How to Calculate the Employee Retention Tax Credit

Are you curious about how to calculate the Employee Retention Tax Credit? Look no further! In this article, we will guide you through the process of calculating this credit step by step. Whether you are a business owner or an individual interested in understanding this tax credit, we’ve got you covered. By the end of this article, you will have a clear understanding of how to calculate the Employee Retention Tax Credit and how it can benefit you or your business. So, let’s get started!

Overview of the Employee Retention Tax Credit

The Employee Retention Tax Credit (ERTC) is a valuable tax break designed to provide financial relief to businesses that have been negatively impacted by the COVID-19 pandemic. This tax credit, established under the CARES Act and extended under subsequent legislation, encourages employers to retain their employees during these challenging times. The ERTC is intended to help businesses cover a portion of the wages and health benefits paid to their employees, thereby reducing their overall payroll costs.

What is the Employee Retention Tax Credit?

The Employee Retention Tax Credit is a refundable tax credit that allows eligible employers to claim a percentage of qualified wages paid to their employees. This credit is calculated based on specific criteria and can provide substantial financial assistance to businesses that have experienced significant revenue declines or faced government-imposed restrictions due to the pandemic.

Purpose of the Employee Retention Tax Credit

The primary purpose of the Employee Retention Tax Credit is to incentivize employers to retain their employees and continue paying them during times of economic uncertainty. By providing a tax credit for wages and health benefits, the ERTC aims to help businesses alleviate the financial burden of retaining their workforce. This, in turn, helps to maintain employment levels and support the overall economic recovery.

Eligibility for the Employee Retention Tax Credit

To qualify for the Employee Retention Tax Credit, businesses must meet specific eligibility criteria. Understanding these requirements is crucial for determining whether your business is eligible to claim the credit.

Businesses Eligible for the Tax Credit

The ERTC is available to businesses of all sizes, including tax-exempt organizations. However, certain entities are excluded from claiming the credit, such as state and local governments and any businesses that received a Paycheck Protection Program (PPP) loan.

Qualified Wages for the Tax Credit

Qualified wages are a key factor in determining the amount of the tax credit. For businesses with 100 or fewer full-time employees, all wages paid to employees during an eligible period qualify. However, for employers with more than 100 full-time employees, only wages paid to employees who are not providing services due to specific pandemic-related circumstances are eligible.

Impact of PPP Loans on the Tax Credit

If a business received a PPP loan, it may affect their eligibility for the Employee Retention Tax Credit. Specifically, businesses that received a PPP loan can still claim the credit for wages that were not covered by the loan funds. However, the same wages cannot be used for both the PPP loan forgiveness and the ERTC. It’s important for businesses to carefully consider how the ERTC interacts with their PPP loan forgiveness process to maximize their potential benefits.

Calculating the Employee Retention Tax Credit

Calculating the Employee Retention Tax Credit involves several steps that businesses must follow to accurately determine the credit amount they can claim.

Step 1: Determine the Applicable Time Period

The first step in calculating the ERTC is to determine the applicable time period. Generally, eligible wages paid between March 13, 2020, and December 31, 2021, can be considered for the credit. However, there are variations in the time periods for different scenarios, such as whether the business experienced a full or partial suspension due to government orders or reduced gross receipts.

Step 2: Calculate the Average Number of Full-Time Employees

Next, businesses need to calculate the average number of full-time employees they had during the applicable time period. Full-time employees are defined as employees who worked an average of at least 30 hours per week or 130 hours in a calendar month.

Step 3: Determine Qualified Wages

Once the average number of full-time employees is determined, businesses need to identify the qualified wages that are eligible for the tax credit. The definition of qualified wages depends on the size of the business. For businesses with 100 or fewer full-time employees, all wages paid during the eligible period qualify. However, for businesses with more than 100 employees, only wages paid to employees who are not providing services due to pandemic-related circumstances are eligible.

Step 4: Calculate the Tax Credit

The final step is to calculate the actual tax credit amount based on the determined qualified wages and the applicable percentage. The percentage of qualified wages eligible for the credit varies depending on the time period and the size of the business. For wages paid between March 13, 2020, and December 31, 2020, the credit is equal to 50% of qualified wages, up to a maximum of $10,000 per employee. For wages paid between January 1, 2021, and December 31, 2021, the credit percentage increases to 70%.

Step 1: Determine the Applicable Time Period

To accurately calculate the Employee Retention Tax Credit, it is essential to determine the applicable time period based on the specific circumstances of the business.

Quarterly Time Periods for the Tax Credit

In general, the ERTC considers eligible wages paid between March 13, 2020, and December 31, 2021. However, for simplicity, the credit can be calculated on a calendar quarter basis. This means that businesses need to determine the qualified wages for each quarter to accurately claim the credit.

Eligible Periods for Businesses Impacted by Government Orders

For businesses directly impacted by government orders, such as full or partial suspensions, the eligible time periods may vary. If a government order fully or partially suspended business operations, the eligible periods can extend until the quarter following the one in which the order was lifted. However, if the business experienced a decline in gross receipts, the eligible periods continue until a quarter where gross receipts exceed 80% of the same quarter in the prior year.

Step 2: Calculate the Average Number of Full-Time Employees

Determining the average number of full-time employees during the applicable time period is crucial for accurately calculating the ERTC.

