How to Claim the $26k Employee Retention Tax Credit

The “26k tax credit” is the common name for the Employee Retention Credit (ERC), a refundable tax credit established through the CARES Act in March 2020. It was created as a financial incentive for businesses to keep employees on their payroll during the economic disruptions of the COVID-19 pandemic. This credit is not a loan and does not need to be repaid. It is a dollar-for-dollar credit against certain payroll taxes, and because it is refundable, a business can receive a payment from the IRS if the credit amount exceeds the payroll taxes owed.

Determining Eligibility for the Employee Retention Credit

A business must meet one of three tests to qualify for the Employee Retention Credit for any given calendar quarter. The first path to eligibility is experiencing a significant decline in gross receipts. For 2020, this meant a company’s gross receipts in a calendar quarter were less than 50% of the gross receipts for the same quarter in 2019. For 2021, the rules were relaxed, requiring a decline of only 20% compared to the same quarter in 2019.

A second route to eligibility involves a full or partial suspension of business operations due to a government order. This requires that a government mandate limited commerce, travel, or group meetings due to COVID-19. The suspension must have had more than a minimal effect on the business’s operations. For example, a restaurant forced to close its indoor dining due to a local ordinance, even if it could continue with takeout services, would qualify under this test.

The third option is for a “recovery startup business.” This category was created for businesses that began operations after February 15, 2020, and had average annual gross receipts under a specified threshold. These businesses could be eligible for the credit for the third and fourth quarters of 2021 without a significant decline in revenue or a government-ordered shutdown. As eligibility for all other businesses ended on September 30, 2021, recovery startup businesses were the only employers who could claim the credit for the fourth quarter.

Calculating the Maximum Credit Amount

The calculation for the Employee Retention Credit differs between 2020 and 2021, which is how the widely cited “$26,000 per employee” figure is reached. For wages paid after March 12, 2020, and before January 1, 2021, the credit is 50% of the first $10,000 of qualified wages per employee for the entire year. This results in a maximum credit of $5,000 per employee for 2020.

For 2021, the credit was calculated as 70% of the first $10,000 in qualified wages per employee for each eligible calendar quarter. This allows for a maximum credit of $7,000 per employee per quarter. For most businesses, the credit was available for the first three quarters of 2021, totaling up to $21,000 for the year.

The definition of “qualified wages” depends on the size of the employer, based on the number of full-time employees in 2019. For employers with 100 or fewer full-time employees in 2019 (for the 2020 credit) or 500 or fewer (for the 2021 credit), qualified wages include payments made to all employees during the eligible period. For larger employers, qualified wages are restricted to payments made to employees for not providing services. Wages used to claim the ERC cannot be the same wages that were used to obtain Paycheck Protection Program (PPP) loan forgiveness.

Information and Forms Needed to Prepare a Claim

To prepare a claim for the Employee Retention Credit, a business must compile specific financial and payroll data. This documentation is needed to perform the eligibility tests and calculate the credit.

Necessary information and documents include:

• Quarterly gross receipts for 2019, 2020, and 2021 to perform the revenue decline test.
• Detailed payroll records showing the gross wages paid to each employee for the quarters being claimed.
• Records of any employer-paid health plan expenses allocable to those wages, as these can be included in the qualified wage calculation.
• Copies of the specific government orders that impacted operations if eligibility is based on a government-ordered suspension.
• The Paycheck Protection Program loan forgiveness application to ensure there is no overlap between wages used for forgiveness and those for the ERC.

The claim itself is made on Form 941-X, Adjusted Employer’s QUARTERLY Federal Tax Return or Claim for Refund. This form is used to amend a previously filed Form 941, the employer’s standard quarterly payroll tax return.

The Process for Filing a Claim

Since the ERC is claimed retroactively, the completed Form 941-X must be physically mailed to the IRS service center, as electronic filing is not an option for this amended return. The correct mailing address depends on the business’s location and is provided in the instructions for Form 941-X.

There are deadlines for filing a claim. The statute of limitations for filing Form 941-X is three years from the date the original Form 941 was filed. For payroll tax purposes, all quarterly returns for a calendar year are considered filed on April 15 of the following year. This means the deadline to file a claim for any eligible quarter in 2021 is April 15, 2025.

Once the claim is mailed, businesses should be prepared for a lengthy wait. The IRS is processing a high volume of these claims, and it can take many months, sometimes over a year, to receive the refund. The IRS may issue correspondence requesting additional information or documentation to substantiate the claim, and it is necessary to respond to any such requests promptly to avoid delays or denial.

IRS Scrutiny and Claim Withdrawal Options

In response to a surge of aggressive marketing and potentially fraudulent claims, the IRS implemented a temporary moratorium on processing new ERC claims filed in late 2023. While that pause has ended, all submissions are undergoing enhanced scrutiny. This review process is designed to protect businesses from promoters pushing ineligible applications and has resulted in extended processing times for both new and older claims.

For businesses that have filed a claim but have not yet received the refund, the IRS established a claim withdrawal process. This option is available to employers who now believe their claim was submitted in error. It allows them to retract their submission before it is paid, thereby avoiding future penalties and interest that would accrue if the IRS later determined the claim was invalid.

A separate program, the ERC Voluntary Disclosure Program, was created for businesses that already received and cashed an ERC refund they were not entitled to. This program, which had a deadline of March 22, 2024, allowed these businesses to repay the credit. In exchange for the voluntary repayment, the IRS offered to waive penalties and required the business to pay back only 80% of the received credit if a third-party promoter was used and charged a fee.