If your business was impacted by COVID-19-related government orders or has seen its revenue significantly decline because of the pandemic, then keeping everybody on your payroll has likely been a huge challenge. Fortunately, the Employee Retention Credit (ERC) — which is available to any organization that kept workers on the job throughout the pandemic — might offer some relief. This fully refundable tax credit can deliver up to $33,000 per employee (as much as $5,000 per employee for 2020 and up to $7,000 per employee per calendar quarter for 2021).
The government has amended the ERC multiple times. Plus, the IRS published non-binding opinions during 2020 that aren’t the same as the guidance it published in March 2021. So, getting through the credit is complex. Your best bet for handling the ERC calculation on your own is to go through all the eligibility and qualification criteria, one by one, to make sure you’re counting the right employees and wages. This requires the following eight steps.
1. Identify which controlled entities you’re going to treat as a single employer.
Under the ERC, the IRS generally treats all of the companies that are members of or affiliated with a larger group as a single employer. The ERC varies based on the average number of full-time employees you had in 2019. So, this rule influences how you calculate the gross receipts, eligibility, qualified wages and the overall ERC calculation. If you had somebody who was employed separately by sister companies, for instance, and the ERC treats those companies as one employer, then you’d count that employee just once.
2. Figure out if the business is eligible.
The first ERC eligibility situation is when health department or state/local government officials put out a formal order (e.g., a declaration of a state of emergency) that specifically limits commerce, travel or group meetings. You can get the credit if the order cuts your gross receipts or employee hours by at least 10% or if your business had to suspend operations completely because the virus caused disruptions for one or more of your suppliers.
You can also be eligible through a standalone decline in your gross receipts. If your gross receipts went down over a period in 2020 by at least 50% compared to the same period in 2019, then you qualify. You also qualify if your gross receipts went down by at least 20% in 2021 compared to the same period in 2020.
3. Pinpoint the time period when the business was eligible.
Let’s say your company qualifies based solely on a drop in your gross receipts. Then, the IRS bases your eligibility time period on the quarters where you started and stopped meeting the ERC gross receipt guidelines.
First, figure out the 2020 calendar quarter where you had gross receipts that were less than 50% compared to the same quarter in 2019. Alternately, figure out the 2021 calendar quarter where you had gross receipts that were less than 80% compared to the same quarter in 2020. Your eligibility period starts on the first day of this quarter.
Next, identify the 2020 quarter where your gross receipts ticked back up over 50% compared to the same quarter in 2019. Alternately, identify the first 2021 quarter where your gross receipts were more than 80% compared to the same quarter in 2020. Your eligibility period ends on the last day of this quarter or at the end of the calendar year.
4. Determine the wages that qualify for the tax credit.
The first thing to know about qualified wages for the ERC is that it makes a difference to the IRS whether you’re a small or large employer. The IRS looks at the average number of full-time employees (FTEs) you had in 2019 to make this determination. For 2020, the IRS considers you small if you had 100 or fewer average FTEs in 2019. For 2021, a business is considered small if it had 500 or fewer average FTEs in 2020.
Second, qualifying wages start on March 13, 2020. They include most employer healthcare contributions, including contributions you’ve made for furloughed employees. The maximum qualifying wages under the ERC are $10,000 per employee for 2020 and $10,000 per employee per calendar quarter for 2021. You don’t need to justify more than this amount for each employee.
If you’re a small employer, then you can include all wages, including paid time off, for all eligible employees. Otherwise, you’re allowed to include just the wages you pay to employees for sitting idle or not working. You also need to document whatever methodology you use to figure out idle wages.
You can’t count wages for paid time off if you’re a large company because those are treated as employee benefits. Remember, though, that you’re only required to justify wages up to the per-employee maximum for the year in 2020 or the calendar quarter in 2021.
Qualifying wages are arguably the most subjective part of your ERC calculation. As a result, they’re the element that the IRS is most likely to challenge if they decide to audit you. The good news is, the IRS won’t hit you with any penalties for ERC calculation mistakes. So, your maximum level of risk is just the amount of your credit.
5. Calculate the tax credit amount.
For 2020, your tax credit is 50% of qualifying wages, and you can take a maximum credit of $5,000 per employee. For 2021, your tax credit is 70% of qualifying wages, and the IRS allows a maximum credit of $7,000 per employee per calendar quarter.
6. Compare relief between ERC and PPP programs.
When you’re comparing the Paycheck Protection Program (PPP) and ERC, you have to look closely at your wages and where those monies come from. For example, if you’ve paid wages through a forgiven PPP loan, then you can’t use those same wages to qualify for the ERC, too. But you can use wages you paid that exceeded the amount of the forgiven PPP loan to apply for the ERC. If you paid $150,000 in wages in total, for example, and just $100,000 of that came from your PPP loan, then you’d have $50,000 left to direct toward your ERC.
Additionally, let’s say you have an unforgiven PPP loan, you crunch the numbers, and it turns out that it’s actually going to help you more to use the wages to qualify for the ERC. In that scenario, you can just put the wages toward the credit instead of applying for forgiveness. Take a little extra time to evaluate what the best option is for your company.
7. Optimize with other tax credits and eliminate overlap.
Typically, the IRS lets you use qualifying wages to calculate a single tax credit, which means you can’t use the same wages for the ERC and other credit options, such as the R&D tax credit. You also can’t take a payroll tax deduction for wages used to qualify for the ERC. And if you’re the majority business owner, then there are also restrictions on the wages you pay to certain relatives. Modeling different scenarios is the best way to optimize the total amount of your credit in 2020 and 2021.
8. Review and organize your documentation.
Pull together documentation that leaves no question about the step-by-step processes for every decision you made. It should read like one big instruction manual that an IRS agent can follow to see exactly how you came to your final calculation. For example, if you qualify based on a government order, then include a copy of the specific order that impacted your business and add details outlining the extent of the impact. If you qualify based on a decline in gross receipts, then include documentation of those receipts.
Most experts view COVID-19 as a once-in-a-lifetime crisis, so the ERC hopefully won’t be a credit that you’ll need to worry about for long. If you follow the above steps carefully, then you should be able to calculate your ERC accurately and maximize the relief you receive. Because it is a complex program, however, you should outsource to qualified tax credit professionals to ensure you get the most out of it for your business.