Definition of Full-Time Employees

For the purposes of the Employee Retention Tax Credit, full-time employees are defined as those who work an average of at least 30 hours per week or 130 hours in a calendar month. Part-time employees should be converted into full-time equivalents to calculate the average number of full-time employees.

Calculation Method for the Average Number of Full-Time Employees

To calculate the average number of full-time employees, businesses need to add up the full-time employee count for each pay period within the applicable time period, then divide the total by the number of pay periods. This calculation provides a reliable estimate of the average number of full-time employees.

Step 3: Determine Qualified Wages

Identifying the qualified wages that are eligible for the Employee Retention Tax Credit is a crucial step in the calculation process.

Definition of Qualified Wages

Qualified wages include all wages paid to employees during the applicable time period. For businesses with 100 or fewer full-time employees, all wages qualify for the credit. However, for businesses with more than 100 employees, only wages paid to employees who are not providing services due to pandemic-related circumstances, such as government orders, qualify.

Qualified Health Plan Expenses

In addition to qualified wages, qualified health plan expenses can also be considered for the tax credit. This includes both the employer’s share of health plan premiums and the amount that employees contribute through pre-tax salary reductions.

Determining Qualified Wages for Employers with Over 100 Full-Time Employees

For businesses with more than 100 full-time employees, determining qualified wages requires identifying employees who are not providing services due to pandemic-related circumstances. This can be a complex task, considering the potential variations in employee schedules and work arrangements. However, meticulous record-keeping and accurate identification of eligible employees are vital to ensure the proper calculation of the tax credit.

Step 4: Calculate the Tax Credit

The final step in calculating the Employee Retention Tax Credit is determining the actual credit amount based on the qualified wages and the applicable percentage.

Calculating the Credit for Qualified Wages

The tax credit is calculated as a percentage of qualified wages. For wages paid between March 13, 2020, and December 31, 2020, the credit is equal to 50% of qualified wages, with a maximum of $10,000 per employee. For wages paid between January 1, 2021, and December 31, 2021, the credit percentage increases to 70%.

Interaction with Other COVID-19 Relief Programs

It’s important to note that the Employee Retention Tax Credit can interact with other COVID-19 relief programs, such as the Paycheck Protection Program (PPP) loan. Businesses that received a PPP loan can still claim the tax credit for wages not covered by the loan funds. However, the same wages cannot be used for both the PPP loan forgiveness and the ERTC, as this would result in a duplication of benefits.

Claiming the Tax Credit

To claim the Employee Retention Tax Credit, eligible businesses need to report the credit on their employment tax return, typically Form 941. If the credit exceeds the employer’s total liability for social security taxes, they can request an advance payment of the remaining credit by filing Form 7200.

Limitations and Considerations of the Employee Retention Tax Credit

While the Employee Retention Tax Credit provides substantial financial support to businesses, there are certain limitations and considerations that need to be taken into account.

Interaction with PPP Loan Forgiveness

One of the key considerations is the interaction between the Employee Retention Tax Credit and PPP loan forgiveness. As mentioned earlier, businesses cannot use the same wages for both the PPP loan forgiveness and the ERTC. It’s essential for businesses that received a PPP loan to carefully analyze how these two relief programs interact and determine the most advantageous approach.

Comparison with Payroll Tax Deferral

Another consideration is the comparison between the Employee Retention Tax Credit and the payroll tax deferral option available under the CARES Act. While both options provide financial relief, they have different eligibility criteria and benefits. Businesses need to assess which option best suits their specific situation and financial needs.

Expired and Extended Provisions

It’s important to note that certain provisions related to the Employee Retention Tax Credit expired at the end of 2020. However, new legislation has extended the credit through December 31, 2021, and made various changes to its provisions. Businesses should stay updated on the latest updates and consult with tax professionals to ensure they are aware of all applicable provisions and requirements.

Documentation and Record Keeping

Proper documentation and record-keeping are crucial when claiming the Employee Retention Tax Credit.

Retaining Supporting Documents for the Tax Credit

Businesses should retain supporting documents that demonstrate their eligibility and the calculations used to determine the tax credit amount. This includes payroll records, employee work schedules, qualifying health plan expenses, and any other documents deemed necessary to substantiate the credit claimed.

Requirements for Documentation

The IRS has specific requirements for documentation to support the Employee Retention Tax Credit. These requirements may differ depending on the size and complexity of the business. It’s essential to review the IRS guidelines and consult with tax professionals to ensure compliance with the documentation requirements.

Period for Retaining Documents

Businesses are generally required to retain their tax records for a certain period. For the Employee Retention Tax Credit, it is recommended to retain all supporting documents for at least four years, as the IRS may request them for review or verification of the claimed credit.

Conclusion

The Employee Retention Tax Credit is a valuable resource that can provide much-needed financial relief to businesses during these challenging times. By understanding the eligibility criteria and following the proper calculation steps, businesses can determine their eligibility and accurately claim the tax credit. It’s important for businesses to stay updated on any legislative changes or guidance provided by the IRS to ensure compliance and maximize their potential benefits from the Employee Retention Tax Credit. Consulting with tax professionals or qualified advisors can help businesses navigate the complexities of this tax credit and make informed decisions regarding their financial strategies.