Tax Credits

Employee Retention Credit For Self-Employed (June 2023)

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Discussions surrounding the economic repercussions of the COVID-19 pandemic have predominantly centered around businesses. However, it is crucial to recognize that self-employed individuals have also been significantly impacted by the ensuing lockdowns, albeit to varying degrees.

While the employee retention credit (ERC) has garnered considerable attention for providing financial relief to employers who retained their workforce despite a decline in revenue, the question remains: how are self-employed individuals weathering this storm?

In this article, we shed light on the eligibility of self-employed individuals for the ERC. Furthermore, for those who are ineligible, we explore alternative tax credits they can potentially avail.

In these challenging times, understanding the support available for the self-employed is essential. By delving into the intricacies of the ERC and uncovering the options for self-employed individuals, we hope to provide clarity and guidance for navigating the economic hurdles posed by the pandemic.

Overview

  • Self-employed individuals are not eligible for the employee retention credit. However, they may qualify for sick leave credits and family leave credits based on IRS criteria.
  • Qualified self-employed workers can claim up to $5,110 in sick leave tax credits if they were unable to work due to COVID-19-related reasons.
  • Qualified self-employed individuals can also receive up to $10,000 in family leave tax credits if they had to provide care for someone due to circumstances related to COVID-19.
  • If you were unable to work in 2020 or 2021, you can access these COVID tax credits. However, for the tax year 2022, these credits are not applicable to self-employed individuals.

What is the ERC?

Amidst the economic challenges brought on by the COVID-19 pandemic, the Employee Retention Credit (ERC) has emerged as a vital lifeline for businesses. Designed to provide financial relief, this tax credit aims to incentivize employers to retain their employees, even during periods of reduced revenue.

The ERC is a refundable tax credit offered by the U.S. government to eligible employers. It allows businesses to claim a percentage of qualified wages paid to their employees, up to a certain limit. The credit is calculated based on a predetermined percentage of wages paid during a specific period.

As of 2023, the tax credits are available to a wide range of organizations, including both for-profit and non-profit entities. Eligible organizations encompass corporations, partnerships, sole proprietors, and tax-exempt entities.

To determine eligibility and learn more about the ERC, employers can refer to the official Internal Revenue Service (IRS) website. The IRS provides detailed guidelines, examples, and frequently asked questions regarding the ERC.

I’m self-employed — do I qualify for the ERC?

Self-employed workers are not qualified for the employee retention credit. As a tax incentive, the ERC is aimed at supporting pandemic-affected businesses. Self-employed workers are excluded from the tax credits due to the nature of their employment. This distinction arises from the fact that self-employed individuals do not receive qualified wages, a requirement for ERC eligibility.

Under the latest iteration of the ERC, employers can claim tax credits for up to 70% of qualified wages paid in 2021, with a cap of $10,000 per employee per quarter. Qualified wages include salaries, hourly pay, qualified health care plans, and employment taxes.

Unfortunately, self-employed workers, who draw funds directly from their business’s profits, do not fall under the category of qualified wages.

For instance, LLC owners, as sole proprietors, are not considered employees and are unable to claim the tax credit. However, if the LLC has additional employees, the wages paid to those workers remain eligible for the ERC.

Sole proprietors and self-employed individuals who are the sole workers associated with their businesses will not be able to access this tax incentive.

Is there a tax credit for self-employed individuals?

While self-employed workers are not eligible for the ERC, there are still avenues for them to receive tax credits to mitigate the impact of the pandemic. The Families First Coronavirus Response Act (FFCRA) and subsequent legislation have provided relief measures for self-employed taxpayers, offering them much-needed financial support.

Enacted on March 18, 2020, the FFCRA initially provided tax credits to eligible self-employed individuals who were unable to work due to COVID-19 between April and December 31, 2020. The credit period was extended until March 31, 2021, allowing taxpayers to carry over any unused sick leave or paid leave credits from 2020.

Furthermore, the American Rescue Plan Act (ARP), signed by President Joe Biden on March 11, 2021, extended tax credits for self-employed workers through September 30, 2021. This extension allows taxpayers affected between April 1 and September 30, 2021, to claim the credits on their 2021 tax return.

How do I qualify for tax credits as a self-employed individual?

To be considered an eligible self-employed individual for tax credits, you must regularly engage in a trade or business as defined by section 1402 of the Internal Revenue Code. If you would have met the requirements of the Emergency Paid Sick Leave Act (EPSLA) or Emergency Family and Medical Leave Expansion Act (Expanded FMLA) as an employee of an eligible employer, you can still qualify for these credits as a self-employed individual under the American Rescue Plan (ARP).

The tax credit available to eligible self-employed individuals is called the “qualified sick leave equivalent amount” or “qualified family leave equivalent amount.” This credit can be claimed against your federal income taxes for any taxable year.

In simpler terms, if you are self-employed and would have been eligible for sick leave or family leave benefits under the EPSLA or Expanded FMLA as an employee, you can still receive similar tax credits to offset your federal income taxes. These credits recognize the equivalent value of the sick leave or family leave you would have been entitled to if you were an employee.

