In Short:
- As a part of the CARES Act, the Treasury Department and the IRS created the Employee Retention Credit.
- The employee retention credit is designed to encourage businesses to keep employees on their payroll.
- Eligible employers that take advantage of the credit will receive 50% of wages paid to employees, up to $10,000.
At the end of March, the federal government passed the Coronavirus Aid, Relief and Economic Security (CARES) Act. The $2 trillion coronavirus response bill is meant to provide relief for both individuals and businesses. As a part of the package, there is a provision for businesses called the “Employee Retention Credit.” Here’s how it works.
What is the Employee Retention Credit?
As defined by the IRS, the employee retention credit “is 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.”
Let’s delve into that a little bit.
First off, what exactly is a “refundable tax credit”? With a refundable tax credit, if the amount of the credit is larger than the taxes owed, the business will receive a refund for the difference. So if they owe $10,000 and have a credit for $15,000, they’ll get a check for $5,000. With a normal tax credit, the business would owe no tax, but not receive a check.
Secondly, what are considered “qualified wages”? The definition of qualified wages in this case depends on how many employees the company had in 2019.
- If an employer averaged more than 100 full-time employees during 2019, qualified wages are the wages paid to employees that are not working because operations were suspended or due to the decline in gross receipts. For an employee working from home, the wages paid would not be eligible for the credit. These employers can only count wages up to the amount that the employee would have earned for working an equivalent duration 30 days immediately preceding the period of economic hardship. This means that, for example, if some hourly employees were working 40-hour weeks prior to the coronavirus outbreak and some were working 60-hour weeks, the employer couldn’t round everyone’s wages up to 60 hours. Claims need to match the prior month’s payroll for each employee.
- If an employer averaged less than 100 full-time employees during 2019, qualified wages are the wages paid to any employee during the period where operations were suspended or the company experienced a decline in gross receipts, regardless of whether or not its employees are working. This means the employer is eligible to receive the tax credit, even if all its employees are working, whether from home or at the workplace – as long as they fall into one of the categories we list below.
In both cases, qualified wages include certain health care costs. The credit is 50% of up to $10,000 in wages for each employee (which means the maximum credit is $5,000 per employee). It does not include paid sick or family leave for which the employer is reimbursed under the Families First Coronavirus Response Act.
Put simply, the employee retention credit means that a qualified employer can use the credit to cover the federal income tax, the employee share of Social Security and Medicare taxes, and the employer share of Social Security and Medicare taxes with respect to all eligible employees – up to the maximum amount.
The employee retention act is meant to encourage eligible employers financially impacted by the coronavirus to keep employees. The move is intended to provide cash flow relief for businesses.
Who is eligible?
The credit is available to all employers regardless of size, including tax-exempt organizations. However, according to the IRS, eligible employers must fall into one of two categories:
- Fully or partially suspends operation during any calendar quarter in 2020 due to orders from an appropriate governmental authority limiting commerce, travel or group meetings (for commercial, social, religious or other purposes) due to COVID-19.
or
- Experiences a significant decline in gross receipts during the calendar quarter versus the same quarter the previous year.
A business is considered “fully suspended” if restrictions imposed by a governmental authority prevents them from operating. The term “partially suspended” refers to a business that is still operating but not at its normal capacity due to coronavirus-related restrictions.
Example: The restaurant industry is a prime illustration of the “fully” and “partially” suspended definitions. Many state governors have issued an executive order to shut down restaurants to prevent the spread of coronavirus. Restaurants that continue to do takeout and delivery would be considered “partially suspended.” Restaurants that cannot offer the takeout or delivery option – and instead shut down operations completely – would be considered “fully suspended.”
In the second category, a business is considered eligible if they have experienced a “significant decline in gross receipts.” Employers are considered to have a significant decline when gross receipts for the calendar quarter are less than 50% of the gross receipts for the same quarter in the prior year.
Example: If you made $200,000 in the first quarter of 2019 but made $90,000 in the same quarter in 2020, that would be considered a significant decline in gross receipts.
Another caveat? According to the IRS, “the significant decline in gross receipts ends with the first calendar quarter that follows the first calendar quarter for which the employer’s 2020 gross receipts for the quarter are greater than 80 percent of its gross receipts for the same calendar quarter during 2019.”
On the surface, that’s a little confusing. This just means an employer stops being eligible for the employee retention credit the quarter after they post more than 80% of their gross receipts compared to the quarter from the previous year.
Example: Let’s say a company made $200,000 each quarter in 2019. In 2020, they made $90,000 their first quarter – 45% of what they made previously. In Q2 of 2020, they made $95,000 – 47.5% of what they made in the same quarter in 2019. However, in Q3 of 2020, they made $164,000 –82% of what they had made in 2019. The employee retention credit will apply for the first three quarters in 2020. However, the credit will not apply to the fourth quarter since they made over 80% of its gross receipts in Q3.
