Definition of Employee Retention Credit (ERC)
The Employee Retention Credit (ERC) is a refundable tax credit that was introduced as part of the COVID-19 stimulus measures. It was designed to help eligible businesses affected by the pandemic to retain their employees and keep their operations running. The credit provides employers with a percentage of qualified wages paid to employees, subject to certain eligibility requirements. While the ERC offers a significant financial incentive to eligible businesses, not everyone is qualified to claim this tax credit. In the following sections, we'll explore who is not eligible for ERC.
Overview of Who is Eligible for ERC?
The Employee Retention Credit (ERC) is a refundable tax credit available to eligible businesses that have been adversely affected by the COVID-19 pandemic. To qualify for the ERC, a business must meet certain eligibility requirements.
One of the primary eligibility requirements for the ERC is that the business must have experienced either a partial or full suspension of operations due to a government-mandated shutdown or a significant decline in gross receipts. Additionally, the business must have had employees during the eligible calendar quarter.
For businesses with 100 or fewer full-time employees, all wages paid during an eligible calendar quarter qualify for the credit, including qualified wages and qualified health plan expenses. However, it's important to note that attribution rules apply to businesses with familial ownership, and wages paid to family members may be subject to limitations.
A new category of eligible businesses has been introduced under the ERC: recovery startup businesses. These are businesses that were established after February 15, 2020, and have average annual gross receipts of less than $1 million. Recovery startup businesses have different eligibility criteria than other eligible businesses, and the credit amount they can claim is limited.
In terms of payroll costs, eligible businesses may claim a credit of up to 70% of qualified wages paid to employees per eligible employee per quarter, with a maximum credit of $7,000 per quarter per employee. Eligible wages include wages paid to all employees who provide services for the business, regardless of the number of hours per week worked.
Overall, the ERC is a valuable resource for eligible businesses facing financial hardship due to the COVID-19 pandemic. By carefully reviewing the eligibility requirements and payroll costs that qualify for the credit, businesses can make informed decisions about whether to pursue this valuable tax credit.
Who is Not Eligible for ERC?
Although many businesses have been able to take advantage of the Employee Retention Credit (ERC) during the COVID-19 pandemic, not all businesses are eligible for this refundable tax credit. Here are some of the factors that could disqualify a business from claiming the ERC and receiving tax credits for the qualified wages paid to employees.
Businesses with More than 100 Full-Time Employees
Businesses with more than 100 full-time employees are not eligible for the Employee Retention Credit (ERC). The ERC is a refundable tax credit designed to help eligible employers retain their employees during the COVID-19 pandemic. The eligibility requirements for this credit include a partial suspension of operations or a significant decline in gross receipts, among others.
According to the IRS, an eligible employer with more than 100 full-time employees can claim the ERC only for those employees who are not providing services due to the suspension of operations or because of a significant decline in gross receipts. This eligibility limitation applies to each distinct calendar quarter, making ineligible businesses that have a large workforce.
For example, a restaurant with 200 full-time employees cannot claim the ERC if it does not meet the eligibility requirements during a specific calendar quarter. Even if the restaurant experiences a significant decline in gross receipts during the quarter and suspends the operations of some of its employees, it can only claim the credit for up to 100 employees.
Additional guidance from the IRS confirms that the credit is limited to eligible employers with 100 or fewer full-time employees during the 2021 calendar year. However, the attribution rules and constructive ownership rules may also apply in determining employer size and eligibility.
In summary, businesses with more than 100 full-time employees are not eligible for the ERC if they do not meet the eligibility requirements during each calendar quarter. It is important to understand the eligibility limitation and consult additional guidance from the IRS to see if your business qualifies for this refundable tax credit.
Tax-Exempt Organizations and Nonprofits
Tax-exempt organizations and nonprofits may also qualify for the Employee Retention Credit (ERC) if they meet certain eligibility requirements. To claim the credit, these organizations must have been fully or partially suspended due to government orders related to the COVID-19 pandemic or have experienced a significant decline in gross receipts.
Eligible tax-exempt organizations include those that operate under section 501(c) of the Internal Revenue Code, such as charities, educational organizations, and religious organizations. Unlike eligible for-profit employers, there is no limitation on the number of full-time employees an eligible nonprofit or tax-exempt organization may have to claim the ERC for qualified wages paid to their employees.
However, tax-exempt organizations and nonprofits must be aware of the attribution rules when determining their eligibility for the ERC. The attribution rules apply when determining if an organization has more than 500 employees according to the family attribution rules, which attribute the employees of certain related persons, such as family members and their interests in businesses, to the organization for the purposes of determining employer size.
