What to Know About ERC Pandemic Relief

The Employee Retention Credit (ERC) is a refundable tax credit for businesses that kept employees on their payroll during the COVID-19 pandemic. Established by the Coronavirus Aid, Relief, and Economic Security (CARES) Act in March 2020, the credit was intended to provide financial relief to employers. The rules governing the credit are complex and have been modified since its inception, with different requirements for different time periods.

Determining Employer Eligibility

An employer’s eligibility for the ERC is determined by meeting one of two tests for a given calendar quarter. The first is a full or partial suspension of operations due to a governmental order limiting commerce, travel, or group meetings because of COVID-19. This suspension must have had a more than nominal effect on business operations; for example, a restaurant mandated by a government order to close its indoor dining would likely qualify.

The second path to eligibility is a significant decline in gross receipts, with different thresholds for 2020 and 2021. For 2020, a business qualifies if its gross receipts for a calendar quarter were less than 50% of the same quarter in 2019. Eligibility continued until receipts recovered to more than 80% of the same quarter in 2019.

For 2021, an employer qualifies if gross receipts for a calendar quarter were less than 80% of the same quarter in 2019. An alternative rule also allows employers to use the immediately preceding calendar quarter to test for a decline. For example, eligibility for the first quarter of 2021 can be determined by comparing gross receipts from the fourth quarter of 2020 to the fourth quarter of 2019.

A “recovery startup business” has a separate eligibility path. This applies to businesses that began after February 15, 2020, with average annual gross receipts of $1 million or less. A recovery startup business did not need to meet the suspension or gross receipts tests to qualify for the ERC in the third and fourth quarters of 2021, with the credit capped at $50,000 per quarter.

Calculating the Credit Amount

The calculation method for the ERC differs between 2020 and 2021. For 2020, the credit is 50% of qualified wages, capped at $10,000 in wages per employee for the entire year, resulting in a maximum credit of $5,000 per employee. For 2021, the credit increased to 70% of qualified wages, with the wage cap raised to $10,000 per employee per quarter, allowing for a maximum credit of $7,000 per employee per quarter.

Qualified wages include cash compensation and employer-provided health plan expenses, but the definition depends on employer size, which changed between the two years. For 2020, small employers were those with 100 or fewer full-time employees in 2019, and they could count all wages paid. For large employers with more than 100 employees, only wages paid to employees for not providing services were qualified.

For 2021, the small employer threshold increased to 500 or fewer employees, allowing more businesses to count all wages paid as qualified. The rule for large employers, now defined as those with more than 500 employees, remained the same, limiting qualified wages to those paid to non-working employees.

An employer cannot use the same wages to calculate both the ERC and to obtain forgiveness for a Paycheck Protection Program (PPP) loan. This prevents “double-dipping” on federal relief. Businesses that received PPP loans must allocate wages between the two programs to avoid invalidating their ERC claim.

Required Information and Documentation

To claim the ERC, an employer must collect documents to substantiate eligibility and the credit amount. This includes quarterly financial statements or profit and loss reports to demonstrate a decline in gross receipts by comparing quarters in 2020 or 2021 to the 2019 baseline.

If eligibility is based on a suspension of operations, the employer must retain copies of the governmental orders and document how they impacted operations. Required documentation can include internal communications, revised schedules, or financial data showing the effect of the restriction. Detailed payroll records are also necessary, including Form 941 filings, payroll registers, and records of health plan expenses.

The credit is claimed retroactively by filing Form 941-X, Adjusted Employer’s QUARTERLY Federal Tax Return or Claim for Refund, for each eligible quarter. On the form, the employer must complete a detailed worksheet to recalculate the tax liability. The form also requires reporting the nonrefundable and refundable portions of the credit and providing a clear explanation for the correction.

The Process for Claiming the Credit

The completed Form 941-X must be physically mailed to the IRS. The correct mailing address, which depends on the business’s state, is listed in the form’s instructions. Sending the claim to the wrong service center can cause significant delays or processing issues.

There are strict deadlines for filing a claim. The deadline for 2020 quarters passed in April 2024. For all eligible quarters in 2021, the deadline is April 15, 2025. Missing this deadline results in forfeiting the credit.

After mailing the claim, businesses should expect a long waiting period, as the IRS is facing significant processing backlogs. Following its review, the IRS will issue a determination. This may be a refund check, an adjustment notice if the claimed amount is changed, or a request for more information.

Navigating Current IRS Scrutiny and Programs

The ERC is under high scrutiny from the IRS. In response to questionable submissions, the IRS announced a moratorium on processing new claims starting September 14, 2023, which is still in effect with no announced end date. This pause allows the agency to implement stronger fraud detection, though it has resumed processing some claims filed before the moratorium.

Businesses should be aware of the warning signs of fraudulent ERC promoters, known as “ERC mills.” Red flags include unsolicited advertisements or phone calls, promises of a guaranteed refund amount before any records are reviewed, and fee structures based on a large percentage of the expected refund. These promoters may pressure businesses to claim the credit even if they do not qualify.

For businesses with concerns about a filed claim, the IRS has a claim withdrawal process. This is available if a refund has not been received or if a received check has not been cashed or deposited. Withdrawing an improper claim helps avoid future penalties and interest.

The IRS previously offered time-limited programs, like the Voluntary Disclosure Program, for employers who received and cashed an improper refund. Although these specific programs have concluded, they show the agency’s focus on resolving improper claims.