The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) contains a business relief provision known as the Employee Retention Credit (ERC), a refundable payroll tax credit for "qualified wages" paid to retained full-time employees between March 13 and Dec. 31, 2020.

Update

The Taxpayer Certainty and Disaster Tax Relief Act (TCDTR) of 2020, which is part of the Consolidated Appropriations Act (CAA), 2021, signed into law Dec. 27, 2020, significantly modifies and expands provisions of the ERC including for wages paid in the first half of 2021.

The purpose of the Employee Retention Credit 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 updated credit.

Key Takeaways

  • The updated Employee Retention Credit (ERC) provides a refundable credit of up to $5,000 for each full-time equivalent employee you retained between March 13 and Dec. 31, 2020, and up to $14,000 for each retained employee between Jan. 1 and June 30, 2021.
  • You qualify as an employer if you were ordered to fully or partially shut down or if your gross receipts fell below 50% for the same quarter in 2019 (for 2020) and below 80% (for 2021).
  • If you were not in business in 2019, you could use the corresponding quarters from 2020.
  • 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.
  • The new law, retroactive to March 27, 2020, now allows employers who received Paycheck Protection Program (PPP) loans to claim the ERC for qualified wages not treated as payroll costs in obtaining forgiveness of the PPP loan.

Consolidated Appropriations Act (CAA) Changes to ERC

If you are already familiar with the ERC under the CARES Act, this section lays out changes made by the CAA, 2021.

The CAA includes the following retroactive changes to the ERC. These changes apply to the period from March 13 through Dec. 31, 2020.

  • If you received a PPP loan, you may still qualify for the ERC for any wages not paid with proceeds from the forgiven portion of your PPP loan.
  • The Consolidated Appropriations Act clarifies how qualifying tax-exempt organizations determine “gross receipts.”
  • Group healthcare expenses are considered “qualified wages.” This is true even if no other wages are paid to that employee.

The following elements apply to the ERC for Jan. 1 through June 30, 2021:

  • The ERC credit rate per employee is increased to 70% of qualified wages (from 50%) and the per-employee wage limit is increased from $10,000 for the year to $10,000 per quarter for 2021.
  • Your eligibility as an employer is based on gross receipts of less than 80% (versus less than 50%) when compared to the same quarter in 2019. This means if your gross receipts decline more than 20% in 2021, you are eligible to take the credit.
  • You can elect to use the immediately preceding calendar quarter (i.e., Q4 2020 and Q1 2021) instead of Q1 and Q2 2021, respectively, compared to the same quarter in 2019 to determine eligibility.
  • If your company did not exist in 2019 you may compare 2021 quarterly gross receipts to the same 2020 quarters to determine eligibility.
  • The 2021 credit is available to public colleges, universities, organizations providing medical or hospital care, and certain organizations chartered by Congress.
  • For 2021 the definition of large employer changes from more than 100 to more than 500 employees which allows you to use a broader definition of qualified wages if you fall within that threshold. In short, you can count wages paid to both active (working) employees and those not providing services.
  • The CAA also removes the limit on qualified wages defined as no more than the employee would have received in the 30 days before the qualifying period. Now, for example, you can take the ERC if you pay a bonus to an essential worker.
  • If you have fewer than 500 full-time equivalent employees, you will be allowed advance ERC payments during the quarter in which the wages were paid to those employees. This includes seasonal employers and part-time employees, and employers not in existence in 2019.

How to Qualify as an Eligible Employer

Whether you qualify as an “Eligible Employer” depends on the time period in question. 

For the period March 13, 2020, through Dec. 31, 2020, you must have carried on a trade or business, or were a tax-exempt organization that:

  • Was partially or fully suspended due to COVID-19 orders from an appropriate governmental authority
  • Experienced a significant decline in gross receipts, defined as less than 50% of gross receipts for the same calendar quarter in 2019

In addition:

  • Government and state entities and political subdivisions are not eligible for the 2020 ERC.
  • If you were self-employed, you are not eligible for the 2020 ERC for your own wages but if you employed other people, you may qualify for the ERC wages paid to those employees.

For the period Jan. 1, 2021, through June 30, 2021, you must have carried on a trade or business or were a tax-exempt organization that:

  • Was partially or fully suspended due to COVID-19 orders from an appropriate governmental authority
  • Experienced a significant decline in gross receipts defined as less than 80% of gross receipts for the same calendar quarter in 2019

In addition:

  • If you were not in business in 2019, you can use 2020 as your comparison year.
  • Government and state entities and political subdivisions are not eligible for the 2021 ERC, however, tax-exempt public colleges, universities, and hospitals are eligible.
  • If you are self-employed, you are not eligible for the 2021 ERC for your own wages. But if you employ other people, you may qualify for the ERC wages paid to those employees.

The "significant decline in gross receipts" test for both 2020 and 2021 applies whether your business was affected by COVID-19 or not.

The table below illustrates both qualification tests for 2020 and 2021.