A business will need to assess on a quarterly basis whether they still fall under one of the eligibility criteria. If not, they will return to normal tax procedures the quarter after they stopped meeting the criteria.
Who is not eligible?
The most important thing to emphasize here is that small businesses who take a Small Business Interruption Loan under the Paycheck Protection Program (PPP) are not eligible for the employee retention credit.
Other than PPP loan recipients, other ineligible entities are state and local governments and their instrumentalities. if you are self-employed, you cannot claim the credit for your self-employment services and earnings.
How to Take Advantage of the Employee Retention Credit
Luckily, taking advantage of the credit is relatively simple. Since it is applicable for wages paid after March 12, 2020, and before January 1, 2021, employers can immediately start reducing their required deposits of payroll taxes that have been withheld from employees’ wages by the amount of credit. Eligible employers will report their total qualified wages and the related health insurance costs for each quarter on their quarterly employment tax returns or Form 941 beginning with the second quarter.
Example: An employer pays $25,000 in qualified wages to an employee in the first quarter. The federal withholding tax and Medicare and Social Security (from the employer and employee side) add up to $6,983.16. That means that they can keep up to $5,000 of the $6,983.16 that they were going to deposit. Now, the employer will only have to deposit the remaining $1,983.16 on its required deposit date. The employer will later account for the $5,000 it retained when they file Form 941 for the quarter. However, that employee’s credit is now exhausted. The employer will have to pay the full payroll tax amount in future quarters.
| Q1 | Q2 | Q3 | Q4 | |
| Qualified Quarterly Wages | $25,000 | $25,000 | $25,000 | $25,000 |
| Quarterly Federal Withholding Tax | $3,181.68 | $3,181.68 | $3,181.68 | $3,181.68 |
| Quarterly Employee Social Security and Medicare | $1,900.74 | $1,900.74 | $1,900.74 | $1,900.74 |
| Quarterly Employer Social Security and Medicare | $1,900.74 | $1,900.74 | $1,900.74 | $1,900.74 |
| Total Federal Employment Taxes Per Quarter | $6,983.16 | $6,983.16 | $6,983.16 | $6,983.16 |
| Amount Owed | $1,983.16 | $6,983.16 | $6,983.16 | $6,983.16 |
Example #2: Let’s say an employer pays an employee $10,000 in qualified wages per quarter to one employee. The federal withholding tax and Medicare and Social Security (from the employer and employee side) add up $2,680.75. That means that they do not have to deposit any on the first quarter. For the second quarter, they will only have to deposit $361.50 on its required deposit date. The employer will later account for the $5,000 it retained when they file Form 941 for the quarter. However, that employee’s credit is now exhausted. The employer will have to pay the full payroll tax amount for the last two quarters.
| Q1 | Q2 | Q3 | Q4 | |
| Qualified Quarterly Wages | $10,000 | $10,000 | $10,000 | $10,000 |
| Quarterly Federal Withholding Tax | $1,150.75 | $1,150.75 | $1,150.75 | $1,150.75 |
| Quarterly Employee Social Security and Medicare | $765 | $765 | $765 | $765 |
| Quarterly Employer Social Security and Medicare | $765 | $765 | $765 | $765 |
| Total Federal Employment Taxes Per Quarter | $2,680.75 | $2,680.75 | $2,680.75 | $2,680.75 |
| Amount Owed | $0 | $361.50 | $2,680.75 | $2,680.75 |
Because quarterly payroll returns are not filed until after qualified wages are paid, some eligible employers may find they need immediate cash to fund the qualified wages. In that case, employers can claim an advance of any remaining credit through Form 7200, Advance Payment of Employer Credits Due to COVID-19 (opens in new tab). So, using example #2 above, after utilizing the designated credit for Q1, the employer still has $2,319.25 left of the credit (for that employee). If they need the cash for wages, they could request an advance of that $2,319.25.
PPP Loan vs. Employee Retention Credit
At the time of this writing, the PPP had run out of its initial funding and is currently pending government replenishment. However, depending on several factors, the employee retention credit could be a better fit for your business than a loan under the PPP. A PPP loan is not available for many businesses with over 500 employees (it is dependent on the industry), so the credit may be a better option in that case. For businesses with less than 500 employees, a PPP loan is tempting because it can be forgiven. However, a loan will not be forgiven if a company reduces its workforces or wages – the same is not true for the employee retention tax credit. Accordingly, if a reduction in workforce or pay rates is a possibility, a company might want to consider taking the tax credit rather than the PPP loan. Lastly, there will be employers that may not receive a loan through the CARES Act. In those cases, the employee retention credit would be a useful provision.
Bottom Line
As companies look to free up cash flow and keep employees on payroll, the employee retention credit could be a good provision set forth by the CARES Act to utilize. Be sure to weigh it against the option a PPP loan to determine which route is best for your company.
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