Employee Retention Tax Credit: You Have 3 More Years to Claim It, Here’s How

The Employee Retention Credit was enacted in 2020 to support businesses who retained employees during the height of the COVID-19 pandemic, especially despite lockdowns and reduced revenue. The tax credit applies to employee wages, including employer-paid healthcare costs, that were paid after March 12, 2020 until October 1, 2021. What most businesses don’t realize, though, is that you can retroactively claim this credit for up to three years by amending prior-year tax returns. As noted by Forbes earlier this year, “Billions of dollars are available for businesses and charities to retain employees and hire new employees. But you have to apply.” The credit requirements and amounts have changed several times over the last year with each new recovery act passed, so here’s the most up-to-date information for you to know.

WHO QUALIFIES FOR THE EMPLOYEE RETENTION TAX CREDIT?

In order to qualify for this credit, a business must have experienced one of the following in 2020 or 2021:

• A full or partial suspension of operations because of governmental orders limiting commerce, travel or group meetings due to COVID-19, or
• A decline in gross receipts in a calendar quarter in 2020 or 2021

The parameter used by the IRS to define “decline in gross receipts” was amended by the Relief Act of 2021 and is now dependent on the calendar quarter for which a business is seeking to apply the credit. Here is the breakout: 

One of the other changes from the Relief Act of 2021 that many are not aware of is the “alternative quarter election.” Under this election, an employer may determine if the decline in gross receipts test is met for a calendar quarter in 2021 by comparing its gross receipts for the immediately preceding calendar quarter with those for the corresponding calendar quarter in 2019. [3]

Under the initial CARES Act, businesses that received a Small Business Interruption Loan under the Paycheck Protection Program (PPP) were not eligible for this credit. Many companies opted for the loan without truly comparing the benefits of the employee retention tax credit vs. PPP and may have seen a more significant impact by claiming the ERC. Fortunately, the Consolidated Appropriations Act of 2021 amended the initial program restrictions so that an employer who is eligible for the ERC can still claim it even if they received a Small Business Interruption Loan under the Paycheck Protection Program. The critical item to note is that the ERC can only be claimed on any qualified wages that are not counted as payroll costs in obtaining PPP loan forgiveness. Any wages that could count toward eligibility for the ERC or PPP loan forgiveness can be applied to either of these two programs, but not both. [2]

HOW DOES THE EMPLOYEE RETENTION TAX CREDIT WORK?

The ERC is a refundable tax credit for a portion of the qualified wages that were paid to employees during the eligible periods and is applied to a company’s federal payroll tax liability. Any amount in excess of what is owed is fully refundable to the company.  

Qualified wages are defined as compensation paid to employees, including health plan expenses, but are also further delineated by the company’s average number of full-time employees. With all the employee retention tax credit updates that have been released since the initial CARES Act, it’s hard to keep up. The chart below breaks down each time period and the corresponding rules for how the credit is applied, taking into account the factors mentioned above. It’s also important to note that wages paid to owners and their relatives are not eligible for this credit.

*A Recovery Startup Business is defined as a business that started after 2/15/2020 and had an average of $1MM or less in gross receipts for the 3-taxable-year period preceding the calendar quarter for which they are applying the credit.

RETROACTIVELY CLAIMING THE EMPLOYEE RETENTION TAX CREDIT 

With the myriad of challenges faced by companies during the pandemic, many did not claim the employee retention credit on their 2020 or 2021 returns. We’ve filed the credit retroactively for ~100 of our clients, with credit amounts ranging from a few thousand to well in the millions. The most impactful quarters we see are Q1 & Q2 of 2021, as the credit increased significantly from $5K per employee total to $7K per employee per quarter. Businesses with a larger workforce that experienced a revenue decline in one of those quarters could see substantial savings. A company of around 200 employees, for example, could see a credit of $1.4MM per quarter!

The process involves filing form 941-X to amend the Employer’s Quarterly Federal Tax Return for the time period in which the employer was eligible for the credit, but it was not applied. While there is no documentation required when submitting the amended form, all records justifying the decline in revenue or the government order that led to a complete or partial shutdown must be kept in good order as the IRS will certainly begin auditing these in the near future. These include items like payroll reports for the dates qualified, a solid financial statement showing the quarterly revenue on the same accounting basis as their tax filing, and PPP loan forgiveness applications. 

With all the iterations and changes to this credit due to the CARES Act extensions in 2021, businesses may unknowingly be leaving money on the table. Even if you did not qualify when the ERC was initially launched, the changes introduced from the subsequent legislation may mean your business can now retroactively take advantage of this benefit. Need help navigating your eligibility before the statute of limitations expires? Contact us today!

[1] IRS Employee Retention Credit Comparison
[2] IRS Notice 2021-20
[3] IRS Notice 2021-23