What Is the Employee Retention Credit (ERC) in Accounting?

The Employee Retention Credit (ERC) was a refundable tax credit for businesses that maintained employee payrolls during the COVID-19 pandemic. Enacted as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act in March 2020, the ERC aimed to provide financial relief and encourage employers to retain their workforce. The credit was designed to offset payroll taxes, offering a direct financial incentive to eligible employers.

Determining Eligibility

Businesses generally qualified for the ERC through one of two primary pathways. The first involved a significant decline in gross receipts. For 2020, eligibility required gross receipts for a calendar quarter to be less than 50% of the same quarter in 2019. This eligibility continued until gross receipts exceeded 80% of the 2019 quarter. For 2021, the threshold was adjusted, allowing eligibility if gross receipts for a calendar quarter were less than 80% of the same quarter in 2019. Businesses could also elect to compare the immediately preceding calendar quarter to the corresponding 2019 quarter to determine eligibility.

The second qualification path centered on a full or partial suspension of operations due to a governmental order. This required a mandate from a federal, state, or local government authority limiting commerce, travel, or group meetings because of COVID-19. Examples included forced closures, capacity restrictions, or curfews that directly impacted business hours. A partial suspension could also qualify if a “more than nominal” portion of operations was affected, typically defined as 10% or more of gross receipts or hours of service. Informal guidance or suggestions, such as from the Centers for Disease Control and Prevention (CDC), did not qualify as governmental orders for ERC purposes.

Businesses that received Paycheck Protection Program (PPP) loans were eventually able to claim the ERC, a change from initial legislation. However, employers could not claim the ERC for wages used for PPP loan forgiveness, preventing “double-dipping” of benefits for the same payroll costs. Certain entities were excluded from eligibility, including most governmental entities, with exceptions for colleges, universities, or organizations primarily providing medical or hospital care. Self-employed individuals could not claim the credit for their own wages.

Calculating the Credit Amount

The Employee Retention Credit amount was determined by “qualified wages” paid to employees during eligible periods. Qualified wages included compensation subject to FICA taxes and qualified health plan expenses paid by the employer. The definition of qualified wages and maximum credit amounts varied between 2020 and 2021, and by employer size.

For 2020, the credit was 50% of qualified wages paid between March 13 and December 31. The maximum qualified wages per employee for 2020 was $10,000, resulting in a $5,000 maximum credit per employee. In 2021, the credit was 70% of qualified wages paid from January 1 through September 30 for most businesses. For 2021, maximum qualified wages were $10,000 per employee per calendar quarter, allowing a potential $7,000 maximum credit per employee per quarter, totaling up to $21,000 for the first three quarters.

Employer size influenced which wages qualified. For 2020, “small employers” had 100 or fewer full-time employees in 2019. For them, all wages paid during the eligible period qualified, regardless of whether employees were actively working. “Large employers” in 2020, with more than 100 full-time employees, could only count wages paid to employees not providing services. This distinction shifted for 2021, raising the “small employer” threshold to 500 or fewer full-time employees. The rule for large employers continued into 2021.

Process for Claiming the Credit

Businesses claimed the Employee Retention Credit by amending previously filed payroll tax returns. The primary form used was IRS Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund. A separate Form 941-X was submitted for each calendar quarter claimed. This form allowed businesses to correct information on their original Form 941, Employer’s Quarterly Federal Tax Return, to reflect the ERC amount.

When completing Form 941-X, employers indicated they were filing a claim for refund. Qualified wages and health plan expenses were reported. The credit was allocated between nonrefundable and refundable portions. A clear explanation for the corrections, detailing the basis for ERC eligibility, was necessary.

Accurate record-keeping is paramount to support any ERC claim. Businesses must retain detailed payroll records, including wage statements and health insurance premiums paid. Records substantiating eligibility, such as evidence of gross receipts declines or governmental orders, are essential. The deadline for filing Form 941-X to claim the ERC is three years from the original Form 941’s due date. Claims for 2020 wages had a deadline of April 15, 2024, while 2021 wages could be filed until April 15, 2025.

Current Program Status

The Employee Retention Credit program concluded for most businesses, with qualified wages generally eligible through September 30, 2021. “Recovery startup businesses” could claim the credit for wages paid through December 31, 2021. While the period for earning new credits has passed, eligible employers can still file amended returns for past quarters.

The Internal Revenue Service (IRS) has increased its focus on ERC claims due to concerns about improper filings and fraudulent activities. In response to aggressive marketing and questionable claims, the IRS implemented a moratorium on processing new ERC claims filed after September 14, 2023. This moratorium has ended, and the IRS began processing claims filed between September 14, 2023, and January 31, 2024, prioritizing those deemed highest and lowest risk.

The IRS continues to scrutinize claims, conducting audits and pursuing civil and criminal investigations where fraud is suspected. The agency offers a voluntary withdrawal program, allowing businesses that filed incorrect claims and have not received payment to retract their submission and potentially avoid future penalties. Businesses that filed ERC claims should review their eligibility and supporting documentation, and seek professional advice if they have concerns about their claim’s accuracy.