What is the Employee Retention Credit?
The Employee Retention Credit, which was enacted as a part of the CARES Act in March 2020, was created to keep small businesses operational and staff on the payroll as businesses navigated pandemic-related shutdowns and restrictions.
“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, who is a tax policy expert formerly at the U.S. Chamber of Commerce, who is a partner at Capitol Tax Partners.
Small businesses that keep employees on their payroll can claim a credit on their qualified wages. The tax credit was extended until the end of 2021 as a part of the American Rescue Plan.
Under the legislation, eligible employers can claim a refundable tax credit that is equal to 70% of the qualified wages they pay employees. It 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.
FYI: The Employee Retention Credit is an immediate benefit to small business owners. You can deduct the money directly from the payroll tax you pay quarterly or get a refund for prior periods filed.
Which small businesses are eligible for the pandemic tax credit?
The 2021 tax credit is available to small businesses with 500 or fewer employees that have seen a 20% or more decline in gross receipts compared with the same quarter in 2019. If your business is new, the IRS allows you to use gross receipts for the first quarter the business was operating as a reference. 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 ERTC [employee retention tax credit], 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.”
Why aren’t small businesses taking advantage of the ERC?
The ERC can save employers hundreds of thousands of dollars, yet many small businesses 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% were either familiar or very familiar with the ERC and that only 8% actually claimed the tax credit in 2020. However, close to half of the survey respondents said they would apply for it in 2021. 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.
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, it [the ERC] 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, Woods said.
“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.”
Tip: You can take advantage of the ERC through the end of 2021. It can be complicated, so lean on your CPA or bookkeeper to help you navigate it.
How do you claim the Employment Retention Credit?
The Employment Retention Credit is immediate and is claimed by reducing your business’s employment tax deposits before you file your quarterly employment tax returns. Some employers can request advance payment of the credit using IRS Form 7200.
If the tax credit is more than the employer’s total tax liability, the excess will be refunded to the small business owner.
What are the benefits of taking the Employment Retention Credit?
The major benefit of the ERC to small business owners is the sizable sum they won’t have to pay in payroll taxes, thus resulting in extra liquidity that can be used to keep the business afloat as the economy reopens. Some businesses are utilizing the credit to handle an influx of customers and/or increased demand now that more people are vaccinated and are 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 now be used in addition to a PPP loan. Business owners who avoided the ERC 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.
FYI: Small business owners no longer have to choose between a PPP loan and the ERC; changes to the program mean you can use both.
Could the ERC get extended beyond 2021?
The Employee Retention Credit was designed to be a short-term fix to help business owners through the pandemic. The credit has already been extended twice since it was initially enacted, and many small business experts don’t expect the federal government to extend the credit beyond this year. However, they aren’t willing to rule it out. Alternatively, small business owners might receive a different form of federal aid.
“There are all sorts of grants coming out right now from the SBA,” Woods said. “With the Biden administration, this is a new normal.”