Qualified Wages for the Employee Retention Credit: Tips for Small Businesses

The employee retention tax credit provides welcome tax relief for employers retaining staff during the pandemic. But only qualified wages paid to employees can count toward calculating this valuable credit. What exactly constitutes qualified wages? Read on for a full overview of the qualified wage rules and how they determine your available credits.

Overview of the Employee Retention Credit

First, let’s quickly recap what this tax credit entails:

CARES Act Creation

The credit was established by the CARES Act in March 2020 to incentivize employers to retain employees during COVID-19 shutdowns.

Legislative Expansions

Congress then expanded the credit twice through follow-up COVID relief legislation, increasing the potential benefits.

Importance of Qualified Wages

The definition of qualified wages is critical because it directly impacts two key factors:

Credit Calculation Based on Qualified Wages

The credit equals 50% of the qualified wages paid, so the qualified wage amount determines the credit value.

Documentation Needed to Substantiate

Employers must also substantiate qualified wages paid to justify the credit claimed.

Understanding qualified wages is essential to maximizing benefits.

Definition of Qualified Wages

Qualified wages are defined differently in 2020 vs. 2021:

2020 Qualified Wage Rules

The definition was more limited in 2020, especially for larger employers.

2021 Qualified Wage Rules

The American Rescue Plan Act greatly expanded the definition for 2021.

Major Expansion in 2021

For many employers, all wages paid now qualify up to the $10,000 per employee quarterly cap.

Types of Wages That Qualify

What types of wage payments to employees qualify for the 50% credit?

Regular Wages for Time Not Worked

Regular wages paid to employees for time they did not provide services because of COVID-19 disruptions qualify.

Overtime and Bonuses

Overtime pay and discretionary bonuses also qualify toward the $10,000 per employee quarterly limit.

Paid Leave and Furloughs

Amounts paid for sick leave, family leave, and furloughs related to COVID-19 qualify as well.

Interaction with Tax Credits

Qualified wages cannot also be credited toward the sick/family leave tax credits.

Allocable Qualified Health Expenses

Employers can also include:

Employer Insurance Contributions

The employer portion of health plan expenses is considered qualified wages.

Limits and Calculations

These expenses must be properly allocated on a pro-rata basis and are subject to limits.

Wages That Do NOT Qualify

However, some wage payments are excluded:

Wages Used for Other Credits

Wages are used toward sick leave and family leave tax credits.

PPP Loan-Funded Payroll

Payroll costs are paid with a forgiven PPP loan.

Special Rules for Religious Employers

Certain wages paid by religious organizations do not qualify.

Determining Qualified Wages

Given the complexities, how can employers identify qualified wages?

Tracking Excluded Wages

Closely track wages used for other credits or PPP loans that must be excluded.

Documenting Reasons for Absences

Require employees to provide documentation for COVID-19-related absences.

Substantiating Health Insurance Costs

Detail calculations separate out the employer portion of health premiums.

Thorough wage data enables accurate credit calculations.

Claiming the Credit Based on Qualified Wages

Once qualified wages are determined, make sure to properly claim the credit:

Quarterly IRS Form 941

Report qualified wages and credits on Form 941 payroll tax returns.

Documenting Qualified Wage Calculations

Retain detailed documentation on the calculation since it must be substantiated.

Careful wage tracking and filing maximize benefits.

Conclusion

Only qualified wages are eligible for the valuable employee retention tax credit. Closely monitor wage payments to identify inclusions and exclusions from the definition of qualified wages. With strategic wage documentation and understanding the qualified wage rules, employers can properly justify and maximize their available credits.

FAQs

Q: Do health insurance contributions count toward the $10K limit?

A: No, allocable health expenses are considered qualified wages but do not count toward the $10,000 wage limit per employee.

Q: Can wages be qualified if no hours are worked at all?

A: Yes, wages for time not providing any services can qualify, even if zero hours were worked.

Q: How are tips treated for the credit?

A: Tips are not considered wages paid by the employer so they would not qualify for the retention credit.

Q: Can wages paid to furloughed employees qualify?

A: Yes, compensation paid to furloughed workers counts as qualified wages.

Q: Do qualified wages have to be paid to US employees?

A: The credit only applies to wages paid to employees whose principal place of residence is in the United States.

Here are two relevant links related to the article on qualified wages for the employee retention tax credit:

IRS Guidance on Qualified Wages

The IRS website provides official detailed guidance on the definition of qualified wages for purposes of the employee retention credit. This credible government source covers inclusions and exclusions.

Analysis of the Impact of ARPA’s Expansion of Qualified Wages

The Joint Committee on Taxation analyzed the impact of the American Rescue Plan Act’s expansion of qualified wages for the retention tax credit. Their findings informed the legislative language.

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