The Employee Retention Credit: who is eligible, how is ERC claimed and answers to other frequently asked questions
The Coronavirus Aid, Relief, and Economic Security Act (“CARES”) includes several business relief provisions, including a refundable credit for qualifying wages paid to certain employees over a period that may exceed 9 months (the “Employee Retention Credit” or “ERC”). The ERC is intended to help employers, who have been financially impacted by the coronavirus, keep employees on their payroll by providing immediate payroll tax relief of up to $5,000 per employee. The ERC is generally available to all employers, regardless of size.
Who is Eligible?
Any employer, including non-profits, carrying on a trade or business during 2020 that:
- fully or partially suspends operations during any calendar quarter in compliance with a governmental order limiting its commercial activity, travel or gatherings (a “Covid-19 Order”), or
- experiences a “significant” decline in revenue during that calendar quarter.
What constitutes a significant decline in revenue?
An employer will be regarded as suffering a significant decline in revenue beginning on the first day of the calendar quarter in 2020 in which the employer’s gross receipts drop below 50% of the gross receipts earned in the corresponding quarter of 2019 and that significant decline in revenue will be deemed to continue through the last day of a subsequent calendar quarter in which gross revenue exceeds 80% of the gross receipts earned during the corresponding quarter of 2019.
Example: An employer’s gross receipts were $100,000, $190,000, and $230,000 in the first, second, and third calendar quarters of 2020, respectively. Its gross receipts were $210,000, $230,000, and $250,000 in the first, second, and third calendar quarters of 2019, respectively. Thus, the employer’s 2020 first, second, and third quarter gross receipts were approximately 48%, 83%, and 92% of its 2019 first, second, and third quarter gross receipts, respectively. Accordingly, the employer will be regarded as suffering a significant decline in revenue commencing on the first day of the first calendar quarter of 2020 (the calendar quarter in which gross receipts were less than 50% of the corresponding quarter in 2019) and ending on the last day of the second calendar quarter of 2020 (the quarter for which the gross receipts were more than 80% of the same quarter in 2019).
How to calculate the ERC?
The ERC is calculated on a calendar quarter basis and is equal to 50 percent of the “qualified wages” of each employee of an eligible employer.
- Wages. For purposes of the ERC, “wages” has the same meaning as wages for Social Security tax purposes except that it also includes the cost of employee health care benefits paid by the employer.
- Qualified Wages. Which wages qualify depends upon whether the employer’s work force averages 100 or more full-time employees.
- Employers with more than 100 FTEs. If the average number of full-time employees during 2019 was greater than 100, wages are counted only to the extent that they are paid to employees who are not providing services due to (i) a COVID-19 Order, or (ii) due to a significant decline in gross receipts. Wages for these employees cannot exceed the amount that such employees would have been paid for working an equivalent duration during the 30 days immediately preceding such period.
- Employers with 100 or less FTEs. If the average number of full-time employees of the eligible employer during 2019 was 100 or less, all wages paid to employees during a period of economic hardship that is due to a COVID-19 Order or due to a significant decline in gross receipts are eligible.
The key distinction between the two categories is that the 100 or less full-time employee category allows wages to be counted for all employees, even if the employees have not been prevented from providing services, and the greater than 100 full-time employees category allows wages to be counted only for those employees who cannot provide services due to the COVID-19 Order or due to a significant decline in gross receipts.
- Wage Limit. The ERC is limited to wages paid after March 12, 2020 and through December 31, 2020. While the ERC calculation starts with qualified wages, these wages are capped at $10,000 per employee for all quarters. Given this wage cap and the 50 percent of qualified wages limit, the maximum ERC is $5,000 per employee.
- Other Limitations.
- Wages are not counted if taken into account under Section 7001 or Section 7003 of the Families First Coronavirus Response Act, which provide for refundable tax credits for most employers with fewer than 500 employees that pay qualified sick leave wages or qualified family leave wages to their employees.
- Employers may not claim the same employee for ERC and the Work Opportunity Tax Credit for the same period.
- The ERC does not apply if an employer takes a Small Business Interruption Loan under Section 1102 of CARES, which is referred to as the Paycheck Protection Program (a “PPP Loan”). An employer who applies for and receives a PPP Loan, would forego future ERCs, and recapture previously taken ERC. The timing of the recapture is not yet clear; however, the Internal Revenue Service (“IRS”) is authorized to issue regulations and other guidance regarding the ERC including recapture of the ERC when a PPP Loan is obtained in a subsequent quarter.
How is the ERC Claimed?
- Offset. Starting with the second quarter of 2020, the ERC is allowed against the employer portion of social security taxes, and for most employers the ERC is claimed on IRS Form 941 (the Employer’s Quarterly Federal Tax Return) by reporting 50% of qualified wages paid.
Example: If you paid any qualified wages between March 13, 2020, and March 31, 2020, you will account for 50% of those wages together with 50% of any qualified wages paid during the second quarter of 2020 on your second quarter Form 941. Form 941 has not yet been revised to accommodate the ERC.
- Refund. ERC amounts in excess of the employer share of social security taxes that the employer is liable for with respect to all employee wages paid in Q2 2020 may be refunded by filing Form 7200 with the IRS.
- Accessing Payroll Taxes. The ERC may also be used to reduce the required deposits of payroll taxes for each quarter that have been withheld from an employee’s wages. Under this approach, the employer keeps the withheld payroll taxes (instead of depositing the taxes with the IRS) in an amount up to that of the ERC that the employer reasonably anticipates earning for the quarter. This frees up cash flow by eliminating the deposit requirement.
- Importantly, the IRS is required to waive any penalty for the failure to make a timely deposit of employment tax if the failure was due to the reasonable anticipation of the ERC being allowed.
- The IRS recently issued guidance on the mechanics for claiming the ERC.
While the ERC rules are complicated and require careful analysis, there is significant benefit to eligible employers who continue to pay employees during the balance of 2020, particularly when the ERC is refunded and can then be used to fund other tax obligations or business expenses.