How to Apply for Employee Retention Credit Step by Step

The Employee Retention Credit (ERC) has emerged as a financial relief measure for businesses facing economic disruptions. This tax credit offers eligible employers a refundable credit against certain employment taxes, encouraging them to retain their workforce during challenging times.

Eligibility Requirements

To claim the Employee Retention Credit, businesses must meet specific IRS criteria, such as experiencing a full or partial suspension of operations due to government orders or a significant decline in gross receipts. For 2024, a significant decline is defined as at least a 20% reduction in gross receipts compared to the same quarter in 2019.

Business size also affects eligibility. For the 2024 tax year, employers with 500 or fewer full-time employees can claim the credit on all wages paid during the eligible period. Larger employers may only claim the credit for wages paid to employees who were not providing services due to business disruptions.

Businesses that received a Paycheck Protection Program (PPP) loan can still qualify for the ERC, but wages covered by forgiven PPP funds cannot be included. Precise accounting is critical to ensure compliance with both programs and to maximize benefits.

Determining Qualified Wages

Qualified wages depend on business size and employee activity. For businesses with 500 or fewer full-time employees, all wages paid during the eligible period are considered qualified. Larger businesses can only claim wages paid to employees who were not providing services due to a downturn or suspension in operations. Employers must document employee activity and compensation to support these claims.

Payroll records must be detailed and accurate, including periods of non-service and corresponding wages. This includes regular wages, health plan expenses, and other eligible costs. Employers should also note the $10,000 wage cap per employee per quarter, which limits the maximum credit per individual.

Preparing Necessary Documentation

Comprehensive documentation is essential when claiming the Employee Retention Credit. Employers must maintain detailed payroll records, capturing relevant wage details, including health plan expenses and other eligible costs. These records must substantiate the wages paid during periods when employees were retained under qualifying conditions.

Businesses should also document any government orders that affected their operations, retaining copies of official communications such as executive orders or health directives. Additionally, financial statements illustrating the required decline in gross receipts for 2024 should be prepared in accordance with Generally Accepted Accounting Principles (GAAP) to ensure compliance and accuracy.

Filing the Applicable Tax Forms

Claiming the Employee Retention Credit involves filing the correct tax forms. Employers use Form 941, the Employer’s Quarterly Federal Tax Return, to report income taxes, Social Security tax, and Medicare tax, and to claim the ERC by reducing required tax deposits.

If the credit was not claimed in the quarter when the wages were paid, employers may need to file Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund. This form allows businesses to amend previously filed returns and adjust their reported tax liabilities to reflect ERC calculations.

Addressing IRS Correspondence

After filing for the ERC, businesses should be prepared to respond to IRS correspondence, which may request additional information or clarify discrepancies. Timely responses are critical, as businesses typically have 30 days to reply. Responses should directly address the IRS’s concerns, providing supporting documentation such as payroll records, financial statements, or government orders when necessary.

Maintaining a clear audit trail is advisable throughout the ERC application process. Businesses should keep copies of all correspondence with the IRS and detailed records of how the credit was calculated. In cases of disputes, providing a breakdown of calculations and referencing applicable tax code provisions can strengthen a business’s position. Consulting a tax professional or legal advisor can help navigate complex issues or appeals effectively.