How does the Employee Retention Credit work?

The Employee Retention Credit (ERC) is a temporary tax credit for companies that retained employees during the COVID-19 pandemic. It was created in 2020 to provide financial support to eligible employers.

Although the Internal Revenue Service (IRS) discontinued the ERC in 2021, it’s still possible to claim the credit retroactively. However, the window is closing, so it’s important to understand if your business is eligible and, if so, how to claim the credit. 

In this article, we’ll explain everything you need to know, so let’s jump right in.

What is the ERC?

The ERC (also known as the Employee Retention Tax Credit, or ERTC) is a tax relief measure for US businesses. It’s designed to aid employers who kept their employees between 2020 and 2021, despite the economic hardship imposed by the COVID-19 pandemic.

Introduced under the Coronavirus Aid, Relief, and Economic Security (CARES) Act in March 2020, it was initially a way to encourage businesses to retain their workforce, and alleviate some of the financial strain.

Today, it continues to provide eligible businesses a way to offset their payroll taxes and reduce their overall tax burden.

How does the ERC work?

The ERC is credited against what you, as the employer, owe in payroll taxes. It’s calculated as a percentage of qualified wages that were paid to your W-2 employees, as follows: 

• 50% of qualified wages paid in 2020 (up to $10,000)

• 70% of qualified wages paid in 2021 (up to $10,000)

Note that the credit is capped at $5,000 per employee for 2020, and $21,000 per employee for 2021 (or $7,000 per quarter).

The ERC is a refundable credit, so if it’s more than your payroll tax liability, you get to keep the difference.

Is it still possible to claim the ERC?

If you didn’t claim the ERC on your quarterly payroll tax returns in 2021, you can still claim for each quarter that you were eligible for during the credit-generating period.

This means that you might be able to claim the ERC for wages paid during March 13 to December 31, 2020, as well as for the first three quarters of 2021.

However, this window will close soon. You can claim the 2020 ERC up until April 15, 2024, and the 2021 ERC up until April 15, 2025.

ERC requirements: who is eligible to claim?

If COVID shutdowns and market disruption affected your bottom line, you may qualify for the ERC — regardless of your industry.

To be eligible, your organization must have either:

• Undergone a partial or full suspension of their operations due to government mandates

• Suffered a major decline in gross receipts compared to the same quarter in 2019

For 2020, this decline must have been at least 50% compared to the same quarter in 2019.

For 2021, the decline must have been at least 20% compared to 2019.

For example, compare your gross receipts in Q1 of 2021 to Q1 of 2019. If they were down by 30%, this exceeds the 20% threshold, and you can claim the ERC for that quarter.

What if you received a PPP loan?

If you received a Paycheck Protection Program (PPP) loan, your business may still qualify for the ERC.

When the ERC was first announced, businesses couldn’t get both a PPP loan and the ERC unless they repaid the loan first. However, this part of the act was subsequently repealed to allow PPP loan recipients to qualify for the ERC.

Note that you can’t claim the ERC on wages that were covered by your PPP loan.

What wages qualify for the ERC?

The ERC’s definition of qualified wages extends beyond salaries and hourly rates. It also encompasses employer-sponsored health insurance costs. 

Qualified wages also depend on the size of your company.

• For large employers: Qualified wages are those paid to employees during periods when they didn’t work. This includes health plan expenses. The focus here is on supporting wages paid when business operations were likely to be limited or halted.

• For small employers: You can claim the ERC for all wages paid, whether they were to part-time or full-time employees. This includes both regular wages and health plan expenses.

Note that, for 2020 claims, small employers are classed as 100 or fewer full-time employees. For 2021 claims, small employers are classed as 500 or fewer full-time employees.

How to calculate the ERC

To calculate the ERC, follow these steps:

1. Determine eligibility. Assess whether your business meets the criteria set for economic hardship during the specified period (i.e., did your gross receipts decline beyond the comparative thresholds).

2. Calculate qualified wages. Identify which wages you paid to your employees during the specified periods.

3. Apply wage limits. Apply the specified cap for wages per employee to determine the maximum amount of creditable wages.

4. Compute the credit amount. Calculate the credit as a percentage of the qualified wages (up to the maximum limit).

5. Subtract the PPP loan forgiveness. If applicable, deduct the PPP loan forgiveness amount from your calculated credit.

6. Adjust for other grants or credits. Make the necessary adjustments for any other grants or credits received to avoid duplication.

If you find this process to be complex and messy, you might want to consider keeping your payroll data in one, secure place going forward. With Remote, you can quickly access information like past wages, how much was paid per quarter, and other key details — without the headache.

To learn more, check out our in-depth payroll technology guide.

How to apply for the ERC

If you believe you’re eligible for the ERC, the next step is to make a formal application. This is a relatively straightforward process, but if you’re unsure, it’s advisable to speak with a tax expert.

Here are the key steps:

1. File the revised payroll tax returns

Using Form 941-X, amend your past tax returns. This is a correction form for your original Form 941. Fill out the information required, and provide an explanation that includes:

• The date you discovered you qualified for the ERC

• How much you believe the error amounts to (based on your earlier calculation) 

2. Gather the necessary documentation

Collect and supply the essential records that demonstrate proof of eligibility, including financial statements and payroll records. You will need to show what you paid your employees and when they were paid.

You’ll also need to demonstrate that your business had to suspend your operations, and/or that you experienced a significant financial loss.

3. Adhere to the deadlines

As mentioned, the applications windows are due to close soon. If you file after April 15, 2024 for the 2020 ERC, or after April 15, 2025 for the 2021 ERTC, you won’t be successful. 

Tax management with Remote

If you’re eligible for the ERC, you may be able to reduce your upcoming payroll taxes significantly. In some cases, you may even be entitled to a cash refund.

Either way, the ERC is a great example of why it’s important to monitor and understand tax credit schemes. Maximizing your tax refunds allows you to reinvest in your business, and can really help it grow and thrive. 

If you want to simplify your tax, compliance, and payroll obligations — no matter where you or your team members are based — our Global Payroll platform is the ideal solution. To learn more, book a demo, or ask one of our friendly payroll experts how we can help today.

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