019 are considered “large employers.”
How Do Qualified Wages Change Based on Whether You are a Small Employer or a Large Employer?
For small employers, qualified wages are all wages paid to employees providing services, including qualified health plan expenses, for the quarter.
For large employers, the rules are slightly different. Qualified wages are any wages paid to employees (including qualified health plan expenses) for the period for which the employees did not perform services to receive the wages. This means that only wages that were paid to employees who were not working or providing any services for the business are qualified wages. If an employee was still providing services for the company and working their job – i.e. not just being paid to sit home for example – then their wages do not qualify for the ERC.
Are Wages of Owners Qualified Wages?
Under the current IRS guidance, the wages of most majority owners are not considered qualified wages. In a very strange aspect of the bill setting up the ERC, owners who have any living lineal descendants, brothers or sisters (including half-brothers and sisters), or ancestors are not eligible to have their wages qualify. This eliminates most business owners across the United States who have family members or related individuals who are still living.
What If You Took Out a PPP Loan?
One of the biggest points of confusion has been over whether small businesses who took advantage of the Paycheck Protection Program (PPP) and obtained a PPP loan still qualify for the ERC. Under the current IRS guidelines, the fact that your business received a PPP loan in 2020 does not mean that you are not able to take advantage of the ERC for qualified wages.
However, you can only claim the ERC on qualified wages that were not counted as part of your business’s payroll costs to obtain forgiveness of all or part of your PPP loan. Any wages that were included in the forgiveness application and forgiven have already been paid for by the federal government and taxpayer dollars. As such, these wage expenses cannot then be used to obtain the ERC as well.
If your loan forgiveness application is denied and you do not receive forgiveness, the wages may then be eligible for the ERC afterward, which is something to keep in mind if your business does not receive loan forgiveness.
Recovery Startup Business Guidelines
While the main purposes of the employee retention credit center around helping existing businesses weather the pandemic, there have been some recent developments in favor of newer small businesses. For Q3 and Q4 of 2021, the American Rescue Plan Act added in an ERC qualification for “recovery startup businesses.” This is designed to support small businesses that were started just prior to or during the pandemic.
Recovery Startup Businesses are businesses that:
- Began operations on or after February 15, 2020, and
- Have average annual gross receipts that do not exceed $1 million in total
Businesses that meet these two qualifications are eligible to take advantage of the ERC in Q3 and Q4, something to keep in mind if you just recently started a small business and have one or more employees. Unfortunately, these businesses are ineligible to claim the credit for 2020 or for Q1 or Q2 of 2021 – it is strictly for the third and fourth quarters.
Additionally, while these businesses are eligible to receive the full $7,000 per employee if they pay them more than $10,000 in qualified wages per quarter, their total ERC benefit is capped at $50,000 for each quarter – or $100,000 in total for the two quarters. This should only impact your business if you have 8 employees or more.
IRS Safe Harbor Guidelines
The IRS has also recently issued guidelines that provide a safe harbor for employers who will be claiming the ERC for 2020 and/or 2021. Under this safe harbor, businesses are allowed to exclude certain qualified amounts from their gross receipts as they determine whether they are eligible for the ERC benefit.
Businesses are allowed to exclude the following amounts from their gross receipts in their determination:
- Paycheck Protection Program (PPP) Loan amount
- Restaurant Revitalization Grant amount
- Shuttered Venue Operators Grant amount
Note that this safe harbor is only for the purpose of determining whether or not your business is eligible to claim the ERC benefits on your tax return. These amounts cannot be excluded in the calculations for other aspects of your federal tax return.
Consider Working with a CPA
Navigating IRS tax codes and working through all the details can be difficult and confusing for small business owners who don’t have a great deal of experience in accounting and dealing with the IRS. Plus, with all the other things small business owners have on their plates right now, it is understandable that many of them do not have the time or energy to try to sort through all of this. This is part of what has made all the confusion surrounding these programs even more difficult for small business owners – they simply don’t have the time to sort through all the changes that are constantly being made to see if their business qualifies for the various benefits.
As a result, we highly recommend getting in touch with a certified public accountant (CPA) who specializes in working with small businesses. They will be able to provide additional guidance and assistance that is specific to the circumstances of your small business in particular. Whereas the information in this article is more generalized for a wide array of business owners, a CPA will be able to dive into the actual financial standing of your small business and determine if you are eligible for many of these programs. Plus, they’ll have a detailed understanding of things like aggregation rules, revenue procedures, attribution rules, disallowance, and other IRS tax rules and how they might pertain to your business’s situation.
If you also took out a PPP loan, they will also be able to assist you in that process. Plus, they will be able to help reconcile the PPP benefits with any other ERC benefits you may be eligible for afterward.
Many of these programs can provide your small business with a significant financial windfall – which could mean the difference between success and failure for your business at a time like this. As such, we recommend trying to take full advantage of each of the available programs and we recommend getting qualified and professional help that will enable you to do so.
Implications of the Infrastructure Bill
It looked for some time like Congress was going to end the ERC early when the Senate approved the infrastructure bill in August. Under the terms of the bill, the ERC would end in Q3, and all wages paid after September 30, 2021, would no longer be eligible for the credit. Despite this, the IRS has continued to issue guidelines regarding the ERC, including its extension into Q4. With the current state of affairs on Capitol Hill, it does not look like there is too much to worry at this point about the ERC ending since there is very little to suggest that the infrastructure bill will be signed into law before 2022 – if ever. That said, there still remains a level of uncertainty regarding what the state of the ERC benefits will be if and when the bill is signed into law. Hopefully, lawmakers in Washington will be able to sort out any issues pertaining to the ERC before the bill is passed.
Remember to Keep Clear and Organized Financial Records
With all the benefits that are up for grabs for small businesses on account of the pandemic, having clear and organized financial records that are easy to read and access is more important than ever before. Qualifying for many of these benefits depends in large part on your business’s finances over the last few years. As such, this is yet another example and reminder for small businesses about the importance of good record keeping. Putting in a little effort now to keep all your affairs in order can pay dividends in the future and save you a lot of time down the road.
Plus, with all the affordable online software designed for keeping your small business’s finances neatly and systematically filed, there really is no excuse for not making sure you always have access to a complete picture of the financial history and health of your small business. A CPA can help get you started in terms of keeping proper records for your small business.
Make Sure the Information You Are Reading Is Up to Date
With all the changes that have taken place regarding the ERC since its initial inception back in 2020, it is critical that you ensure the information you are reading is up to date with the latest IRS guidelines. As such, be sure to check the date on the top of any articles or guidance you are reading to make sure it is recent.
Qualifying for the ERC can be a significant boost for small businesses during this time. The ERC is a significant tax credit that can help your business keep more money in its bank account and have greater control over its cash flow. However, as with most things related to taxes, the ERC is confusing. Getting qualified and professional help in the process can be a real game-changer, and we highly recommend seeking out the assistance of a CPA as a result. With a little bit of research and diligence you can ensure your small business receives all the pandemic-related benefits it is entitled to – benefits that can make a real difference for your company.
At Biz2Credit, our number one priority is serving the millions of small business owners across the United States in their efforts to build and grow successful and sustainable companies. With the ongoing pandemic and the natural disasters that the nation has recently faced, we realize that our mission has never been more important than it is now. As such, we work tirelessly to bring our readers the latest information and news pertaining to developments in the U.S. small business community. So, please continue to check back here at our Biz2Credit Blog for the most recent articles and posts!