What to Know About the Employee Retention Credit

The Employee Retention Credit (ERC) is a refundable tax credit that was designed to help organizations keep their employees on payroll during the COVID-19 pandemic. While the deadline to file an ERC claim for 2020 was April 15, 2024, we still have until April 15, 2025 to file a claim for any eligible 2021 quarter.

Here’s what you need to know to navigate the process of the ERC and maximize your benefit.

Who Qualifies for the ERC?

The ERC is available to businesses, nonprofit organizations, and specific governmental entities during a calendar quarter if they:

• Were fully or partially suspended by government order during the pandemic.
• Saw 2020 gross receipts fall below 50% of the same calendar quarter in 2019 or
• Saw 2021 gross receipts fall below 20% of the same calendar quarter for 2019.

Fully or Partially Suspended by Government Order

A business is considered to be fully or partially suspended if an appropriate government authority imposed restrictions limiting travel, commerce, or group meetings due to COVID-19. Even if a business was allowed to operate, they could still be eligible if they weren’t allowed to operate at normal capacity. For example, a restaurant who only provided drive-thru services due to an executive order would be considered partially suspended.

Here’s what else you should know about a full or partial suspension of operations:

• Being classified as an essential business does not automatically disqualify an employer from being an eligible employer.
• If an essential business had operations suspended due to a supplier being fully or partially suspended due to a governmental order, the essential business can be an eligible employer.
• If an employer’s workplace was closed by a governmental order for certain purposes, but the employer’s workplace could have remained open for other purposes, or the employer is able to continue certain operations remotely, the employer’s operations would be considered partially suspended.
• If, on the other hand, a business could do all usual functions via teleworking, its operations would not have been deemed partially suspended.
• An “order from an appropriate governmental authority” includes “orders, proclamations, or decrees” but wouldn’t, for example, include statements made during a press conference.
• A governmental order limiting hours of operations for a business would constitute a partial suspension of operations.
• An employer that operates an essential business that is not required to close its physical location or otherwise suspend operations is not considered to have a full or partial suspension of its operations.
• Employers that operate a trade or business in multiple locations and are subject to state and local government orders limiting operations at some, but not all, locations are considered to have a partial suspension of operations.
• In addition to a government order being in place, a business must also meet more than nominal testing to be eligible for the ERC.

How the ERC is Calculated

The credit amount for 2020 is 50% of up to $10,000 of qualifying wages per employee for the period of March 13, 2020, through December 31, 2020. In other words, the maximum credit for 2020 is $5,000 per employee.

For 2021, the credit amount is 70% of up to $10,000 of qualifying wages per employee for each eligible quarter. In other words, the maximum credit per employee is $7,000 per quarter.

Qualifying Wages

Qualifying wages include not only cash compensation paid to each employee, but the allocable portion of their health care costs as well.

There are some stipulations related to qualifying wages under the ERC:

• Severance payments do not qualify for the ERC.
• Wages paid for vacation, sickness, or other personal leave under a preexisting plan aren’t qualified wages for ERC for large employers because the leave time was accrued during a time when the employees were providing services.

ERC Minimum Number of Employees

For the 2020 ERC, while there is no company size restriction to qualifying for the ERC, special rules apply if the number of full-time employees (as defined in IRC section 4980H) in 2019, on average, exceeds 100. Those businesses may only compute the credit based on wages and health care paid to employees not providing services during an eligible 2020 period. If the 2019 average full-time employee count is 100 or fewer, the company is deemed to be a small employer and the credit is based on wages paid to all employees, whether they were working or not.

For the purposes of determining the 100-employee count, aggregation rules apply under IRC section 52(a) controlled group of corporations, 52(b) employees of partnerships, proprietorships, etc. under common control, 414(m) employees of an affiliated service group, or 414(o) related regulations.

Similar rules apply to the 2021 ERC. However, the number of full-time employees was raised to 500 or fewer to be deemed to be a small employer, still based on 2019 average full-time employees.

How to Claim the ERC

The ERC is taken by amending the organization’s payroll tax returns for the eligible quarters.

The ERC differs from some other COVID incentives in that the credit is taxable. Guidance provides that the organization taking the credit must reduce their wage deduction on their income tax return for the year which the ERC was claimed. For example, if an organization claimed ERC for 2020, the organization may need to amend their tax return for a reduction of the wage deduction in the amount of the credit if it wasn’t captured on an originally filed income tax return.

Here’s a breakdown of the changes to the ERC across 2020 and 2021:

The ERC and the Paycheck Protection Program

Changes to the Employee Retention Credit program at the end of 2020 allowed eligible employers to take the ERC in addition to the Paycheck Protection Program loan. Originally, many employers were forced to choose between the ERC and a PPP loan under the CARES Act.

Eligible employers can now claim the ERC on wages to the extent the wages were not paid with forgiven PPP loan proceeds. An eligible employer is one that has elected not to include any qualifying wages for ERC purposes “up to (but not exceeding) the minimum amount of payroll costs, together with any other eligible expenses reported on the PPP Loan Forgiveness Application, sufficient to support the amount of the PPP loan that is forgiven.”

Additionally, if any qualified wages are included on a PPP loan forgiveness application but the loan is not forgiven, those qualified wages can be taken into account for ERC purposes.

Withdrawing an Erroneous ERC Claim

The vast majority of ERC claims received by the IRS show signs or fraud or errors, and as a result, the IRS has launched efforts to address fraud, educate about erroneous claims, and help employers resolve improper claims without penalty. Perhaps the most notable example of these efforts was the ERC Voluntary Disclosure Program (VDP), launched in January 2024. Under the VDP, eligible participants returned 80% of the ERC received, retaining 20% of the credit and avoiding civil penalties and interest.

The VDP was closed March 22, 2024, and it is unclear if the program will reopen in the future. However, the IRS has created a process for employers to withdraw an erroneous claim that was made unintentionally.

Note that you can only use the ERC claim withdrawal process if all of the following apply:

• You made the claim on an adjusted employment tax return (Forms 941-X, 943-X, 944-X, CT-1X).
• You filed your adjusted return only to claim the ERC, and you made no other adjustments.
• You want to withdraw the entire amount of your ERC claim.
• The IRS has not paid your claim, or the IRS has paid your claim, but you haven’t cashed or deposited the refund check.

Benefit from the Employee Retention Credit

Many companies see immense potential in the ERC, even years after the pandemic; however, understanding if you qualify is just the first step. There is much to consider about how to take the credit, which employees qualify, and more. That’s why it’s important to work with a designated team to help you understand and maximize the benefit of the ERC.