What to Avoid When Claiming Employee Retention Credit

When the government grants businesses the ability to collect a refundable payroll tax credit, you expect every business owner to perk up their ears and listen. There are more than 30,0000 businesses that did just that, claiming more than $1 billion in employee retention credit (ERC).

The ERC credit is not a loan but a refund from the IRS for payroll taxes. If you have not heard about this benefit for businesses suffering from COVID-19, you aren’t the only one. More than 50% of eligible companies are unaware they qualify for the program.

The good news is that even though it is beyond the deadline, you can still apply for your 2020 and 2021 credits. The IRS is allowing a 3-year lookback. You can claim your refund by ensuring you meet qualifying criteria and filing an amended form 941-X.

There are several changes to the program, plus numerous steps and documents necessary for determining eligibility. Many businesses make mistakes when deciding eligibility, calculating a refund, record keeping, and more.

Avoid IRS scrutiny. Keep reading to learn about ERC calculation mistakes businesses often make.

Refund vs. Loan         

Many businesses assume the Employee Retention Credit is a loan. This is not true. The ERC is the most extensive stimulus program in government history.

Your business may receive up to $26,000 per employee for 2020 and 2021 as a refund against payroll taxes. There are no restrictions on how you spend this money. Companies filing retroactively against taxes already paid receive a refund check from the IRS.

My Business Did Not Shutdown

Businesses with full or partial shutdowns meet the qualifications for the Employee Retention Credit. This applies to shutdowns from any government level: local, state, or federal. You may qualify if your business suffers the trickle-down effect of a shutdown.

If your business’s ability to receive supplies from vendors, ability to ship products, and more due to COVID-19 results in a disruption in your business, you may be eligible. This includes a disruption in services, business hours, or a shutdown.

The total or partial shutdown is only one way to qualify. You may also qualify due to a reduction in gross receipts.

Essential Businesses Do Not Qualify

Even businesses with the essential classification not experiencing a decline in revenue or a shutdown may qualify. The IRS allows essential companies to claim the credit if a higher than “nominal portion” of their operations experience a suspension because of a government shutdown.

According to IRS Notice 2021-20, the IRS determines nominal as less than 10%. This can happen with a reduction in hours because of the pandemic. For example, hospitals cannot perform elective surgeries, production facilities have to close plants but not warehouses, or businesses are subject to curfews.

To determine the 10% threshold, you compare revenue and total work hours in the 2020 and 2021 quarters with the same 2019 quarters. If the revenue or total work hours is at least 10% below the 2019 totals, it qualifies as more than nominal.

If you believe your essential business may qualify for the Employee Retention Credit in 2022 or 2021, contact ERC Smart to schedule a consultation.

Confirm Qualification Requirements

There are differences in qualification requirements for 2020 and 2021. The basic criteria is a partial or complete shutdown because of a government order or a decline in revenue.

Eligible wages are those you pay to employees unable to work during a government shutdown order or a significant decline in business. Wages include hourly pay, salary, commissions, health insurance, and other compensation. Retention of the employee for that period, with them receiving a minimum of $600 in wages per quarter, qualifies your business.

The rules for 2020 calculations are in IRS Notice 2021-20.

Businesses with less than 100 employees may claim a maximum of $10,000 in wages per employee per quarter. The refund amount is 50% of wages paid for a total refund of $5,000 per qualifying employee. Qualifying wages are paid between March 12, 2020, and January 1, 2021.

The rules for 2021 calculations are in IRS Code § 3134 and IRS Notices 2021-23 and 2021-49

Businesses with 500 or fewer employees may claim ERC credit against 70% of qualifying wages. The employee wages that qualify are those paid between December 31, 2020, and October 1, 2021.

The maximum amount of wages per employee per quarter is $10,000. This means you may claim up to $7,000 for each qualifying employee.

Determining Number of Employees

To figure the number of qualifying employees, you need to determine your average employee count during 2019.

You may only count wages up to what the employee would be receiving if working during the same period immediately before the shutdown.

• 100 or more full-time employees—wages paid to employees not working due to declining receipts or suspension in operations
• 100 or fewer full-time employees—claim all wages regardless of whether or not the employee is working during a suspension or decline in gross receipts
• 500 or fewer full-time employees—for 2021 only, businesses may claim ERC, but only for employees who are unable to work but still receiving payroll

We Do Not Qualify With Over 500 Employees

Make sure you understand hour the IRS determines a full-time employee. Employees are full-time if, during 2019, they worked a minimum of 30 hours per week or 130 hours per month. This is different from the calculations for PPP forgiveness loans.

Your company may have more than 500 employees, but if their average work hours during 2019 do not meet the above full-time classification, you may still qualify for the credit.

Do Not Claim Owner Wages

Owners of businesses cannot claim their wages for ERC. This includes self-employed, sole proprietors, partnerships, and government entities. If the company employs staff, the wages they pay to those employees may qualify.

Owners of LLCs cannot claim ERC because their wages come from business profits, not payroll. If the owner receives wages as part of payroll, they may qualify.

The majority of S Corp and C Corp businesses do not qualify. The owner’s share of ownership in the company is the determining factor. This includes how the shareholders relate to each other and their percentage of ownership.

If an owner has less than 50% ownership, they may qualify. This option is only available if all relatives do not have a combined ownership of 50% or more.

Even if family members are working in your business and receiving a payroll check, they will likely not qualify. This restriction applies to your children, stepchildren, grandchildren, spouse, and parents. It also applies to extended family members, including uncles, aunts, in-laws, sisters, and brothers.