2020 % of 2019 Receipts Government Order Qualify Receipts Qualify Order
Jan. - Mar. 55% Yes No Yes
Apr. - Jun. 20% Yes Yes Yes
Jul. - Sep. 90% No Yes No
Oct. - Dec. 80% No No No
2021 % of 2019
Receipts
Government
Order
Qualify
Receipts
Qualify
Order
Jan. - Mar. 90% Yes No Yes
Apr. - Jun. 79% No Yes 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 and in Q1 of 2021. Based on the "gross receipts" test, you would qualify in the 2nd and 3rd quarters of 2020 and Q2 of 2021. Since either test determines qualification, overall your business would qualify in Q1, Q2, and Q3 in 2020 and both quarters in 2021. Neither test would apply in Q4 of 2020, so you would not qualify in that quarter.

Other Qualification Standards

The CARES Act prohibited you from receiving the ERC for:

  • Wages for which you received a tax credit for paid sick and family leave under the Families First Coronavirus Response Act (Phase II)
  • Any wages you counted as part of the credit for paid family and medical leave under section 45S of the Internal Revenue Code
  • Wages paid to certain related individuals
  • Any employee for whom you were granted a Work Opportunity Tax Credit under section 51 of the Internal Revenue Code

Under the CAA, 2021, this prohibition is also extended to wages affected by certain other credits including the Research Activities Credit, Indian Employment Credit, Credit for Employer Differential Wage, and Empowerment Zone Employment Credit.

Qualified Wages

The number of full-time employees you averaged in 2019 determines which employees you can claim for the credit, depending on the year.

For 2020, if you averaged more than 100 full-time employees, only wages for those you retained who are not working can be claimed. If you employed 100 or fewer workers, you can claim wages for all employees whether or not they are working.

For 2021, the threshold is raised to 500 full-time employees, meaning if you employ more than 500 people, you can only claim the ERC for those who are not providing services. If you have 500 or fewer employees, you can claim the ERC for all of them, working or not.

The Employee Retention Credit applies to individuals employed on a full-time, part-time, or another basis if their employer meets the necessary requirements.

Amount of the Credit for 2020

For 2020, 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 Dec. 31, 2020. This works out to a maximum credit of $5,000 per employee for the period.

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 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 overpayment 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.

Amount of the Credit for 2021

For 2021, the credit is equal to 70% of up to $10,000 in qualified wages (including amounts paid towards health insurance) per full-time employee for each eligible calendar quarter beginning Jan. 1 and ending June 30, 2021. This works out to a maximum credit of $14,000 per employee ($7,000 per quarter) 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 overpayment and be refunded to you after subtracting your share of those taxes. The table below illustrates your payroll costs for one full-time employee (the term 'employee' includes full-time, part-time, or other basis) for the first half of 2021 based on two 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 $3617.04 $2,767.20
Q2 Yes $4,800 $367.20 $5,167.20 $3617.04 $2,767.20
Total Total $9,600 $1,468.80 $11,068.80 $7234.08 $5,534.40

The table shows that your regular payroll costs for this employee for the first half of 2021 would have been $11,068.80. With the Employee Retention Credit, your payroll costs drop to $5,534.40. Your credit for this employee for Q1 and Q2 exceeds the amount you pay in Social Security taxes. How to get your credit is covered in the next section.

How to Get the ERC for Wages Paid in Q4 2020

The process to file for the ERC for Q4 2020 wages is essentially the same as the process followed for all of 2020. Calculate the amount of your credit for Q4 2020 and reduce your Form 941, Employer's Quarterly Federal Tax Return deposit by that amount.

For example: If your credit for Q4 2020 was $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 Jan. 31, 2021.

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.

How to Get the ERC for Unforgiven PPP Loan Proceeds

The fact you received a PPP loan in 2020 does not preclude you from claiming the ERC for qualified wages that were not counted as payroll costs in order to obtain forgiveness of all or part of your PPP loan. Further, if you included wages paid in Q2 and/or Q3, 2020 on your forgiveness request and your rquest was denied, you can claim those wages on your Q4 2020 Form 941 due Jan. 31, 2021.

You can also report on your 4th quarter Form 941 any ERC attributable to health expenses that are qualified wages that you didn't include on your 2nd and/or 3rd quarter Form 941.

Time is short, but if you choose to use this procedure, add the appropriate ERC attributable to Q2 or Q3 qualified wages and health expenses on line 11c or line 13d of your original Q4 2020 Form 941 along with qualified wages paid in Q4. Complete detailed instructions can be found on the IRS website.

Alternatively, you can file an adjusted return or claim for a refund for the appropriate quarter to which the additional ERC relates using Form 941-X.

How to Get the ERC for Wages Paid in 2021

The process for obtaining the ERC for 2021 is expected to be similar to that outlined for 2020 above. Be sure to take into account changes enacted by the CAA and outlined above.

Also, just like in 2020, you can obtain your ERC for Q1 and Q2 2021 by reducing your employment tax deposits. If you qualify as a small employer (500 or fewer full-time employees in 2019) you may request advance payment of the credit using Form 7200, Advance of Employer Credits Due to COVID-19. In 2021, advances are not available for employers with more than 500 employees.