To calculate your tax credits, you need to calculate your average daily self-employment income. This can be done by dividing your net earnings from self-employment for the taxable year by 260. These credits can only be claimed for the days you were unable to work for a covered reason between April 1, 2020, and March 31, 2021.

How much do I get in sick leave tax credits?

Self-employed workers are eligible to receive a credit equal to 100% of your average daily self-employment income, capped at a maximum of $511 per day. This applies if an individual is unable to work for one of the three specified reasons laid out by the IRS:

  • When you are under a Federal, State, or local quarantine or isolation order related to COVID-19.
  • When a healthcare provider advises you to self-quarantine due to concerns related to COVID-19.
  • Or:
    • When you are experiencing symptoms of COVID-19 and seeking a medical diagnosis.
    • When you are waiting for the results of a diagnostic test or medical diagnosis for COVID-19 and have been exposed to the virus or cannot work while awaiting the results.
    • When you are receiving immunization related to COVID-19 or recovering from any injury, disability, illness, or condition associated with the immunization.

For the days that you are unable to work due to the following reasons, self-employed workers can receive a credit equal to 67% of your average daily self-employment income, with a maximum of $200 per day:

  • When you are caring for an individual who is under a Federal, State, or local quarantine or isolation order related to COVID-19, or who has been advised by a healthcare provider to self-quarantine due to concerns related to COVID-19.
  • When you are caring for a child and their school or place of care has been closed, or their child care provider is unavailable due to COVID-19 precautions.
  • The Secretary of HHS, in consultation with the Secretaries of Treasury and Labor, has determined that a substantially similar condition includes:
    • Taking leave to accompany an individual to obtain immunization related to COVID-19.
    • Taking leave to care for an individual who is recovering from any injury, disability, illness, or condition related to the immunization.

In both cases, taxpayers can only account for a maximum of ten days when calculating the qualified sick leave equivalent amount.

How is the family leave tax credit calculated?

The family leave credit is also determined based on your average daily self-employment income. Here, self-employed workers can receive a credit equal to 67% of your average daily self-employment income, capped at $200 per day. The self-employed individual is eligible for the family leave tax credit if they had been:

  • Providing care for an individual who is under a quarantine or isolation order related to COVID-19.
  • Caring for a son or daughter when their school or place of care has closed, including situations where the childcare provider is unavailable due to COVID-19.
  • Experiencing other similar conditions as specified by relevant health and government agencies.

Unlike the sick leave credit, the family leave credit can be claimed for a maximum of 50 days.

What do I need to show when claiming these tax credits?

It is important to maintain records when claiming the sick leave tax credit and family leave tax credit. Documentation and records are necessary to support your eligibility for the credits and the specific reasons for which you were unable to work. These records may include:

  1. Documentation of the qualifying reasons for leave, such as quarantine or isolation orders, healthcare provider advice, school closures, or childcare unavailability due to COVID-19.
  2. Documentation of your average daily self-employment income.
  3. Records of the number of days for which you claimed the credits.
  4. Any other relevant supporting documentation, such as medical documents, school closure notices, or communication from healthcare providers.

Having these records on hand will help ensure accurate and reliable information when claiming the sick leave tax credit and family leave tax credit.

What are the limitations of these tax credits?

If a self-employed individual qualifies for a refundable credit for either the qualified sick leave equivalent amount or the qualified family leave equivalent amount under the American Rescue Plan (ARP), and also receives corresponding wages as an employee, certain reductions apply.

For the qualified sick leave equivalent amount, the credit is reduced if the combined total of the equivalent amount and the qualified sick leave wages exceeds $2,000 (or $5,110 for any day that includes specific paid sick time as described in the EPSLA).

Similarly, for the qualified family leave equivalent amount, the credit is reduced if the combined total of the equivalent amount and the qualified family leave wages exceeds $12,000.

In summary, if a self-employed individual receives both the equivalent amount and corresponding wages, the credits are subject to reduction based on specific thresholds outlined in the text.

Summary

Self-employed workers have been grappling with the financial impact of the COVID-19 pandemic, but unfortunately, they are not eligible for the Employee Retention Credit (ERC). However, there are alternative avenues for relief.

Recent legislation has introduced sick leave tax credits and family leave tax credits to support self-employed individuals facing income losses due to pandemic-related circumstances.

Under these provisions, qualified individuals can potentially claim up to $15,110 in tax credits to offset their income losses. These refundable credits can be obtained by filing a Form 7202 with the 2021 or 2020 tax return. It is crucial to work closely with a tax professional to ensure accurate calculations when claiming these credits.

While the ERC remains inaccessible to self-employed workers, availing themselves of the sick leave and family leave tax credits can significantly alleviate the financial burden caused by COVID-19. By taking advantage of these tax credits, self-employed individuals can mitigate the impact of lost income resulting from contracting the virus, caring for an affected loved one, or other pandemic-related challenges.