Many small businesses have begun to claim tax credits on their 2020 and 2021 payroll tax returns to take advantage of the Employee Retention Tax Credit (commonly called the ERTC or ERC). Many others still have yet to claim them. This valuable credit came about as part of the Coronavirus Aid, Relief and Economic Security (CARES) Act and is refundable, regardless of any liability. Congress designed the ERC to encourage employers to keep employees on payroll despite government shutdown orders or substantial declines in revenue caused by the COVID-19 pandemic. The ERC reimburses eligible employers up to $33,000 for qualified wages paid to employees during 2020 and 2021.
The ERC is available to every company, regardless of size, if they experience a full or partial suspension due to government orders or a substantial decline in gross receipts when compared to 2019. Much like a Paycheck Protection Program (PPP) loan, companies are entitled to the benefit as long as they paid employees’ wages during the pandemic. Furthermore, PPP recipients became eligible to apply for the ERC in early 2021— a welcomed relief to so many businesses impacted by the pandemic.
Congress intended for many businesses to qualify, so every company should closely examine their eligibility and not hastily assume a lack of it. Very few small businesses were not impacted by the pandemic, but because of a lack of tax resources or expertise — or simply a lack of awareness — many have missed this valuable opportunity.
If small businesses follow best practices, they should be able to prepare their own claims and realize a significant benefit. If an audit occurs, complete transparency with the IRS is critical in three major areas: qualification, methodology, and calculation.
As previously stated, a decline in gross receipts and/or demonstrating a full or partial suspension due to government orders are the pathways to eligibility. Before even beginning this analysis, defining the aggregated group dictates the rest of the process. Besides ownership and control, business relationships between companies can impact the aggregated group. This determination can help, but if done incorrectly, it can be detrimental. For example, a business owned by a spouse, minor child, or business partner can all affect the analysis.
Any good accountant knows that they need to document as much as possible and show how amounts are determined and decisions are made. Being able to clearly document and illustrate each step in the process for the IRS is key – and should not be done after the fact. Although you may know what happened and how horrible the impact might have been, without verifiable facts and figures, a concise narrative, and an analysis of how the government orders played out over time, you may be sorry. If you do get audited, you will be very happy that you took the time to document everything. Handing an auditor, a methodology memo often streamlines the process and keeps you in the driver’s seat.
You may think the calculation is simple but knowing what to base the calculation on (e.g., health plan expenses) may not be obvious. To complicate matters, if you had a PPP loan, you must be careful about which wages you can still include. Also, knowing who you cannot claim credits on (e.g., owners, family members, 1099 employees, etc.) is very important. Knowing which quarter to apply the credits to can also be tricky, but as a rule, the credits must be claimed in the quarter they were paid, not necessarily when they were earned.
Calculating your credit is not the only concern. You also need to know how to calculate your income taxes considering this credit. Unlike the PPP, which was determined by the IRS to not be included in gross income, there is a wage to add back under IRS rules that reduces the wage expense and increases taxable income. The IRS came out recently and reiterated the need to claim this add-back in the year in which the wages were paid, which in turn will require the amendment of any 2020 tax returns already filed if claiming 2020 Employee Retention Credit.
Although few companies actually get $33,000 per employee, many are still getting very significant benefits. Even small companies are amazed by how large their savings turn out to be, and any ERC opportunity that goes unexamined might just be the claim that produces a surprisingly large amount of credit. If you work with the experts to help determine your eligibility and prepare the proper documentation in advance of an IRS audit, then you’ll ultimately maximize your potential ERC benefit.