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.
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.
The Employee Retention Credit is still available. Small business owners can get a refund for prior periods filed.
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.”
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]
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.”
If you haven’t taken advantage of the ERC yet and are an eligible employer, here is everything you need to know to take advantage of the available funds.
The major benefit of the ERC to small business owners is the sizable refund they will receive in payroll taxes, thus resulting in extra liquidity. At the height of the COVID-19 pandemic, some businesses utilized the credit to handle an influx of customers and/or increased demand, especially after vaccinations became widely available and more people began venturing out again.
“We’ve got clients that need the cash desperately to keep the business afloat and other clients that are doing fine and want the extra security blanket,” Woods said. “They don’t know what’s coming and are taking advantage of a government subsidy they have never seen in their lifetime.”
Another benefit is that the ERC can be used in addition to a PPP loan. Business owners who avoided the credit because they couldn’t combine it with their PPP loan can now have the best of both worlds, with one caveat: The employee wages used to obtain forgiveness for a PPP loan can’t be used to calculate the ERC amount.
The Employee Retention Credit can still be obtained even if a small business owner took out a PPP loan during the COVID-19 pandemic.
The ERC was designed to be a short-term fix to help business owners through the pandemic, and the credit was extended twice since it was initially enacted.
In 2023, the ERC is still available to employers that can prove their business was negatively impacted by the COVID-19 pandemic. This credit continues to provide eligible businesses with the support they need to work toward — or stay on — a steady path to success.
“There are all sorts of grants coming out right now from the SBA,” Woods said. “With the Biden administration, this is a new normal.” [Read: Which Business Credit Card Fees Are Tax-Deductible?]
Businesses that claim the ERC improperly can find themselves in a bad spot. The IRS states that any business that claims the credit in this way will have to pay back the sum they receive, possibly with interest and additional penalties. As of July 2023, the IRS was working on additional details for this type of situation.
The Employee Retention Credit is available exclusively to recovery-phase startup businesses for the fourth quarter of 2021.
Scammers have emerged to deceive both eligible and ineligible business owners about the ERC. With the goal of receiving thousands of dollars from your business in excessive fees that are not required when you apply for the credit, scammers will taunt employers by advertising an “easy application,” immediate checks and other empty promises.
The IRS warns employers to be cognizant of aggressive campaigners who send fake letters about the credit, omit crucial information like that outlined above, and try to market to you across multiple channels.
Donna Fuscaldo contributed to this article. Source interviews were conducted for a previous version of this article.