To claim the ERC, tax-exempt organizations and nonprofits must file Form 941-X, Adjusted Employer's Quarterly Federal Tax Return or Claim for Refund, for the relevant calendar quarter. They must also include eligible qualified wages and qualified health plan expenses paid to their employees for the specific reporting period in their payroll tax returns.
Additional guidance is available to help tax-exempt organizations and nonprofits better understand the ERC, including information on the safe harbor provisions for satisfying the gross receipts test and the qualifications for qualified recovery startup businesses.
However, some situations may prevent tax-exempt organizations and nonprofits from claiming the ERC. For instance, if they have a high turnover rate of employees per quarter or calendar month, it may disqualify them from qualifying for the credit. Consequently, such institutions must carefully evaluate their eligibility before claiming the ERC.
Majority Owners of Eligible Employers
When it comes to the Employee Retention Credit (ERC), not all employees of eligible employers are eligible for the credit. Specifically, majority owners of eligible businesses may not be able to claim the ERC. For an employer to be eligible for the ERC, they must have 500 or fewer full-time employees. A majority owner is defined as an owner with more than 50% ownership interest in the business. Therefore, if an owner has more than 50% ownership interest in the eligible employer, they may not be eligible for the credit.
However, there is an exception. A majority owner may still qualify for the credit if they receive W-2 wages and provide evidence of active participation in business operations. This means that a majority owner must be able to show that they are involved in the day-to-day operations of the business, and they must receive W-2 wages in order to qualify for the credit. If they meet these two requirements, they may be able to claim the ERC on wages paid to themselves.
It's important to note that eligible wages for a majority owner are limited to the amount of wages paid to other employees during similar periods and should exclude any owner's draw. This means that a majority owner cannot claim the ERC on a higher amount of wages than what is paid to other employees during similar periods. Additionally, any owner's draw should not be included in the calculation of eligible wages.
In summary, majority owners of eligible businesses may not be eligible for the ERC unless they receive W-2 wages and provide evidence of active participation in business operations. Eligible wages for a majority owner are also limited to the amount of wages paid to other employees during similar periods and should exclude any owner's draw.
Businesses That Receive a PPP Loan Forgiveness After 1/1/21
Businesses that receive a PPP loan after December 31, 2020, may still be eligible for the employee retention tax credit (ERC), as long as they meet other eligibility requirements. However, it's important to note that businesses that receive PPP loan forgiveness after January 1, 2021, may be prohibited from claiming credits on qualified wages that are included in the forgiveness calculation.
This means that if an employer receives forgiveness for PPP loan funds that were used to pay employee wages during a period that also qualifies for the ERC, they cannot "double-dip" and claim the ERC on those same qualified wages. Both the wages paid during the covered period and the wages paid before the covered period may be subject to this restriction.
In addition to the PPP loan forgiveness restriction, businesses must still meet other eligibility requirements to qualify for the ERC. This includes being an eligible employer with business operations that were either fully or partially suspended due to COVID-19, or experiencing a significant decline in gross receipts. The amount of the ERC that a business can claim is also limited based on the number of full-time employees they have and the amount of qualified wages paid.
It's important for businesses to carefully consider the impact of PPP loan forgiveness on their eligibility for the ERC and to consult with a tax professional for guidance. While the ERC can provide a valuable refundable tax credit to eligible businesses, double-dipping and claiming credits on qualified wages used for PPP loan forgiveness may result in penalties or other negative consequences.
Businesses That Are Partially Suspended or Fully Suspended Due to COVID-19 Restrictions
Businesses that are partially or fully suspended due to COVID-19 restrictions may be eligible for the Employee Retention Credit (ERC), a refundable tax credit designed to help eligible businesses keep their employees on payroll during the pandemic. But what exactly does partial and full suspension mean, and how do they affect a business's eligibility for the credit?
A full suspension, as the term suggests, means that a business's operations were completely shut down due to COVID-19 restrictions. A partial suspension, on the other hand, means that while the business was not forced to close entirely, it was still significantly affected by these restrictions, resulting in a reduction in its hours of operation, customer demand, or supply chain.
To determine if a business is eligible for the ERC based on the extent of its suspension, it must first satisfy certain eligibility requirements. For instance, eligible businesses must have experienced either a partial or full suspension of operations due to COVID-19, which started on a specific date and lasted for a certain duration. They must also have experienced a significant decline in gross receipts, which is determined by comparing their revenue in 2020 to the same calendar quarter in 2019.