You must be extremely careful to avoid miscalculations regarding family members’ wages. Claiming credit for a non-qualifying employee can result in fines and penalties.

No Rollovers

If an employee’s wages are higher than the eligible $10,000 per quarter, you may not roll the excess into the next quarter. The rules require you to submit quarterly payroll records when filing an Employee Retention Credit claim.

Quarterly payroll records must match the amount you claim on Form 941-X. If your business is in Puerto Rico, you must file Form 941-X (PR).

Understand Employee Retention Credit Eligibility

Determining eligibility begins with understanding the size of your business. A small business is one with 100 or fewer employees in 2020 and 500 or fewer in 2021. If you have more than 500 employees, you may qualify for a refund on wages paid to employees while they did not work.

2020 Qualification Requirements:

• Maximum $5,000 per employee per quarter
• Subject to a full or partial government shutdown or decline of 50% or more gross receipts when compared with the same 2019 quarter
• Applies to wages between March 13, 2020, to December 31, 2020
• Refund is against Social Security payroll taxes paid in each quarter—6.2% of wages 
• PPP loan recipients are eligible

2021 Qualification Requirements:

• Maximum $7,000 per employee per quarter
• Subject to a full or partial government shutdown or decline of 20% or more gross receipts when compared with the same 2019 quarter
• Applies to wages between January 1, 2021, through September 30, 2021
• PPP recipients are eligible

ERC was initially available for wages paid until January 1, 2021. Congress made changes changing the deadline to September 30, 2021. You have up to three years from the original filing date of Form 941 to file an amendment claiming your credit.

Understand ERC vs. PPP

The Employee Retention Credit (ERC) is a tax refund. The Payroll Protection Program (PPP) is a loan backed by the Small Business Administration and must be repaid. You may qualify for PPP forgiveness if you maintain employee compensation levels and use at least 60% of the loan on payroll costs.

In the beginning, those receiving PPP did not qualify for ERC. The Consolidated Appropriations Act of 2021 made changes allowing businesses to collect both. Those businesses that did not claim ERC in 2020 because of the restriction may now claim it retroactively.

To prevent IRS penalties, ensure the payroll wages you claim on ERC and PPP are not for the same pay period.

Provide Required Documents

When applying for ERC, you need the following records:

• Form 941—employers’ quarterly federal tax return
• Form 7200—advance payment of employer credits due to COVID-19
• Form 8655—reporting agent authorization
• Payroll Protection Plan applications and forgiveness, if applicable
• 2019 financials—Q1, Q2, Q3, Q4
• 2020 financials—Q1, Q2, Q3, Q4
• 2021 financials—Q1, Q2, Q3
• COVID-19 forms for grants or other credits—PPP, §§ 7001, 7003 of FFCRA, Code § 45S, paid medical and family leave credits
• Government shutdown or suspension of operation order, if applicable

You will want to gather these documents and have them on hand before contacting ERC Smart to determine the amount of your credit.

Penalty Waiver

When filing for ERC retroactively, adjustments to your payroll expenses may increase your income. Because of an intense backlog in the IRS processing returns, many businesses find their higher taxes are due before receiving their ERC refund.

IRS notice 2021-49 notifies businesses that if they show “reasonable cause” rather than “willful neglect” for not paying taxes on time, they may receive a penalty waiver. They may also be able to file for a release under the First Time Penalty Abatement Program if they:

• Did not previously file a return or have no penalties for the previous three tax years
• Filing of all returns or extensions on time
• Paid all taxes due or made arrangements to pay

Suppose the IRS conducts an audit and determines you did not calculate your ERC correctly, meaning you took more credit than you qualify for. In that case, they will access an underpayment of taxes, plus interest and penalties.

You may be able to receive a waiver of the penalties if the Secretary of the Treasury determines your underpayment is due to a “reasonable anticipation” of credit. The determining waiver factor is your ability to show that you are attempting to comply with tax laws but cannot pay because of circumstances outside your control.

ERC Is Not Taxable Income

The Employee Retention Credit is a refund. It is not taxable income. The refund creates a reduction in payroll expenses equal to the refund amount. 

When claiming a retroactive Employee Retention Credit in 2022, the wage reduction occurs in the same year as the original filing. This means adjustments to your wage expense may occur in 2020, 2021, or both. You may not take the adjustment on your 2022 tax returns.

You reduce your yearly wage expenses by filing your amendment using Form 940-X. This may cause you to owe additional taxes and need to file for penalty relief. IRS Notice 2022-89 addresses the agency’s acknowledgment that businesses may be unable to pay their taxes because they are waiting for the ERC refund.

The IRS backlog in processing a higher-than-normal number of amendments is causing a delay in processing. You may be waiting ten months or more for your refund. This delay fits the “reasonable cause” requirement. 

Understand the Claim Process

Understanding how to claim for ERC ensures you receive your refund as quickly as possible. Submitting an amended 941-X for each quarter you qualify for is time-consuming and tricky, especially if you are unsure your calculations are accurate.

If you do not report information in the correct format or miss providing mandatory documentation, you will experience delays in receiving your refund.

ERC Smart makes the process easy by allowing you to upload all your documents using our website. Our experts will then calculate the amount of your credit, assist you in filing Form 941-X amendments, and you receive a check from the government.

Claim Your Employee Retention Credit Today

ERC Smart provides small business assistance using a fast, secure process. We will prequalify and validate your employee retention credit eligibility.

After calculating your credit, we will prepare and help you file your payroll return amendments. The IRS will process the amended payroll tax forms and mail you a refund.

Beat the tax refund rush. Contact ERC Smart today. Our experts will begin working on your refund immediately.