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How to Save Thousands of Dollars With the Employee Retention Credit
Eligible employers can receive a tax credit equal to 70 percent of the qualified wages they pay employees.
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For businesses that are still feeling the aftereffects of the COVID-19 pandemic, the Employee Retention Credit (ERC) may be a good option to consider. The credit, enacted as a part of the CARES Act in March 2020, was created to keep small businesses operational and staff on the payroll as they navigated pandemic-related shutdowns and restrictions, but it is still available to certain employers in 2023.
What is the Employee Retention Credit?
Small businesses that had employees on their payroll after March 12, 2020, and before Jan. 1, 2022, can claim a credit on their qualified wages.
“The tax credit encourages businesses struggling to remain operational and bring liquidity to these small businesses,” said Caroline Harris, a tax policy expert formerly at the U.S. Chamber of Commerce and now a partner at Capitol Tax Partners.
Under the legislation, which was extended until the end of 2021 as part of the American Rescue Plan, the refundable tax credit is equal to 70 percent of the qualified wages eligible employers paid their employees. The credit maxes out at $7,000 per employee per calendar quarter, for a total of $28,000 in 2021. Qualified wages include salaries, tips, commissions and any other compensation that is subject to FICA tax. Cash paid to employees and wages paid to family members are not considered qualified wages.
Which small businesses are eligible for the Employee Retention Credit?
The 2021 tax credit is available to small businesses that had 500 or fewer employees and a 20 percent or more decline in gross receipts when comparing quarters from 2019 and 2020. The IRS allows businesses that were new at the time to use, as a reference, gross receipts for the first quarter the business was operating. Businesses that were forced to shut down because of pandemic restrictions are also eligible for the tax credit.
The first iteration of the Employee Retention Credit prohibited businesses that borrowed money through the Small Business Administration’s (SBA) Paycheck Protection Program (PPP) from taking advantage of the ERC. PPP loans are forgivable, provided that small business owners use the funds for payroll. However, with the enactment of the American Rescue Plan, most small businesses, even those that took out PPP loans, can qualify for the credit.
“If you take out a PPP loan, you can also use the [ERC], but you can’t double-dip,” Harris said. “You can’t pay payroll out of PPP and get a deduction. You have to use PPP for other things.”
How do you claim the Employee Retention Credit?
Businesses or organizations that experienced at least a 50 percent reduction in gross receipts in 2020 or a decline in the first three quarters of 2021 can claim the credit. Presently, eligible employers can revise their previously filed forms by completing and submitting Form 941-X. Completing and submitting this form enables business owners to retroactively apply for the ERC. [Read related article: How to File Employee Payroll Taxes]
Why aren’t small businesses taking advantage of the credit?
The ERC can save employers hundreds of thousands of dollars, yet many small businesses still aren’t taking advantage of it. The National Federation of Independent Business (NFIB) surveyed small business owners in January 2021 and found that only 36 percent were either familiar or very familiar with the ERC and that only 8 percent actually claimed the tax credit in 2020. Of the small businesses that did use the tax credit, the vast majority relied on a certified public accountant (CPA), tax professional, bookkeeper or accounting software to help navigate the process of claiming the credit, the NFIB found. [Related: The Best Accounting and Invoice-Generating Software]
The main reason the tax credit is being underutilized is that many small businesses aren’t aware of the benefits.
“Much like a lot of the other times when there are tax changes, [the Employee Retention Credit] is suffering from a PR problem,” Harris said. “There needs to be more education for people to understand what it is and that it’s effective immediately.”
CPAs and companies that serve small businesses should alert their customers to the tax credit and the sizable benefits, said Jay Woods, CEO of Omega Accounting Solutions.
“We’re talking to people left and right that have not really heard about it,” Woods said. “Even payroll companies are not communicating [it] to small business owners.”
Employee Retention Credit FAQs
Donna Fuscaldo contributed to this article. Source interviews were conducted for a previous version of this article.
