A Glance at the Employee Retention Tax Credit
“Employee Retention Tax Credit (ERTC) | Definition & Eligibility” from financestrategists.com and used with no modifications.
In the storm that has been the COVID-19 pandemic, small businesses have had to ride the waves of economic instability. One lifeline has been the Employer Retention Credit (ERC). The ERC is a fully refundable tax credit for employers that can help small businesses maintain their workforces during this challenging time.
Employee Retention Credit Explained
The Employee Retention Credit (ERC) is a tax incentive established under the CARES Act. This credit provides financial relief to businesses that are enduring revenue losses due to the COVID-19 pandemic. The ERC is designed to encourage businesses to keep their employees on payroll by offering a credit on employment taxes.
The key aim of the ERC is to enable businesses to continue their operations and maintain their staff thus ensuring economic stability. All business owners should stay familiar with this credit as it can prove to be an invaluable resource during tumultuous times.
Initially, businesses were required to choose between the Paycheck Protection Program loan or the ERC. However, the recent changes have made it possible for businesses to take advantage of both the ERC and the PPP, providing much-needed flexibility.
CARES Act and Its Role in ERC
The CARES Act played a crucial role in the introduction and management of the ERC scheme. The aim was to provide financial relief to businesses struggling due to the pandemic outbreak and encourage them to retain their employees. Under the provisions of the CARES Act, eligible employers can claim a refundable tax credit against certain employment taxes equal to 50% of the qualified wages an eligible employer pays to employees after March 12, 2020, and before January 1, 2021.
Understanding the Payroll Tax Credit
The payroll tax credit is a crucial element of the Employee Retention Credit. This tax credit equates to 50 percent of up to $10,000 in wages paid by an eligible employer whose business has been financially impacted by COVID-19. For 2021, the credit’s value was increased to 70 percent, providing a greater incentive for businesses to retain their staff.
One of the key reasons for the existence of this tax credit is to enable businesses to offset the cost of keeping their workforce intact during a period of economic downturn. It’s worth noting that the credit applies to wages paid after March 12, 2020, and before January 1, 2021.
The relevant point here is that employers can reduce the employment tax deposits they’re otherwise required to make. In essence, the credit allows them to fund the payment of their employees with less out-of-pocket costs.
Eligibility Criteria for ERC
“Tax Credits | Definition, Types, Qualifications, and Limitations” from financestrategists.com and used with no modifications.
Determining eligibility for the Employee Retention Credit involves several criteria. A baseline requirement is that you must have operated a business during 2020. Thereafter, the factors for consideration include whether your business operations were fully or partially suspended due to a COVID-19-related governmental order, or if you experience a significant decline in gross receipts.
Qualification Based on Wages Paid
When it comes to wages, the ERC is applied against the employer portion of employment taxes of eligible employers. The amount of qualified wages that considers in calculating the amount varies based on the size of the employer.
For smaller employers with an average of 100 or less full-time employees in 2019, all employee wages are counted in the credit calculation. Larger employers, those with more than 100 full-time employees, would only take into account wages paid to employees, to the extent they are not providing services because of the business suspension or the decline in gross receipts.
It is vital for businesses to understand that not all wages qualify for the ERC. Payments to former employees, including severance payments, or wages paid to related parties, are excluded. Therefore, proper accounting and documentation of wages paid is essential for accuracy when claiming the ERC.
Effect of Business Suspension Due to COVID-19
To qualify for ERC, your business must have faced a full or partial suspension due to a government order related to COVID-19. Specific cases of discontinuation of business operations may depend on the nature of your business and the orders issued affecting your location.
Role of Gross Receipts in Eligibility
Another crucial factor that determines eligibility for ERC is your business’s gross receipts. A significant decline in gross receipts during a calendar quarter is also considered a qualifying eligibility criterion. Specifically, the gross receipts for a particular calendar quarter must be less than 50% of the gross receipts for the same calendar quarter in 2019.
Once the gross receipts in a 2020 quarterly period have risen above 80% of the same 2019 quarterly period, they no longer qualify after the end of that quarter. Keeping meticulous records of all receipts ensures an accurate claim of ERC and helps avoid complications.
