How to Calculate Employee Retention Credit With PPP

The Employee Retention Credit (ERC) is a refundable tax credit designed to encourage businesses to retain employees during periods of economic hardship. The interaction of the ERC with the Paycheck Protection Program (PPP) introduced complexities, requiring careful consideration for businesses seeking to maximize both benefits.

Understanding Eligibility and Key Definitions

Businesses can qualify for the Employee Retention Credit through two primary pathways: experiencing a significant decline in gross receipts or a full or partial suspension of operations due to a government order. For 2020, a significant decline in gross receipts means a business’s gross receipts for a calendar quarter were less than 50% of its gross receipts for the same calendar quarter in 2019. Eligibility under this criterion continues until the first calendar quarter after the quarter in which gross receipts are more than 80% of the same quarter in 2019. For 2021, the threshold for a significant decline in gross receipts is met if the business’s gross receipts for a calendar quarter were less than 80% of its gross receipts for the same calendar quarter in 2019. An alternative quarter election rule allows businesses to compare the immediately preceding calendar quarter to the corresponding 2019 quarter to determine eligibility for 2021.

A full or partial suspension of operations occurs if a governmental authority’s order limits commerce, travel, or group meetings due to COVID-19, and this order impacts the employer’s trade or business operations. Operations are considered more than nominally affected if gross receipts or hours of service from the suspended portion are at least 10% of total. Examples include a restaurant ordered to close its dining room but permitted to offer takeout.

“Qualified wages” for ERC purposes include wages subject to FICA taxes and certain qualified health plan expenses paid by the employer. The definition of qualified wages depends on whether an employer is considered “large” or “small” based on their average number of full-time employees (FTEs) in 2019. For 2020, a large employer is one that had more than 100 average full-time employees in 2019, while for 2021, this threshold increased to more than 500 average full-time employees in 2019.

For small employers, all qualified wages paid to employees during an eligible period count towards the credit, regardless of whether the employees were providing services. In contrast, for large employers, only wages paid to employees for time they were not providing services due to the suspension or decline in gross receipts qualify. Large employers must track wages paid specifically for non-service periods.

Aggregation rules require that businesses under common control are treated as a single employer for ERC eligibility purposes. This means entities like parent-subsidiary groups or brother-sister corporations must combine their employee counts and gross receipts to determine overall eligibility. If one member of an aggregated group meets the eligibility criteria, such as a partial suspension of operations, all members of that group are generally treated as eligible.

While businesses can be eligible for both PPP loan forgiveness and the ERC, the same wages cannot be used for both benefits. This means wages used to secure PPP loan forgiveness must be excluded from the qualified wages used for ERC calculation. This prevents “double-dipping” and requires careful wage allocation.

Calculating the Employee Retention Credit

Identifying the specific qualified wages for each quarter during the eligibility period is the first step. This involves reviewing payroll records to determine all wages subject to FICA taxes and allocable qualified health plan expenses paid to employees. For large employers, this identification must specifically isolate wages paid for periods when employees were not providing services.

Once qualified wages are identified, the applicable credit rates are applied. For wages paid in 2020, the credit is 50% of qualified wages. For wages paid in 2021, the credit rate increases to 70% of qualified wages. These rates are subject to per-employee wage limits, which vary by year.

For 2020, the maximum amount of qualified wages per employee for the entire year is $10,000, resulting in a maximum credit of $5,000 per employee for the year. For 2021, the maximum amount of qualified wages per employee is $10,000 per quarter, leading to a potential maximum credit of $7,000 per employee per quarter. This quarterly limit in 2021 allows for a significantly larger potential credit, up to $21,000 per employee for the first three quarters of 2021.

Businesses must ensure that wages included in their PPP loan forgiveness application are not also counted as qualified wages for the ERC. This typically involves a strategic allocation: first, determine the minimum amount of payroll costs needed to achieve full PPP loan forgiveness, considering the requirement that at least 60% of the PPP loan amount must be used for payroll. Any wages beyond this minimum, or wages not used for PPP forgiveness, can then be considered for the ERC, provided they meet all other ERC criteria. For instance, if a business used $150,000 in wages for PPP forgiveness but only $100,000 was necessary to meet the 60% payroll threshold for a $166,667 PPP loan, the remaining $50,000 in wages could potentially be allocated to the ERC calculation.

The rules for gross receipts decline percentages and the large employer threshold changed between 2020 and 2021. Businesses must apply the specific rules relevant to each quarter for which they are claiming the credit.

Claiming the Credit and Maintaining Records

The Employee Retention Credit is claimed by filing an amended payroll tax return, specifically Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund. Businesses must file a separate Form 941-X for each quarter for which they are claiming the credit.

When completing Form 941-X, businesses enter the calculated refundable portion of the Employee Retention Credit on Line 26a and their qualified wages on Line 30. Qualified health plan expenses are reported separately on Line 31a. Always use the most current version of Form 941-X and its instructions from the IRS website.

The credit can be claimed retroactively for eligible quarters in 2020 and 2021. Generally, the deadline to claim the ERC for 2020 wages was April 15, 2024, and for 2021 wages, it is April 15, 2025. After completing the form, it must be signed and mailed to the appropriate IRS address. If the credit amount exceeds the employer’s share of social security tax, the excess is refunded directly to the employer.

Maintaining thorough documentation supports any ERC claim, particularly for potential IRS audits. Businesses should retain detailed payroll records, including wages paid, hours worked, and any qualified health plan expenses. Documentation supporting eligibility, such as gross receipts data for all relevant quarters and copies of governmental orders that led to a full or partial suspension of operations, should also be kept.

All PPP loan documentation, including the loan application, forgiveness application, and supporting payroll costs, must be preserved. This allows for clear demonstration that wages used for PPP forgiveness were not simultaneously claimed for the ERC. Records of all calculations performed to determine the qualified wages and the final credit amount should also be maintained.