Employee Retention Credit Available To Businesses Affected By COVID-19

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  • Contributors:
  • Derik Rynearson
Business owner researching Employee Retention Credit

The passing of the Coronavirus Aid, Relief, and Economic Security (CARES) Act created another incentive for businesses to keep employees on their payroll – the Employee Retention Credit. This tax credit applies to businesses whose operations have been impacted by government executive orders or are experiencing a remarkable decline in revenue.  

The Consolidated Appropriations Act, 2021 (CAA)  passed in December 2020 – increases the credit amount and allows businesses to reap the benefits of both this credit and PPP loans. Some changes are retroactive to the passing of the CARES Act in March 2020, including:

  1. Your ability to claim this credit and obtain a PPP loan
  2. The definition of gross receipts of a tax-exempt entity
  3. Group health care plan expenses that aren’t included in employees’ gross income are considered qualified wages

If you qualify for the Employee Retention Credit, it’ll bring instant cash relief, and the credit amounts may be large. Here’s what you need to know.  

 

What’s the Employee Retention Credit?

It’s a fully refundable tax credit for a percentage of the qualified wages you pay employees. It’s applied to your federal payroll tax liability. Any excess credit amount is refundable. 

 

Am I eligible for this credit?

Businesses and tax-exempt organizations operating in any calendar quarter of 2020 can claim this credit. However, they must have: 

  • Fully or partially suspended business operations for any calendar quarter in 2020 due to governmental orders limiting commerce, travel, or group meetings due to COVID-19
    OR
  • Experienced a significant decline in gross receipts during a calendar quarter in 2020

Governmental employers and self-employed individuals aren’t eligible for this credit. 

Example

Governor Gretchen Whitmer signed an executive order in March 2020 directing Michigan businesses to suspend operations that aren’t necessary to sustain or protect life. If you had to substantially change how you do business to comply with this order (i.e., fully or partially suspend operations), you’re likely eligible for this credit. 

Closing indoor dining and offering takeout is an example of partially suspending operations. Closing your business is an example of fully suspending operations.

 

How does the credit work?

In 2020, the Employee Retention Credit was 50% of all qualified wages you paid employees between March 12, 2020, and Dec. 31, 2020. It was limited to $10,000 in wages per employee for all quarters. Therefore, you could claim a maximum credit of $5,000 for each employee. 

In 2021, the credit is 70% of all qualified wages you pay employees from Jan. 1, 2021, through June 30, 2021. It’s limited to $10,000 in wages per employee for any quarter. Therefore, you can claim a maximum credit of $7,000 for each employee in every quarter. Since the credit is only available for wages paid in the first two quarters of 2021, the maximum credit is $14,000 per employee. 

What are qualified wages?

Generally, qualified wages are compensation you pay to employees, including qualified health plan expenses. But, the definition also depends on your average number of full-time employees in 2019

1. If your average was more than 500 full-time employees in 2019, qualified wages are the wages you paid to employees who aren’t providing services because of: 

  • A full or partial suspension of operations by order of a governmental authority due to the coronavirus
    OR
  • A significant decline in gross receipts

If you fall within this category, the qualified wages can’t exceed what you would have paid the employee for an equivalent duration during the 30 days preceding your economic hardship. If you don’t pay any employees for not working during 2020 or the first two quarters of 2021, you’re not eligible for this credit. However, if you sometimes pay employees for working and not working, you can use the wages you paid employees for not working to claim this credit.

Example: You paid Ted for 40 hours in February 2021. He worked 10 hours and didn’t work 30 hours. In that case, you’d exclude any wages you paid Ted for working when calculating the credit. Only the wages you paid him for not working (30 hours) are qualified wages and eligible for this credit.

If you continue to provide health care benefits to employees who aren’t working, those benefits are qualified wages.

2. If your average was fewer than 500 full-time employees in 2019, qualified wages are the wages you paid to any employee because of: 

  • A full or partial suspension of operations by order of a governmental authority due to the coronavirus
    OR
  • A significant decline in gross receipts 

If you fall within this category, qualified wages aren’t impacted by whether an employee is or isn’t working. Any employee you continue to pay affects your credit amount. 

When claiming the Employee Retention Credit for 2020, the employee thresholds are 100 full-time employees in 2019. The CAA increases the number of full-time employees to 500 for the 2021 credit.

What’s a full-time employee?

A full-time employee is an individual who’s employed at least 30 hours per week (on average). The IRS hasn’t clarified if full-time equivalent employees are included in full-time employee counts.