The measure of gross receipts defined by the Internal Revenue Code includes total sales (net of returns and allowances), all amounts received for services, income from investments, and any other income. Therefore, businesses must have a comprehensive understanding of their financial inflow to correctly determine gross receipts.
Claiming the Employee Retention Tax Credit
“IRS Issues Employer’s Tax Guide for 2021” from payrollpartners.com and used with no modifications.
Claiming the ERC is primarily about reducing payroll tax deposits and reconciling the reduction on the quarterly employment tax return – specifically, Form 941. If your workers’ employment tax deposits are insufficient to cover the credit, you may receive an advance payment from the IRS by submitting Form 7200, Advance Payment of Employer Credits Due to COVID-19.
Reducing Payroll Tax Deposits
Employers can fund their applicable payroll taxes with the ERC. By doing so, businesses have the added benefit of retaining the cash that they would have initially paid out-of-pocket as payroll taxes. The process for this starts simply by reducing employment tax deposits.
More specifically, if the employer’s employment tax deposits are not sufficient to cover the credit, the employer may receive an advance payment from the IRS. This underscores the importance of understanding how employment tax deposits work and ensuring that wage and tax documentation is always up to date.
Filing Form 7200 for a Refund
In certain circumstances, employers with a shortage of employment tax deposits can submit Form 7200, Advance of Employer Credits Due To COVID-19, to request an advance payment of the credit from the IRS. However, businesses need to be mindful of the guidelines and timing of this submission.
In terms of timing, the form can be filed at anytime during a quarter before the month the Form 941, Employer’s Quarterly Federal Tax Return, for that quarter is due. In short, Form 7200 cannot replace the filing of Form 941, which is still needed to reconcile the credit’s total value with the relevant advance.
The process of filing for an advance requires detailed knowledge of your payroll taxes. Therefore, businesses need to ensure that the right systems are in place to accurately fill and submit Form 7200.
Role of IRS Form 941 in Reconciliation
To claim the ERC, it is mandatory to report the total qualified wages and the related health insurance costs for each quarter on your Form 941. Advanced credits received via Form 7200 are also reported on Form 941. In short, Form 941 provides an overview of the complete tax credit, the amount taken in advance, and the difference between actual and reported figures.
By understanding how to correctly navigate Form 941, businesses can ensure a smooth reconciliation process and avoid any unnecessary penalties or tax adjustments. Awareness of the form’s specifications and how it relates to your specific business operations is an undeniable asset when handling the ERC.
Correct Handling of Refunds and Credits
Businesses that receive a tax credit must handle it correctly in terms of accounting practices. For those who receive an Employee Retention Credit, they must remember that it is a tax credit and not a tax deduction. Hence, you cannot deduct the part of the wages paid to employees to the extent equal to the ERC.
Understanding the differences between credits and deductions, and their specific implications on tax obligations is crucial for accurately handling refunds and credits. Always ensure that the credit is added to your gross income for the tax year when the credit is applied.
Understanding Full and Partial Suspension
To qualify for the ERC, businesses must have experienced either a full or partial suspension of their operations due to a governmental order related to COVID-19. But what exactly constitutes full and partial suspension?
Impact of COVID-19 on Business Operations
“Full suspension” is relatively straightforward as it refers to a total shutdown of operations. However, “partial suspension” is a bit trickier. It applies if, under governmental orders related to COVID-19, the business can continue some, but not all, of its typical operations.
This could be due to a reduction in business hours or a limit on the business’s customers, causing an inability to carry out standard operations. Maintaining a clear record of the impact of COVID-19 on your business’s standard operating procedures is crucial for ERC qualification.
Business Suspension and ERC Eligibility
Eligibility for the ERC has a direct relation with the extent of the suspension experienced by the business. The nature of the suspension—whether full or partial, influences the amount of qualified wages that can be considered when calculating the credit.
This intricate understanding of how business suspension directly impacts ERC eligibility, therefore, aids businesses in accurately calculating their credit and minimizing errors in their claims.
Mitigation Measures and Their Effect on Business Operations
The undertaking of mitigation measures also plays a significant role in determining qualification for the ERC. Suppose your business can continue operations by complying with health and safety guidelines for employees and customers, even though a governmental order has led to a partial suspension of business.
That does not necessarily disqualify your business from the ERC. The expenditures on the provision and maintenance of a safe and secure workspace also qualify towards the ERC.