The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) contains a business relief provision known as the employee retention credit, a refundable payroll tax credit for "qualified wages" paid to retained employees between March 13 and December 31, 2020. 

The purpose of this provision is to encourage employers to keep employees on the payroll, even if they are not working during the covered period due to the effects of the coronavirus outbreak. Here's what you need to know as an employer to take advantage of this section of the CARES Act.

Key Takeaways

  • The Employee Retention Credit provides an up to $5,000 refundable credit for each full-time employee you retain between Mar. 13 and Dec. 31, 2020.
  • You qualify as an employer if you were ordered to fully or partially shut down or if your gross receipts fell below 50% of the same quarter in 2019.
  • You can claim your credit immediately by reducing payroll taxes sent to the IRS.
  • If your credits exceed payroll taxes, you can request a direct refund from the IRS.
  • You should compare this credit with PPP since you can't take advantage of both—but since PPP applications are suspended pending additional funding, look at this especially carefully.

How to Qualify as an Eligible Employer

In order to qualify to receive this credit you must carry on a trade or business in 2020 and either have had to:

  • Fully or partially suspend business operations during any calendar quarter in 2020 due to orders from a government authority; or
  • Experienced a "significant decline in gross receipts" during a calendar quarter equal to less than 50% of gross receipts in the same quarter in 2019

For example, if you own a restaurant that is ordered closed to sit-down customers but allowed to continue carryout, drive-thru, or delivery operations, that qualifies you for the credit based on a coronavirus-related partial shutdown. You are qualified for any quarter during which the government order applied—up to four quarters in 2020.

The "significant decline in gross receipts" test applies whether your business was affected by COVID-19 or not. A qualified period begins in any quarter where receipts are less than 50% of receipts in the same quarter in 2019 and ends at the beginning of the first calendar quarter after the first quarter in which gross receipts are greater than 80% of gross receipts for that quarter in 2019.

The table below illustrates both qualification tests.

Quarter % of 2019
Receipts
Government
Order
Qualify
Receipts
Qualify
Order
1 - Jan. - Mar. 55% Yes No Yes
2 - Apr. - Jun. 20% Yes Yes Yes
3 - Jul. - Sep. 90% No Yes No
4 - Oct. - Dec. 80% No No No

In the table above, based on the "government order test," your business would qualify for the employee retention credit in the 1st and 2nd quarters of 2020. Based on the "gross receipts" test, you would qualify in the 2nd and 3rd quarters. Since either test determines qualification, overall your business would qualify in Q1, Q2, and Q3. Neither test would apply in Q4, so you would not qualify in that quarter.

Other Qualification Standards

Self-employed individuals, governmental employers, or any small business that receives a Small Business Interruption Loan under the Paycheck Protection Program (PPP) are not eligible for this credit.

Wages for which you received a tax credit for paid sick and family leave under the Families First Coronavirus Response Act (Phase II) do not qualify.

Any wages you count for this credit can't be counted as part of the credit for paid family and medical leave under section 45S of the Internal Revenue Code.

Any employee for whom you were granted a Work Opportunity Tax Credit under section 51 of the Internal Revenue Code cannot be counted for this credit.

Qualified Wages

The number of full-time employees you averaged in 2019 determines which employees you can claim for the credit. If you averaged more than 100 full-time employees, only wages for those you retain who are not working can be claimed. If you employed 100 or fewer workers, you can claim wages for all employee whether they are working or not.

The Employee Retention Credit applies to full-time workers only.

Amount of the Credit

The credit is equal to 50% of up to $10,000 in qualified wages (including amounts paid towards health insurance) per full-time employee for all eligible calendar quarters beginning March 13 and ending December 31, 2020. This works out to a maximum credit of $5,000 per employee for the period.

The credit is applied to your portion of the employee's Social Security taxes and is fully refundable. This means the credit will serve as an over payment and be refunded to you after subtracting your share of those taxes. The table below illustrates your payroll costs for one full-time employee for 2020 based on three qualified quarters.The table only includes FICA taxes as a cost since other costs would not be affected.

2020 Qualified Wages FICA Reg. Payroll Credit New Payroll
Q1 Yes $4,800 $367,20 $5,167.20 $2,400 $2,767.20
Q2 Yes $4,800 $367.20 $5,167.20 $2,400 $2,767.20
Q3 Yes $4,800 $367.20 $5,167.20 $200 $4,967.20
Q4 No $4,800 $367.20 $5,167.20 $0 $5,167.20
Total Total $19,200 $1,468.80 $20,668.80 $5,000 $15,668.80

The table shows that your regular payroll costs for this employee for 2020 would have been $20,668.800. With the Employee Retention Credit your payroll costs drop to $15,668.80. Your credit for this employee for Q1 and Q2 exceeds the amount you pay in Social Security taxes. That is not the case in Q3. How to get your credit is covered in the next section.

How to Get the Credit

You can obtain immediate reimbursement of at least part of your credit and request an advance payment of any balance from the IRS, depending on the total amount of your credit. It's important you follow the steps below in order.

Step 1: Calculate the amount of your credit for the preceding quarter and reduce your Form 941, Employer's Quarterly Federal Tax Return deposit by that amount.

For example: If your credit for Q1 2020 is $10,000 and the amount you are scheduled to deposit is $15,000, reduce the deposit by $10,000 and deposit $5,000. You will account for this credit on Form 941 which you must file by April 30, 2020.

You can claim your credit by deducting it from any withholding amount including federal income taxes, employee FICA taxes, and your share of FICA taxes for all employees up to the amount of the credit.

Step 2: Starting with Q2 2020, if your credit for Q1 exceeded the amount withheld for payroll taxes, you can receive an advance payment from the IRS by submitting Form 7200 Advance Payment of Employer Credits Due to COVID-19. You can submit Form 7200 any time during the month following the quarter for which your claim is being made.

For example: If your credit for Q1 2020 was $18,000 and the amount you were scheduled to deposit was $15,000, your credit will wipe out the deposit and leave you with an additional $3,000 credit which you can claim any time during April 2020 by submitting Form 7200. Note: The IRS has not yet commented on the timing of Form 7200 refunds.

Repeat Steps 1 (and 2 if applicable) for each quarter during 2020 in which you qualify for a credit. 

Employee Retention Credit vs. PPP

Both the Employee Retention Credit and Paycheck Protection Program (PPP) provide financial relief to businesses that retain employees. Unfortunately, you can't take advantage of both. You have to choose.

Read about the Paycheck Protection Program and compare the benefits of that program with those of the Employee Retention Credit program. You will want to know which program provides the most economic support for you and your employees. This will include a determination of your eligibility for both programs as well as what you need funds for.

Note that PPP applications were suspended by April 17, 2020, pending additional funding for the program. This could shape your choices.