Employee Retention Tax Credit

As we roll into tax season, a tax credit that began in the early days of COVID is back in the news, offering small businesses both the opportunity to save money … and the potential for problems.

The Employee Retention Tax Credit (ERC) was designed to reward small businesses that kept their employees on payroll during the COVID-19 pandemic. By essentially reimbursing companies for money spent on salaries, even those companies that didn’t owe federal income tax, it was one of the most valuable tax benefits to come out of the pandemic. Although it closed on December 31, 2021, some businesses are still eligible to claim it retroactively this tax season. Unfortunately, many businesses are on the receiving end of bad advice about whether they qualify and for how much.

If you’re eligible for the ERC—or if you are not sure if you’re eligible—here’s what you need to know:

What Is the Employee Retention Credit (ERC)?

Part of the CARES Act of 2020, the ERC was an incentive for businesses to retain their employees. It was a refundable tax credit for organizations of any size, including tax exempt ones, that continued to pay employees while fully or partially shut down by government order due to COVID-19 or whose gross receipts were 50% below the comparable quarter in 2019. Once gross receipts rose to more than 80% of a comparable quarter, the employer no longer qualified.

The ERC has since been amended three times, first by the Taxpayer Certainty and Disaster Relief Act of 2020 (Relief Act), which extended it by six months to June 30, 2021, next by the American Rescue Plan which extended it to December 31, 2021, and finally by the Infrastructure Investment and Jobs Act (IIJA), which extended the deadline to December 31, 2021, for “recovery startup businesses” that met the following criteria:

• Opened on or after February 15, 2020
• Have one or more W2 employees, not including owner-operators or family members.
• Annual gross receipts don’t exceed $1 million for the individual 2020 and 2021 tax years

The credit is worth 50% of qualified wages up to $10,000 per employee per year for 2020 and 70% of up to $10,000 in wages paid by an employer per quarter in 2021, including certain health care expenses. For 2020 and 2021 together, the maximum amount that a business can claim for an employee is $26,000.

Some taxpayers are able to claim the credit retroactively for both 2020 and 2021 by filing an amended tax return known as Form 941-X.

Businesses Fall Victim to “ERC Mills”

While the ERC is legitimate, not all the claims for it are. On March 7, 2023, the IRS issued a renewed warning to taxpayers about third-party promoters who claim they can help employers file for the credit but who may not use the correct criteria for eligibility and computation, resulting in fraudulent claims. These “ERC mills” also often charge hefty fees.

Employers who file fraudulent claims, even unintentionally, will have to pay back the credit with interest and may be liable for penalties or criminal prosecution.

Before attempting to claim the ERC, businesses should be aware of the following:

• The amount of ERC that can be claimed may be affected if a business accepted a Paycheck Protection Program (PPP) loan
• Wage deductions claimed on a business’s federal income tax return must be reduced by the amount of the credit
• Not all every government order qualified a business for the ERC
• Most businesses will not be eligible to claim $26k for every employee

What to Do if You Encounter an ERC Mill

If you are approached by a questionable third-party promising too-good-to-be-true returns, you can report it, anonymously if you wish, to the IRS using Form 3949-A. You can also report fraud and other IRS-related criminal attempts to the Treasury Inspector General for Tax Administration at 800-366-4484.

How Can Eligible Employers Legitimately Claim the ERC?

The ERC is a valuable credit, and we urge employers who are eligible to apply for it. However, because a large number of fraudulent claims are expected, returns that include the ERC are likely to be at a high risk of being audited. Employers who claim the ERC should ensure they truly qualify and be prepared to back up their claim with appropriate documentation.

We strongly recommend working with a reputable accounting firm and an experienced CPA. At Tonneson + Co, we have decades of experience helping taxpayers, including small businesses. We can help you determine if you qualify and for which quarters, prepare correct documentation, calculate your credit, taking PPP loans into account, and figure out which employee wages qualify. And if your business has already filed an income tax return deducting qualified wages before filing an employment tax return claiming the credit, we can help you file an amended income tax return to correct any overstated wage deduction.

Contact us at Tonneson + Co today to learn how we can help.