How Does the Employee Retention Credit Work?

The COVID-19 pandemic necessitated widespread business shutdowns and revenue declines across all sectors. As an employer, retaining your valued team members likely became increasingly difficult amidst cost cuts. The Employee Retention Tax Credit provides timely relief to struggling employers of all types, helping cover payroll costs to keep employees on staff. This article provides an in-depth overview of how this credit works and how your company can potentially benefit.

What is the Employee Retention Credit?

The employee retention credit is a tax credit that eligible employers can claim on their quarterly employment tax returns. It was created in 2020 by the CARES Act to help employers retain employees and continue payroll during COVID-19. The credit was then extended and expanded by the Taxpayer Certainty and Disaster Tax Relief Act of 2020 and the American Rescue Plan Act of 2021.

This valuable tax credit provides an incentive for struggling businesses to keep employees on payroll. If your business meets the requirements, you can reduce your federal employment tax liability by the amount of the credit. This improves cash flow and saves on payroll tax expenses.

Who Qualifies for the Employee Retention Credit?

The most important criteria for claiming the employee retention credit are:

Qualified Wages

Only qualified wages paid to employees are eligible for the tax credit. This includes wages and certain health plan expenses.

Eligible Employers

To qualify, you must be an eligible employer. This is defined as an employer that:

Tax-Exempt Organizations

  • Operates as a tax-exempt organization under section 501(c)

Governmental Organizations

  • Is a governmental office, agency, or instrumentality

In addition, any employer can qualify if they experience:

  • A full or partial suspension of operations due to a COVID-19 government order
  • A significant decline in gross receipts compared to the same quarter in 2019

How Much is the Employee Retention Credit?

Maximum Credit Amount

The maximum credit amount per employee depends on the year:

2020 Maximum

In 2020, it was $5,000 per employee for the full year.

2021 Maximum

This increased to up to $7,000 per employee per quarter in 2021, equaling $28,000 for the year if maximized each quarter.

Credit Calculation

The credit is calculated as 50% of up to $10,000 in qualified wages per employee per quarter. This provides a maximum credit of $7,000 per employee per quarter.

Here is an example calculation:

  • Qualified wages paid to employees in Q1 2021: $15,000
  • 50% x first $10,000 of wages = $5,000 credit
  • Total Q1 2021 credit for employee = $5,000

How Do You Claim the Credit?

Reporting on Tax Returns

Eligible employers claim the employee retention credit on their quarterly employment tax returns, such as Form 941. The credit is taken against the employer’s share of Social Security tax owed for that quarter.

Requesting Advance Payments

Employers can also request advance payments of the credit by submitting Form 7200. These advance payments are then reconciled on the quarterly tax return.

Advance payments allow immediate access to the cash flow benefits of the credit.

When Can You Claim the Credit?

2020 Credits

For 2020, the credit applies to qualified wages paid after March 12, 2020, through December 31, 2020.

2021 Credits

For 2021, the credit applies to qualified wages paid during the first three calendar quarters – January 1 to September 30, 2021.

What Expenses Does the Credit Apply To?

Qualified Wages and Health Plan Expenses

The credit applies to:

  • Wages paid to employees for time they did not work due to COVID-19 circumstances
  • Company-paid qualified health plan expenses allocable to those wages

For 2020, the definition of qualified wages depends on the number of employees.

For 2021, qualified wages are expanded and generally include all wages paid, up to $10,000 per employee per quarter.

Paid Leave Credits

Wages used to claim tax credits for paid leave under the FFCRA are excluded and cannot also be used for the employee retention credit.

Can You Receive Other Tax Credits?

Interaction With Other Credits

Employers who claim the employee retention credit can also qualify for other payroll tax credits, such as the credit for small businesses paying health insurance premiums.

However, wages used for one credit cannot be used again for another credit.

Exceptions

The employee retention credit cannot be claimed alongside a Paycheck Protection Program loan beginning in 2020 Q3.

Employers who receive a Restaurant Revitalization Fund grant also cannot claim the 2021 credit.

Can Other Tax Credits Be Claimed?

Other Payroll Tax Credits

Employers can claim other credits like the paid leave credit and health insurance credit, just not on the same wages.

Coordination With PPP Loans

If you received a PPP loan, coordinate the timing to first claim qualified wages for the retention credit before applying for forgiven

Frequently Asked Questions

Here are answers to some frequently asked questions about employee retention credit:

Q: Are wages paid to furloughed employees eligible?

A: Yes, wages paid to furloughed employees count as qualified wages up to the $10,000 per employee quarterly limit.

Q: Can new employers claim the credit?

A: Yes, new employers that started business after February 15, 2020, can qualify for the credit if they meet the other requirements.

Q: Do wages paid to family members of the owner qualify?

A: Yes, wages paid to a spouse or children of the owner who works in the business can qualify for the credit.

Q: Is the credit refundable?

A: Yes, the IRS will issue a refund to the employer for any employee retention credit exceeding the employment tax liability.

Q: Can sole proprietors claim the credit?

A: Yes, self-employed individuals operating unincorporated businesses may qualify for a credit for their own wages.

Conclusion

The employee retention credit offers substantial tax savings for eligible employers. Make sure to consult the detailed requirements to qualify. You can proactively claim advance payments and retain employees despite COVID-19 impacts. This valuable credit through 2021 provides relief when you need it most. Reach out to your tax advisor to determine your potential credit amount and how to maximize benefits. With strategic tax planning, you can utilize this credit to improve your business’s financial position.

Here are two relevant links related to the article on how the employee retention tax credit works:

IRS Guidance on the Employee Retention Credit

The IRS website provides official guidance, FAQs, reporting requirements, and examples for calculating and claiming the tax credit. This credible government source covers the latest rules.

Study on the Implementation of COVID-19 Business Tax Relief

This National Bureau of Economic Research paper analyzes the rollout and impact of the CARES Act employee retention tax credit and other COVID business relief programs. It provides insights based on tax data.

Note:

Affiliate Disclaimer: From time to time, I will promote, endorse, or suggest products
and/or services for sale that are not my own. My recommendation is ALWAYS based on
My personal belief is that the product and its creator will provide excellent and valuable
information or service. This may be based on a review of that product, my personal or
professional relationship with that person or company, and/or a previous positive
experience with the person or company whose product I am recommending. In most
cases, I will be compensated via a commission if you decide to purchase that product
based on my recommendation.

Leave a Comment

Your email address will not be published. Required fields are marked *

Scroll to Top