How the Employee Retention Tax Credit Works

By Sam Lipscomb, CEPF®

The Employee Retention Tax Credit (ERTC) is a provision included in the Coronavirus Aid, Relief, and Economic Security (CARES) Act. This credit is designed to incentivize employers to keep employees on payroll during the economic downturn caused by the COVID-19 global pandemic. More specifically, it’s a fully refundable credit that’s equal to 50% of qualified wages paid by an employer to an employee.

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The Employee Retention Tax Credit, or ERTC, is one of many tax provisions included in the CARES Act to encourage small businesses to keep employees on staff instead of furloughing or laying them off. The credit is equal to 50% of qualified wages paid to an employee between March 12, 2020 and Jan. 1, 2021, including qualified health plan expenses. The maximum amount of qualified wages that can be claimed is $10,000, which means the maximum credit for any one employee is $5,000.

The ERTC is fully refundable, and it is applied to the portion of payroll taxes paid by the employer. The IRS has developed a plan to allow eligible businesses to receive an advance payment on their credit. This is designed to alleviate liquidity concerns held by many businesses claiming the ERTC.

Unlike other, more broadly applicable provisions mentioned in the CARES Act, the ERTC is only available to certain qualified employers whose businesses have been affected by the Coronavirus pandemic. These may include most types of businesses, except for self-employed individuals and governmental employers.

There are two ways to qualify for the ERTC as an eligible employer. According to the IRS website, you either need to:

• Fully or partially suspend operations at any point during 2020 due to a coronavirus government mandate.
• Show a significant decline in gross receipts during a calendar quarter in 2020. To qualify under this requirement, gross receipts of any given quarter must be less than 50% of the gross receipts of the same quarter in 2019.

If a business has fewer than 100 employees, all employees are eligible. If a business has more than 100 employees, only those who are being paid but not providing a service due to coronavirus-related cutbacks are eligible.

Note that any employers who receive a Paycheck Protection Program (PPP) loan are not eligible for the Employee Retention Tax Credit. In addition, employers cannot double-claim employees and their wages in relation to the Family and Medical Leave Act (FMLA) and the Work Opportunity Tax Credit.

The Employee Retention Tax Credit can be applied to $10,000 in wages per employee. The time frame for the credit is any wages earned between March 12, 2020 and Jan. 1, 2021. Since it only covers 50% of wages per employee, this gives employers a total credit of up to $5,000 for each employee they retain.

You cannot combine this tax credit with any others. For example, the Families First Coronavirus Relief Act (FFCRA) requires employers to provide certain affected employees with paid sick and family leave due to COVID-19. The FFCRA includes a similar tax credit, so wages cannot be counted for both. This could limit how much an employer can receive through the ERTC program.

Employers are not required to take advantage of the Employee Retention Tax Credit, and some may choose instead to lay off or furlough their employees rather than paying qualified wages and claiming the ERTC.

To claim the ERTC, eligible employers must report their total qualified wages and any related credits on a quarterly basis. These federal returns are typically completed through Form 941, Employer’s Quarterly Federal Tax Return. Through this filing, businesses will report their income, as well as the Social Security and Medicare taxes that were withheld from employees’ paychecks. The employer’s portion of the Social Security and Medicare taxes must be reported too.

Eligible employers should expect to receive the credit, so they can use the funds that would normally be withheld to cover employees’ qualified wages. Businesses can also try requesting an advance from the IRS.

The Employee Retention Tax Credit provides an avenue for businesses to keep employees on their payroll during the tough financial times attached to the coronavirus pandemic. While it’s not a fix-all, the ERTC can help provide meaningful relief to businesses, especially when it’s used in conjunction with other programs. Most businesses are eligible for the credit, but its also important to see if other provisions in the CARES Act affect your eligibility.

• If you’re a business owner navigating taxes and financial planning during a time of economic uncertainty, a financial advisor can help. SmartAsset’s free financial advisor matching tool can match you with financial advisors in your area in only five minutes. If you want to interview potential financial advisors, get started now.
• Federal and state tax deadlines have largely been extended around the country. This, as well as the many other measures the federal government has taken, is designed to help make managing your business easier during the coronavirus crisis. Programs available to you include Economic Injury Disaster Loans (EIDLs) and the Paycheck Protection Program (PPP).

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