Leveraging Employee Retention Credits When Business Slows Down

The economic impacts of COVID-19 have caused many employers to experience a reduction in business and revenue. Fortunately, the employee retention tax credit offers crucial relief for companies struggling with business declines. This blog examines how employers can qualify for potentially substantial credits based on a lack of business during the pandemic.

What Is the Employee Retention Tax Credit?

The employee retention credit is a refundable payroll tax credit that enables employers to offset the costs of retaining employees during COVID-19 disruptions. Key provisions:

  • This applies to eligible wages paid from March 13, 2020, through December 31, 2021.
  • Equals 50% of wages up to $10,000 per employee for 2020. Rises to 70% of up to $10,000 per quarter in 2021.
  • Eligibility requires a gross receipts decline of over 20% compared to the same quarter in 2019.
  • Provides up to $7,000 per employee annually for 2020 and $21,000 per employee for 2021.
  • Refundable credit claimed against employer payroll taxes. Excess credits result in refunds.

This powerful credit offers businesses facing economic challenges the ability to offset payroll costs and weather revenue declines.

Using Lack of Business to Qualify

The threshold for the credit is a 20% quarterly decline in gross receipts compared to the same quarter in 2019. This year-over-year reduction demonstrates the COVID-19 business impacts required to qualify.

For many companies, the pandemic resulted in a major loss of business and revenue as economic activity contracted. Employers can leverage these business declines to qualify for substantial retention credits.

Examples include:

  • Restaurants with reduced patrons due to shutdowns or customer avoidance.
  • Retailers, malls, and stores with lower foot traffic and sales.
  • Hospitality, travel, and entertainment venues with plunging bookings.
  • Manufacturers with reduced production and orders.
  • Professional service firms with fewer billable hours due to delayed projects.
  • Events, sports teams, and promoters with canceled seasons and shows.

Any material disruption that decreases quarterly receipts can qualify, allowing employers to benefit when a business suffers.

Calculating Required Revenue Declines

To substantiate a sufficient reduction in business for credits, employers must compare gross receipts quarterly to the corresponding 2019 quarter. Gross receipts equal all revenue generated before reductions for expenses, costs, or deductions.

Steps to determine declines:

  1. Calculate gross receipts for each quarter in 2020 and 2021. Aggregate all revenue from sales, services, products, membership fees, investments, and other sources.
  2. Calculate gross receipts for the same calendar quarters in 2019. The comparison baseline quarters cannot be changed.
  3. Compare gross receipts for each 2020/2021 quarter to the same 2019 quarter.
  4. If the decline exceeds 20% for that quarter, the employer qualifies for credits on eligible wages paid during that quarter.
  5. Retain detailed calculations, accounting records, quarterly financial statements, and other documentation to prove eligible declines.

Gross receipts used for other tax credits like the research credit form the basis for computing retention credit eligibility. The IRS has cautioned that switching accounting methods to maximize declines will be disallowed.

Qualified Wages

Once an employer meets the revenue decline threshold for a quarter, credits can be claimed on qualified wages paid during that quarter. Rules differ based on number of employees:

  • Employers over 100 employees can only claim wages paid to non-working employees.
  • Small employers with 100 or fewer staff can claim all employee wages, even for working employees.

Qualified wages also exclude amounts over $10,000 per employee for a quarter. Appropriately tracking qualified wages as credits are determined is imperative.

Claiming Process Overview

Retention credits are claimed on IRS Form 941 employment tax returns for quarterly reporting of payroll taxes. Credits are taken against the employer portion of Social Security tax (6.2% of wages). Excess credits beyond this liability become refundable.

Key steps include:

  • Reporting qualified wages and health expenses for the quarter on Form 941.
  • Applying eligible credit amounts against payroll tax liabilities.
  • Requesting excess credits as refunds by filing Form 7200.
  • Reconciling any advance credits received on Form 941 filings for subsequent quarters.

Amending prior 941s to newly claim credits for previous quarters based on lack of business is allowed. However, employers should retain documentation on the reasons for amendments as this often triggers IRS scrutiny.

Maximizing Relief with Proper Planning

Businesses impacted by reduced revenue and operations due to COVID-19 can leverage retention credits to maximize relief:

  • Review financial records and determine quarters with sufficient gross receipts declines.
  • Identify periods that involved full or partial shutdowns.
  • Calculate qualified wages for each eligible quarter.
  • Determine optimal credit claim amounts for payroll tax offsets or refunds.
  • Amend prior 941s if needed to newly claim credits where qualified.
  • Coordinate credits with any PPP loan forgiveness applied for.
  • Establish protocols for computing credits and integrating them into payroll processes.

By proactively assessing qualifications and claiming opportunities, companies can optimize retention credit relief when facing business declines.

Leveraging Employee Retention Credits When Business Slows The Bottom Line

The pandemic triggered widespread revenue losses and business impacts across the economy. Fortunately, the generous employee retention credit enables employers to defray payroll costs and retain staff through COVID-19 business challenges. With proper planning and execution, companies can tap into these credits to provide crucial relief when lacking sufficient business.

FAQ

Q: How do I calculate gross receipts declines?

A: Compare quarterly gross receipts from 2020/2021 to the same calendar quarter in 2019. Gross receipts include all revenues prior to deductions.

Q: What documentation should I maintain?

A: Keep detailed calculations, quarterly financial statements, accounting records to prove eligible declines and documentation of qualified wages.

Q: Can I claim the credit for lack of business in just one quarter?

A: Yes, you can claim the credit for any single quarter in which you meet the 20% gross receipts decline threshold compared to 2019.

Q: When can I claim credits on my payroll tax returns?

A: Credits can be claimed on Form 941 employer payroll tax returns either quarterly for the applicable period, or via amended returns.

Q: Who qualifies as a small employer able to claim all employee wages?

A: Any employer with 100 or fewer full-time equivalent employees can claim credits on wages for all employees during eligible quarters.

Resources:

  • IRS Form 941 Instructions – Reporting Employee Retention Credits
  • IRS FAQs on Employee Retention Credit Eligibility and Claiming Process
  • U.S. Chamber of Commerce ERC Guide for Small Businesses
  • AICPA Calculator for Employee Retention Credits
  • Guide to Substantiating and Documenting Credits (U.S. Chamber)
  • Small Business Administration – Employee Retention Credits for Small Employers

Check with a tax advisor regarding qualifying based on COVID-19-related lack of business. Thorough documentation is key.

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