Added to federal tax law by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and since expanded, the Employee Retention Tax Credit (ERTC) can significantly reduce an employer's federal employment (payroll) taxes.
What is the Employee Retention Credit?
Employers can use the ERTC to offset dollar-for-dollar employer
payroll taxes they otherwise must deposit with the IRS. The ERTC
can offset the employer share of Social Security taxes on wages
consisting of 6.2% OASDI and 1.45% Hospital Insurance, a potential
savings totaling 7.65% of tax otherwise payable. The credit does
not affect the employee's share of required Social Security
The ERTC is “refundable,” meaning that if the available credit exceeds the employer's liability for eligible payroll taxes, then the credit creates an overpayment for which the employer can obtain a refund from the IRS.
The ERTC applies to:
- 50% of the qualified wages an eligible employer pays to employees after March 12, 2020 and before January 1, 2021;
- 70% of qualified wages from January 1, 2021 and before January 1, 2022.
For 2020: Up to $10,000 per employee can be counted to determine the amount of the 50% ERTC. The ERTC is capped at $5,000 for all qualified wages paid between March 13, 2020 and December 31, 2020 to each employee for all calendar quarters in 2020.
For 2021: Eligible employers can claim the ERTC against the employer share of Social Security tax equal to 70% of the qualified wages they pay to employees after December 31, 2020, and before January 1, 2022. Qualified wages are limited to $10,000 per employee per calendar quarter in 2021. The maximum ERTC amount available is $7,000 per employee per calendar quarter, for a total of $28,000 per employee in 2021.
Does Your Business Qualify?
Employers can qualify for the ERTC under any of three tests:
- the “gross receipts” test;
- the “suspension” test; or
- the “recovery startup business” test.
These tests apply separately to each calendar quarter, meaning that an employer may qualify to take the ERTC for some quarters, though not necessarily all quarters, in 2020 and 2021.
Gross Receipts Test
The “gross receipts” test is met by employers who have experienced a greater than 50% reduction in quarterly receipts, measured on a year-to-year comparison between 2019 and 2020, or who have experienced a greater than 20% reduction in quarterly receipts between 2019 and 2021.
Determining eligibility under the “suspension” test proves less clear cut than under the gross receipts test. Under the “suspension” test, employers must demonstrate their business operations were partially or fully suspended due to COVID-19 government shutdowns.
Businesses must demonstrate under the facts and circumstances that their operations were effectively suspended due to an inability to obtain critical goods from suppliers that were shut down, or that their hours of operation were reduced due to a governmental order. It is unclear what constitutes “operations” for businesses that remained partially operational during a shutdown. Other factors include the employer's telework capabilities, portability of the employees' work, or the need for presence in an employee's physical work space.
Essential businesses most likely will not qualify under the “suspension” test. The answers to these questions will become known only as the IRS possibly issues additional legal guidance on the ERTC or examines employer payroll tax returns claiming the ERTC.
Recovery Startup Business Test
Employers that started conducting business after February 15, 2020 can take the ERTC if their average annual gross receipts did not exceed $1 million for the three tax years ending with the tax year preceding the calendar quarter for which the employer seeks to take the credit. These employers are eligible even if they do not satisfy either the gross receipts test or the suspension test.
See Internal Revenue Code Section 3134, added by the CARES Act, as amended by the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Relief Act), the Consolidated Appropriations Act, 2021 (CAA 2021), and the American Rescue Plan of 2021 (ARPA).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.