How to Calculate the Employee Retention Credit

The Employee Retention Credit (ERTC) is a refundable tax credit designed to help businesses retain employees during the COVID-19 pandemic. Established in March 2020 and later expanded, it provides financial relief to eligible employers by covering payroll costs during periods of reduced operations or significant declines in gross receipts. The credit applies to qualified wages paid from March 13, 2020, through September 30, 2021, for most businesses, with some exceptions for recovery startup businesses.

Determining Employer Eligibility

To determine eligibility for the Employee Retention Credit, employers must meet specific criteria for 2020 or 2021. Eligibility is assessed quarterly, requiring one of two primary tests: a significant decline in gross receipts or a full or partial suspension of operations due to a governmental order.

For 2020, a significant decline in gross receipts occurs if a business’s gross receipts for a quarter are less than 50% of its gross receipts for the same quarter in 2019. Eligibility continues until the first quarter after gross receipts are greater than 80% of the same quarter in 2019.

For 2021, a significant decline is met if a quarter’s gross receipts are less than 80% of the same quarter in 2019. Employers could also compare the immediately preceding quarter’s gross receipts to the corresponding quarter in 2019. Businesses not in existence in 2019 can use their 2020 gross receipts for comparison.

Alternatively, an employer qualifies if operations were fully or partially suspended due to governmental orders limiting commerce, travel, or group meetings because of COVID-19. A full suspension means the business was entirely shut down. A partial suspension occurs if a governmental order imposes restrictions impacting a significant portion of business operations that cannot be performed remotely.

A voluntary shutdown or a general decline in customer demand not directly caused by a government order does not qualify an employer under the suspension test. If employees could telework and the business operated largely as normal, it would not be considered suspended. Aggregation rules apply, treating related entities as a single employer for gross receipts and employee counts.

Identifying Qualified Wages

Once eligibility is established, the next step is identifying “qualified wages.” These generally include cash wages, hourly pay, salaries, vacation pay, and other taxable compensation paid to employees. Qualified health plan expenses paid by the employer are also included.

The definition of qualified wages and limits vary by year and employer size, based on the average number of full-time employees in 2019. For 2020, if an employer had 100 or fewer full-time employees in 2019, all wages paid during eligible quarters are qualified. For employers with more than 100 full-time employees, only wages paid to employees not providing services due to suspension or decline in gross receipts are qualified.

For 2021, the employee threshold increased. Employers with 500 or fewer full-time employees in 2019 can count all wages paid as qualified wages. For larger employers with more than 500 full-time employees, qualified wages are limited to those paid to employees not providing services.

Specific per-employee wage limits apply to the credit. For 2020, the maximum qualified wages per employee for all quarters combined is $10,000, resulting in a maximum credit of $5,000 per employee. For 2021, the limit increased; the maximum qualified wages per employee is $10,000 per quarter, allowing for a maximum credit of $7,000 per employee per quarter.

Wages used for Paycheck Protection Program (PPP) loan forgiveness cannot also be counted as qualified wages for the ERTC. This “no double-dipping” rule requires careful tracking to ensure the same wages are not used for both benefits. Employers must maintain clear documentation.

Certain wages are excluded from qualified wages. These include wages paid to related individuals, such as a majority owner and their direct family members. Wages for which other tax credits, like FFCRA leave credits, were claimed cannot also be counted for the ERTC.

Calculating the Employee Retention Credit

After determining eligibility and identifying qualified wages, the Employee Retention Credit is calculated by applying specific percentages and adhering to per-employee maximums for each eligible quarter. The credit is a refundable payroll tax credit; if the credit amount exceeds the employer’s payroll tax liability, the excess is refunded.

For qualified wages paid in 2020, the credit amount is 50% of the qualified wages. The maximum qualified wages for any employee for the entire 2020 calendar year is $10,000. Therefore, the maximum credit an employer can receive per employee for 2020 is $5,000.

For qualified wages paid in 2021, the credit percentage increased to 70% of qualified wages. The maximum qualified wages for any employee for 2021 is $10,000 per calendar quarter. This means the maximum credit per employee per quarter is $7,000 (70% of $10,000). For the first three quarters of 2021, an employer could potentially receive up to $21,000 per employee ($7,000 x 3 quarters).

To calculate the credit for an eligible quarter, identify all employees who received qualified wages. For each employee, determine total qualified wages paid, including health plan expenses, up to the $10,000 quarterly limit for 2021 or the $10,000 annual limit for 2020. Multiply the total qualified wages by the applicable credit percentage (50% for 2020, 70% for 2021). The sum of these individual amounts represents the total credit for that period. Aggregation rules require related businesses to combine gross receipts and employee counts for eligibility and calculation.

Claiming the Credit

Employers must follow specific procedures to claim the credit. The ERTC is claimed by amending previously filed payroll tax returns. Specifically, employers use Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund. Each eligible quarter requires a separate Form 941-X filing. For instance, if an employer qualifies for Q2 2020 and Q1 2021, two separate Form 941-X filings would be necessary.

Completing Form 941-X requires providing key information, including the employer’s identification number, business name, and address. The form also asks for the specific tax period being corrected. Employers will typically select “Claim” in Part 1 of the form. The calculated refundable and non-refundable portions of the ERTC, along with total qualified wages and qualified health plan expenses, must be entered on the appropriate lines of Form 941-X. For wages paid between March 13 and March 31, 2020, these are generally reported on the Form 941-X for Q2 2020.

Once completed, Form 941-X must be signed by an authorized individual. The form is then mailed to the Internal Revenue Service (IRS) at the address specified in the form’s instructions. The deadline to claim the ERTC for 2020 wages is generally April 15, 2024, and for 2021 wages, it is April 15, 2025. While processing times can vary, employers should anticipate a period of several weeks to several months for the IRS to process the amended returns and issue refunds.

The credit’s refundable nature means that if the ERTC amount exceeds the employer’s share of social security tax for a given quarter, the employer will receive the difference as a refund. It is also important to remember that if the ERTC is claimed, the employer must reduce their deduction for wages by the amount of the credit for that same tax period. This adjustment may necessitate amending the business’s income tax return (e.g., Form 1120 for corporations) to reflect the reduced wage deduction.