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Understanding the Employee Retention Tax Credit: Essential Insights

Understanding the Employee Retention Tax Credit: Essential Insights

When an economy is down, many business owners are disadvantaged. They often have to search for ways to solve their finish problem while keeping their employees. In such depressing times, the United States government offers various financial incentives through business tax to relieve this burden. And one of them is the employee retention tax credit. 

As a business owner, tax credits can help you keep your business afloat, grow, and keep workers stable. So, let’s find out all you need about employee retention tax credit and why you need it. 

What is an employee retention tax credit? 

Employee retention tax credit was created to help companies and tax-exempt organizations affected by COVID-19. All eligible employers can file for an amended employment tax return. Business owners who qualify for ERC must have experienced operational suspension because of a government order or a steep reduction in their gross receipts in 2021 or the first three quarters of 2021. There is also a provision for businesses that have met specific criteria for recovery startup. 

Since the inception of the ERC in the CARES (Coronavirus Aid, Relief, and Economic Security) ACT of March 2020, the program has experienced several modifications. These modifications were brought about by legislation like the   Infrastructure Investment and Jobs Act (IIJA), the American Rescue Plan Act (ARPA) of 2021, and the Relief Act. In 2023, for most cases, employee retention tax credit eligibility for salary paid after September 30, 2021, has expired. 

Companies that qualify for employee retention tax credit

Though the employee retention credit was created to help small businesses that lost income due to the pandemic, not all companies are authorized for the incentive. To be eligible, private businesses and nonprofits should meet one of the following criteria:

  • The government (local, state, and federal) ordered your business to partially or fully close down in 2020 or 2021.
  • Your gross receipt for one quarter of 2020 was reduced by 50% against the same quarter for 2019 (for 2020 tax credit).
  • Your gross receipt for one quarter of 2021 was reduced by 20% against the same quarter of 2019 (for 2021 tax credit).

If you did not conduct business in 2019, you can choose a corresponding quarter in 202 to show that your revenue reduced between 2020 and 2021 for ERC qualification. The IIJA brought about considerable changes to the ERC, which marked the program’s conclusion. 

Recovery startups can still claim tax credit for the third and fourth quarters 2021. But, for other business owners, it is best to stop applying ERC amounts to your payroll after September 2021 and reverse such credits as they should be paid to the IRS.

How many employees can count towards Employee Retention Tax Credit Eligibility (ERTC)?

Businesses with 100 or fewer full-time employees, irrespective of whether they provided services during the set period, will count towards the eligibility. For companies with over 100 employees, only full-time employees being paid but not offering their services due to the shutdowns or a reduction in gross receipts can count towards eligibility. You must note that you cannot claim the same employee for work opportunity tax credit and employer credit tax for the same period. Nor should they also claim the same wages under the employee retention tax credit and the employer credit in section 45C of the Family and Medical Leave Act (FMLA).

How to apply for tax credit by HR

Getting the ERC can be a massive relief for companies facing economic difficulties. But, appreciation for the credit and ensuring your documents are in place can be challenging. So, here are the steps that your HR department can follow:

  • Application: the ERC doesn't require a separate application form like other relief programs. Instead, you can claim it directly on your company’s federal employment tax return. You can do this with the Employer’s Quarterly Federal Tax Return Form 941, where you state the whole number of qualified wages for the credit.
  • Documentation: Documentation is vital for ERC claims. So, you must ensure that your documents are detailed and accurate. Such records bolster your claim and also protect your business in the event of queries or audits. Some essential documents you must have include:
  • Eligibility evidence: Documents that show your company was affected by the shutdown or had a considerable reduction in gross receipts. It could be sales records, financial statements, or other government-compelled shutdown orders important to your business. 
  • Employee salary data: Provide comprehensive records showing all employees' salaries during the claim period. Also, it should show a breakdown of the salary component, such as base pay, health benefits, bonuses, etc. 
  • Health insurance cost: If your company claims health benefits as a part of the qualifying salary wage, you need to provide a comprehensive record of the insurance premium paid on your employees' behalf. 
  • Employee count: Provide records that show the average number of full-time employees since credit calculation usually varies based on the business size. 
  • Store the records electronically: The sheer number of documents and easy retrieval facilitates the need for maintaining electronic records. It is invaluable to use software and tools that allow correct payroll tracking, easy retrieval of insurance premiums, and digital storage of financial statements.

Maximizing the benefits of tax credit

The employee retention credit offers several benefits to businesses that include:

  1. Facilitates employee retention: The tax credit provides a financial incentive for companies to retain their employee, which helps them maintain their workforce during challenging times.
  2. Decreases labor costs: Tax credit also helps businesses lessen their labor cost by providing a credit for a part of the salary paid to workers.
  3. Enhances cash flow: Tax credit also improves a company’s flow by providing a refundable credit that you can use for offsetting other tax liabilities or as a cash refund.

Wrapping Up

The business landscape is dynamic and sometimes challenging. Therefore, all business owners must examine all avenues to ensure financial stability and health. The employee retention tax credit is a powerful tool that provides direct economic benefits and contributes to your overall business strategies on employee retention.

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