The employee retention credit is a valuable tax incentive designed to encourage businesses to retain their employees during times of economic uncertainty, such as the COVID-19 pandemic.
To calculate the employee retention credit, businesses need to determine the qualified wages paid to eligible employees and the applicable time periods. By comparing these figures against specific thresholds and considering any applicable limitations, businesses can calculate the credit amount they are eligible to claim. Understanding the calculation process is crucial for businesses to maximize their potential credits and navigate the complex tax landscape effectively. Below, we go into more detail on how to calculate employee retention credit.
Employee Retention Credit Overview
Amidst widespread lockdowns and economic uncertainties caused by the pandemic, businesses faced immense challenges in sustaining operations and retaining employees. In response, the Employee Retention Credit (ERC) emerged as a crucial lifeline for businesses.
This refundable tax credit was specifically crafted to assist employers who persisted in paying their workforce during shutdown periods or encountered substantial declines in gross receipts between March 13, 2020, and December 31, 2021, as stipulated by the IRS. Distinguished from the forgivable loans offered by the Paycheck Protection Program (PPP), the ERC provides relief by reducing employers’ payroll taxes, enabling businesses to receive financial support while retaining their invaluable employees.
Over time, the ERC has been modified and extended through various legislative acts such as the CARES Act, Taxpayer Certainty and Disaster Relief Act, American Rescue Plan Act, and Infrastructure Investment and Jobs Act, broadening eligibility and prolonging its duration to extend its benefits to a larger pool of businesses.
Calculating Employee Retention Credit
In 2020, the Employee Retention Credit (ERC) entailed a credit amounting to 50% of qualified wages paid to employees in a given calendar quarter. This credit applied to wages disbursed between March 12, 2020, and January 1, 2021, with a maximum of $10,000 eligible wages per employee. Consequently, the maximum credit for qualified wages paid to any employee during 2020 was $5,000.
Moving to 2021, the ERC increased to 70% of qualified wages paid in a calendar quarter, with a similar maximum eligible wages limit of $10,000 per quarter per employee. Hence, the maximum credit for eligible wages paid to any employee throughout 2021 amounted to $28,000. It is important to note that businesses without any employees in 2020 or 2021 are not eligible for the ERC.
If your business experienced full or partial suspension during a calendar quarter of either year due to COVID-19-related governmental orders restricting commerce, travel, or group meetings, you might be eligible for the ERC during that specific quarter. Alternatively, if your gross receipts declined significantly, you may still qualify for the credit.
To determine eligibility, compare your business’s revenue in each relevant quarter of 2020 or 2021 to the corresponding quarter in 2019. A drop of more than 50% in revenue is required for quarters in 2020, while a drop of over 20% in revenue for the current or preceding quarter is necessary for quarters in 2021. If unsure, there are tools available to estimate your eligibility.
Even if revenue has not dropped by the specified percentages, you may still qualify for the ERC if your business operations were partially or fully suspended due to government orders related to COVID-19. However, if neither revenue has sufficiently dropped nor business operations were suspended for these reasons, you are not eligible for the ERC.
When calculating the ERC, include qualified wages paid to all employees during the period of full or partial operational suspension or the quarter with a qualifying decline in gross receipts. Qualified wages encompass both regular wages and health plan expenses disbursed during the economic hardship period. For larger employers, qualified wages are generally limited to the time when an employee is not working due to the economic hardship, and in the case of 2020, may not consider wage increases following the commencement of the hardship.
Qualified businesses have specific deadlines to claim the Employee Retention Credit alongside their quarterly Form 941 tax filings. These deadlines are July 31, October 31, and December 31, 2021. To successfully file for the ERC, businesses will need to provide additional payroll data and supporting documentation along with their quarterly returns.
When submitting an updated refundable tax credit request to the IRS, eligible employers can expect a processing time of 90 to 120 days. On the other hand, the processing time for initial ERC returns and employment tax deposits typically ranges from 30 to 60 days.
Calculating the Employee Retention Credit (ERC) involves several key factors. Businesses need to determine the qualified wages paid to eligible employees during specific time periods, such as calendar quarters in 2020 and 2021. The credit amount varies, ranging from 50% to 70% of qualified wages, with a maximum of $10,000 per employee per quarter.
It’s important to note that eligibility for the ERC depends on various factors, including revenue declines and operational suspensions. To determine eligibility, businesses compare their revenue in relevant quarters to the corresponding quarters in 2019. The ERC can be claimed by including qualified wages in tax filings and submitting the necessary payroll data and documentation. Understanding these is vital for businesses to accurately determine their eligible credit amount and effectively navigate the ERC process.