What is the Employee Retention Credit?
In March 2020, Congress passed the Coronavirus Aid, Relief, and Economic Security Act, or CARES act, to address the economic consequences of the COVID-19 pandemic. This momentous bill included provisions for all segments of the economy, including small businesses that saw lost income from the virus.
One part of the CARES act included the Employee Retention Credit (ERC). This credit allowed businesses to receive a refundable tax credit on qualified wages paid to employees after March 12, 2020, and before January 1, 2021. With the ERC, businesses could lower their financial burden and free up capital.
Recently, Congress passed the Consolidated Appropriations Act and the American Rescue Plan Act to extend these benefits and provide additional assistance. As a result, the Internal Revenue Service announced new guidance regarding the Employee Retention Credit for the 2021 tax year.
Let’s look at how you can still claim the ERC on your 2020 tax return and how to plan for it in 2021.
What is a tax credit?
Businesses pay taxes on a variety of items, such as wages, income, selling goods, and more. With a tax credit, a business can reduce how much it owes in taxes.
While this may sound similar to tax deductions, credits have a more significant effect. Deductions reduce the amount of taxable income, while credits reduce the actual tax amount.
For example, if a business owes $100,000 in taxes but has a $5,000 tax credit, it now only owes $95,000.
Who is eligible for the Employee Retention Tax Credit?
Small and large employers can qualify for the ERC if their business was interrupted or they can demonstrate a significant decline in gross receipts. However, there are some additional stipulations.
To qualify for the credit, eligible employers must satisfy one of the following:
- Your business fully or partially suspended operations due to the official coronavirus shutdown.
- (2020) You can demonstrate a 50% decline in gross receipts relative to the same quarter in 2019.
- (2021) You can demonstrate a 20% decline in gross receipts relative to the same quarter in 2020. If you were not open in 2020, you can use the corresponding quarter from 2019.
What are qualified wages?
The ERC can only be used on qualified wages and compensation. When calculating your credit, you can include the salary, hourly wage, tips, and other compensation that you paid employees. You can also include the value of any company health plan benefits when calculating wages.
Depending on which year you’re filing and the size of your business, you can only claim certain employee wages. Generally, qualified wages fall into one of four categories:
- 2020 & fewer than 100 full-time employees: You can claim credit for all employee wages.
- 2020 & over 100 full-time employees: You can claim a credit only for employees who could not provide their services.
- 2021 & fewer than 500 full-time employees: You can claim credit for all employee wages.
- 2021 & over 500 full-time employees: You can claim a credit only for employees who could not provide their services.
Keep in mind that full-time employment is defined as working at least 30 hours per week or 130 hours in a month.
Claiming the Employee Retention Credit on Your 2020 Taxes
If you have yet to file your 2020 tax return, you can benefit from the ERC.
Regarding 2020 taxes, you can use the Employee Retention Credit against 50% of qualified wages paid to employees between March 13 and December 31, 2020. You can online claim up to $10,000 per employee annually.
So if you paid an employee $30,000 in 2020, you can file for a tax credit on $10,000 of their wage. In this scenario, you will reduce your tax burden by $5,000.
Claiming the Employee Retention Credit on Your 2021 Taxes
For your 2021 taxes, you can use the ERC against 70% of the qualified wages paid to employees between January 1, 2021 and December 31, 2021. You can claim up to $10,000 per employee.
However, this updated guidance allows you to deduct this amount quarterly instead of annually. In theory, you can deduct $7,000 four times, equating to a $28,000 annual credit per employee.
How can you use your tax credits?
With the economy on an upward turn, you should feel comfortable investing your tax savings into your business. Consumers are becoming more comfortable shopping and dining in person, especially as more people receive vaccines.
Some of the best ways to re-invest your tax savings include:
- Improving your marketing capabilities
- Hiring employees and outsourcing tasks
- Redesigning your website
- Opening a second location
- Upgrading your point of sale system
- Starting a rainy day fund
Learn more about the Employee Retention Credit
If you would like additional information about the ERC and other coronavirus relief programs, please visit the following resources: