How to Calculate the 2021 Employee Retention Credit

The Employee Retention Credit (ERC) for 2021 was a refundable payroll tax credit to help businesses retain employees during the COVID-19 pandemic. This article details the criteria and steps for calculating the credit amount for eligible businesses.

Determining Eligibility for 2021

A business could qualify for the Employee Retention Credit in 2021 through one of two primary methods. The first method involved demonstrating a significant decline in gross receipts. For any calendar quarter in 2021, a business qualified if its gross receipts were less than 80% of its gross receipts for the same calendar quarter in 2019. For example, to determine eligibility for Q1 2021, a business would compare its Q1 2021 gross receipts to its Q1 2019 gross receipts.

Alternatively, a business could elect to use the immediately preceding calendar quarter to determine eligibility. For instance, to qualify for Q1 2021, a business could compare its Q4 2020 gross receipts to its Q4 2019 gross receipts, provided the decline was more than 20%.

The second method for eligibility was a full or partial suspension of operations due to governmental orders limiting commerce, travel, or group meetings. Examples include orders limiting capacity at restaurants, requiring certain businesses to close, or impacting supply chains due to government-imposed shutdowns on suppliers.

A business was considered to have a partial suspension if its operations were limited but not entirely shut down, and the limitation had more than a nominal effect on its operations. To be eligible under either test, the business must have been operational in 2019 or 2020.

Identifying Qualified Wages for 2021

Understanding what constitutes “qualified wages” is fundamental to calculating the Employee Retention Credit for 2021. Qualified wages generally included cash wages, such as salaries and hourly pay, along with the employer’s share of health plan expenses paid on behalf of employees.

A distinction for qualified wages in 2021 depended on the average number of full-time employees a business had in 2019. For businesses with 500 or fewer full-time employees in 2019, all wages paid to employees during an eligible period were considered qualified wages, regardless of whether the employee provided services. This meant wages paid for working or for not working could count.

For businesses that had more than 500 full-time employees in 2019, only wages paid to employees for time they were not providing services due to the suspension or decline in gross receipts were considered qualified wages. Wages paid for actual work performed would not qualify for the credit.

There was a maximum amount of qualified wages per employee that could be counted for the credit. For each eligible quarter in 2021, a business could count up to $10,000 in qualified wages for each employee. This means that even if an employee earned more than $10,000 in a quarter, only the first $10,000 was considered for the credit calculation.

Businesses that received a Paycheck Protection Program (PPP) loan could also claim the ERC, but not for the same wages. Wages used to qualify for PPP loan forgiveness could not simultaneously be used as qualified wages for the ERC.

Applying the Credit Calculation Formula

The Employee Retention Credit calculation for 2021 involved a straightforward formula once eligibility and qualified wages were determined. For eligible quarters in 2021, the credit was equal to 70% of the qualified wages paid.

The credit was calculated on a quarterly basis, meaning eligibility and qualified wages were assessed for each calendar quarter independently. To begin the calculation, a business first determined which 2021 quarters were eligible based on the gross receipts decline or suspension of operations tests.

Next, for each eligible quarter, the business identified the qualified wages paid to each employee, ensuring not to exceed the $10,000 per employee per quarter limit. Once these individual employee limits were applied, all qualified wages for all employees within that specific quarter were summed to arrive at the total qualified wages for the quarter.

Finally, the total qualified wages for the quarter were multiplied by 70%. The result of this multiplication was the maximum Employee Retention Credit available for that particular quarter. For example, if a small business with fewer than 500 employees had $50,000 in total qualified wages for an eligible quarter in 2021, their credit would be $35,000 ($50,000 x 70%).

Consider a larger business with more than 500 employees that paid $200,000 in wages to employees who were not working due to a government-ordered suspension of operations in an eligible quarter. Assuming these wages adhered to the $10,000 per employee quarterly limit, their credit would be $140,000 ($200,000 x 70%).

Addressing Specific 2021 Calculation Scenarios

Specific scenarios in 2021 introduced nuances that could impact the Employee Retention Credit amount. One such scenario involved Recovery Startup Businesses (RSBs), which had unique eligibility and credit limitations. An RSB was generally a business that began operations after February 15, 2020, and had average annual gross receipts not exceeding $1 million. These businesses could qualify for the ERC even if they did not meet the gross receipts decline or suspension tests.

For RSBs, the maximum credit was capped at $50,000 per quarter for the third and fourth quarters of 2021. This meant that while the 70% of qualified wages rule still applied, the total credit claimed by an RSB for Q3 or Q4 could not exceed $50,000.

Another specific scenario applied to Severely Financially Distressed Employers (SFDEs) in Q3 and Q4 2021. An employer qualified as an SFDE if their gross receipts for the calendar quarter were less than 10% of their gross receipts for the same calendar quarter in 2019, or 2020 if there was no 2019 comparison. For these employers, the rule concerning businesses with more than 500 employees was modified.

For SFDEs, all wages paid to employees during the eligible quarter could be considered qualified wages, regardless of whether the employees were providing services. This effectively treated larger SFDEs similarly to smaller employers for the purpose of qualified wage determination, up to the $10,000 per employee per quarter limit.

Finally, aggregation rules were important for businesses operating under common control. If a group of entities was treated as a single employer for certain employment tax purposes, they generally had to aggregate their employees and gross receipts for ERC eligibility and qualified wage calculations. This aggregation could change whether the entire group fell under the “500 or fewer” or “more than 500” employee threshold, directly affecting which wages qualified for the credit.