 

How do you calculate the credit amount for each employee?

You calculate the credit based on qualified wages you pay your employees each quarter. Let’s look at two examples that reflect the 2021 updates. 

  1. You pay Keith $10,000 in the first quarter of 2021. The credit amount available to you is 70% of qualified wages – $7,000. In Q2 of 2021, you pay Keith $10,000. Once again, you can claim a $7,000 credit in Q2.
  2. You pay Kelly $8,000 in Q1 of 2021. You pay her $12,000 in Q2 of 2021. Your credit is $5,600 in Q1 and $7,000 in Q2Kelly’s wages exceed $10,000 in Q2, so the credit calculation is capped at $10,000.

 

What’s a significant decline in gross receipts?

In 2020, the significant decline was a 50% decrease in gross receipts for the same calendar quarter in 2019.

In 2021, the significant decline is a 20% decrease in gross receipts compared to the same quarter in 2019. Or, you can use the previous quarter’s gross receipts compared to the same quarter in 2019. For example, in Q1 2021, you can compare gross receipts for Q1 2021 to Q1 2019 or compare gross receipts for Q4 2020 to Q4 2019.

The significant decline ends with the first calendar quarter where your gross receipts are greater than 80% of its gross receipts for the same calendar quarter in 2019.

Gross receipts are your total revenue without subtracting returns or discounts, operating expenses, or unpaid invoices. It’s strictly the total amount of revenue your business collects in a tax year. 

For example, you have $250,000 in gross receipts in Q1 2019. In Q1 2021, your gross receipts are $100,000. That’s more than a 20% decrease and marks the start of a significant decline. In Q2 2019, your gross receipts were $200,000. In Q2 2021, your gross receipts are $180,000. Your gross receipts are more than 80% of Q2 2019 gross receipts, so your significant decline period has ended. Therefore, you can only claim the credit for Q1 of 2021. 

 

Flowcharts

If you’re trying to figure out if you qualify for the Employee Retention Credit, take a look at our flowcharts. They provide a simplified, step-by-step guide to help you determine your eligibility in 2020 and 2021. Refer back to this blog post for key definitions, examples, and more.

How do you claim the Employee Retention Credit?

You’ll report your qualified wages and related credits for each calendar quarter of your federal employment tax returns via Form 941, Employer’s Quarterly Federal Tax Return. You use Form 941 to report income, social security, and Medicare taxes you withhold from employee wages and your portion of social security and Medicare tax. 

The CAA includes language that would allow taxpayers to claim retroactive 2020 tax credits on Form 941 for Q4 2020. However, the IRS hasn’t released additional guidance or amended the form to allow this.  

 

How can I pay my employees?

If you expect to receive this credit, you can pay employees by reducing your federal employment tax deposits. If you go this route, you won’t be subject to a deposit penalty. Or, you can request an advance payment of the credits to help pay your employees. To request an advance, file Form 7200 with the IRS.

 

What else do I need to know about the Employee Retention Credit and other coronavirus-related benefits?

You can claim both the Employee Retention Credit and the tax credit for providing paid leave under the Families First Coronavirus Response Act (FFCRA). However, you can’t claim both credits for the same wages. And, you can’t include the paid leave wages under the FFCRA in your calculation of qualified wages for the Employee Retention Credit. Keep them separate. 

If you received a PPP loan, you can now claim the Employee Retention Credit too. When the CARES Act first passed, you had to choose between this credit and a PPP loan. 

If you apply for forgiveness of your PPP loan and it’s approved, you can’t claim this credit for wages you paid with your PPP loan. If your forgiveness request isn’t granted, you can use wages paid with your PPP loan to claim this credit.

We’re waiting for the IRS to answer two questions about PPP loan forgiveness and the Employee Retention Credit.

  1. If you reported more wages on your forgiveness application than was necessary to reach 100% forgiveness of the loan, can you use those excess wages to claim the Employee Retention Credit?
  2. Can you revise your PPP loan forgiveness application? If you’re allowed to use excess wages to claim the credit, you may want to adjust your application to include more nonpayroll expenses. This would give you more ways to maximize your PPP forgiveness request and the Employee Retention Credit.

Regardless of any outstanding questions, the enhanced flexibility could result in substantial savings for your business.  

 

View more frequently asked questions about the Employee Retention Credit here. If you have any questions about this credit, need assistance claiming it, or want to know how it coordinates with other coronavirus relief measures, we can help.  

Originally published 4/10/2020. Updated 2/9/2021.

 

Have questions about the Employee Retention Credit? Let’s talk!