After the arrival of the COVID-19 pandemic last March, businesses across the country entered a long period of turmoil and uncertainty. For many of them, this period has not yet ended. However, the passage of the CARES Act in late March of last year, in addition to the passage of the American Rescue Plan Act this year, offered businesses a number of opportunities to receive support.
One of these support systems comes in the form of Employee Retention Credit, an admittedly complicated and not necessarily well-understood tax credit that, with proper planning, can provide massive benefits to businesses in the form of sizable payouts.
What is Employee Retention Credit?
The Employee Retention Credit (ERC) is a refundable payroll tax credit for “qualified wages” paid to retained full-time employees. I’ll get into more detail later on, but what that essentially means is that you can receive a refundable tax credit (up to a certain amount) based on money paid to retain full-time employees.
This provision was introduced under the CARES Act last year, and covered the period from March to the end of December. Thankfully, under the recently-passed American Rescue Plan, the Employee Retention Credit period has been extended through the end of 2021. When all is said and done, this opens up opportunities for businesses to save tens of thousands of dollars in taxes—or sometimes even more.
That being said, in order to qualify for Employee Retention Credit, you’ll have to meet a set of very specific standards, some of which change depending on what kind of business you run. The rules can get fairly complicated, but keep in mind that with a good tax plan and a qualified CPA like me, you can easily make the most of this provision.
How Does Employee Retention Credit Differ from PPP Loans?
First, a brief clarification. I’ve previously discussed PPP loans and the numerous benefits they provide for businesses struggling during this pandemic. While it’s good to know about those, an important distinction needs to be made: Employee Retention Credit and PPP Loans may seem similar, but they are two completely separate things.
In fact, they cannot be used to cover the same wages. Essentially, it's possible to make use of both, but you can’t “double up” on the same expenditures. Keep this in mind during your tax planning preparation, as it’s not only easy to make a mistake, but you could also be missing out on massive payouts if you don’t plan correctly.
With that in mind, if you applied for PPP Loan forgiveness, I suggest waiting for it to go through so you can see where those funds were allocated. Once you determine your eligibility for ERC, you’ll be able to more accurately and effectively make use of the funds—and you’ll be grinning ear to ear around tax time.
Unlike PPP loans these are not loans and thus do not need to be forgiven.
How Do I Qualify for Employee Retention Credit?
As stated earlier, there are a number of qualifications you need to meet in order to make use of ERC. Of all of these qualifications, you should familiarize yourself with two in particular, as they’re both the most far-reaching and the most complex.
Primarily, you qualify for ERC if business was suspended, either entirely or in part. For most, the latter applies, especially as many businesses begin to open up at partial capacity. In such cases, this usually counts when at least 10% of your business was suspended, though it depends heavily on the facts and circumstances surrounding the suspension.
Of all the qualifying factors for ERC, this is the most straightforward, and due to the widespread nature of the pandemic, it’s likely that your business qualifies. That being said, it’s once again highly recommended to get a CPA to help you, especially when it comes to the second qualifying factor.
That factor is the Gross Receipts Test, and it’s here where things get much more complicated. Under this test, you can compare your quarterly reports for 2020 to corresponding quarters from 2019 (Quarter 2 in 2020 compared to Quarter 2 from 2019, for example). If during these comparisons you saw a considerable drop (specifically, at least 50%) in 2020—and, under the circumstances, this is very possible—it can be assumed that this was due to COVID.
I’ll try to demonstrate this in action through a very probable real-world example. Let's say your business didn’t have to suspend operations at all during 2020 due to the pandemic. However, one or more of your suppliers was forced to suspend operations in some capacity. Your hours may not have been affected directly, but an aspect of your business still suffered.
Even in 2021, you may qualify when your 2021 quarterly comparisons to 2019 (as this was the last pre-covid year and still counts toward your claim) result in a 25% drop in any quarter or the quarter before. In that case, the pandemic has affected you, and with some help from a CPA (your best option, as this gets complicated), you will most likely qualify for Employee Retention Credit, and this can be a massive amount of money. For one of my clients, the credit was over $100,000.
One final note: If you run an S-Corp, C-Corp, or a Partnership, you and your spouse (provided they’re on the payroll) can qualify for ERC funds. However, any relatives beyond that—your sister, your brother-in-law, son-in-law, etc.—will not qualify for ERC if they’re on the payroll.
What Else is There to Know About Employee Retention Credit?
Like I said, dealing with Employee Retention Credit can be profoundly complicated, and it’s not recommended to tackle the subject without a CPA. However, there are a few key points you should know before you apply.
First of all, there’s the math. At the time of writing, ERC for 2021 is 70% of an employee’s wages up to $10,000 per quarter for which you qualify. In a business consisting of four people, each one making more than $10,000 per quarter, and you qualify for ERC for all four quarters, that’s $28,000 per quarter and $112,000 for the year in credit alone. It’s in this way that businesses taking full advantage of ERC can see massive payouts.
For 2020, the credit was limited to 50% of employee wages up to $10,000 per year. This limited the credit for 2020 for a business with four people, each making $10,000 per quarter to $20,000 for the year if they qualified for any quarter.
Most importantly of all, ERC is based on both original and amended 941 forms. Once you make your claim and submit these forms, the IRS has three years to audit them (except for the third and fourth quarter of 2021, as the law extended the audit period to five years). If and when that time comes, you need to be prepared to back it up with documents. Otherwise, you’ll face both financial and legal troubles.
As a quick note: If the situation requires it, you can request an advance in ERC. This, however, like everything else related to this subject, is deeply complicated, and should be dealt with carefully.
While this all may seem to make Employee Retention Credit more clear-cut, please bear in mind that this isn’t always the case. Once again, it’s highly advisable to hire a CPA like me to help you apply for ERC correctly, both to avoid legal complications and to get the most out of your taxes.
One way or the other, this is a massive opportunity that you should not let pass you by. Talk to a CPA, see if you qualify, get your applications in order, and reap the benefits of top-quality tax planning. Good luck, and as I always say, let’s make this our most profitable year ever!