In addition, eligible businesses must have had an average of 100 or fewer full-time employees during 2019 or the last calendar quarter of 2019. For businesses with more than 100 employees, the ERC is limited to wages paid to employees who are not providing services due to the suspension or decline in revenue.
It is also worth noting that the ERC has a Safe Harbor provision that provides relief for businesses that were not mandatory closed but saw a significant decline in revenue due to COVID-19. This provision allows them to be considered partially suspended, making them eligible for the credit.
In conclusion, businesses that were partially or fully suspended due to COVID-19 restrictions must meet certain eligibility requirements to qualify for the ERC. These requirements include when the suspension began and ended, the extent of the business operations affected, and the number of full-time employees on payroll. The Safe Harbor provision also provides relief for businesses that were not mandatory closed but experienced a significant decline in revenue.
Refundable Tax Credits Not Allowed on Wages Paid Under the Paycheck Protection Program (PPP)
One of the relief measures provided to businesses during the COVID-19 pandemic is the Paycheck Protection Program (PPP), which offers forgivable loans to eligible businesses to cover payroll costs and other approved expenses. However, it is important to note that if a business receives PPP loan forgiveness, certain restrictions apply to any refundable tax credits it may be eligible for.
Specifically, refundable tax credits such as the Employee Retention Credit (ERC) are not allowed for any wages that have already been included as payroll costs and forgiven under the PPP loan forgiveness program. This means that any wages paid during the covered period that have been forgiven under the PPP program cannot also be used to claim the ERC or any other refundable tax credits.
However, wages paid during the covered period that have not been included in the amount forgiven under the PPP loan may still be eligible for the ERC or other tax credits. It is important for businesses to carefully consider how they allocate their payroll costs during the covered period, as any wages already forgiven under the PPP loan cannot be used to claim any additional refundable tax credits.
It is also worth noting that this prohibition only applies to wages that have been forgiven under the PPP loan program, and not to any wages paid outside of the PPP program. Businesses must closely review their payroll costs and ensure they are not double-dipping on forgivable expenses when claiming refundable tax credits.
Employees Whose Wages Are Already Qualified By Social Security Taxes Paid by the Employer
Employees whose wages have already been qualified by Social Security taxes paid by the employer are not eligible for the Employee Retention Credit (ERC). To be eligible for the ERC, an employer must have paid "qualified wages" to "eligible employees" during an "eligible calendar quarter." Qualified wages do not include any wages paid to an employee that have already been subject to Social Security taxes, even if the employee has not reached the maximum taxable amount for the year.
Employers must carefully determine which wages are subject to the ERC by examining each employee's wages on a quarterly basis. To determine the maximum credit for eligible employees, an employer must calculate the qualified wages for each employee for each calendar quarter in which the employer qualifies for the credit. The maximum credit for each eligible employee is 50% of the qualified wages paid during the eligible calendar quarter, up to a maximum of $10,000 per employee.
To claim the ERC, eligible employers must report the credit on their payroll tax returns (Form 941) for the calendar quarter in which the qualified wages were paid. If the amount of the credit exceeds the employer's share of Social Security taxes for the calendar quarter, the excess credit may be claimed as a refundable credit on the employer's federal employment tax return (Form 941-X) or on an amended personal tax return.
In summary, employees whose wages are already qualified by Social Security taxes paid by the employer are not eligible for the ERC. Employers must carefully determine which wages are subject to the ERC and calculate the maximum credit for eligible employees based on qualified wages paid during eligible calendar quarters. The credit must be reported on the employer's payroll tax return and any excess may be claimed as a refundable credit on either a federal employment tax return or an amended personal tax return.
Recovering Startup Businesses that Had No Prior Operations in 2019 or 2020
Recovering startup businesses that had no prior operations in 2019 or 2020 may qualify for the Employee Retention Credit (ERC). However, it is important for these businesses to understand the specific eligibility requirements to qualify for the credit.
Firstly, recovering startup businesses must have no gross receipts for the 2019 calendar year. In addition, these businesses must have been in operation for less than one year at the date of receiving ERC. This means that new businesses that were formed in 2020 and businesses that started operations after February 15, 2020, may be eligible for the credit.
Apart from the previously stated requirements, recovering startup businesses must also have less than $1 million in gross receipts during the 2020 calendar year. These gross receipts should have been generated from all sources, not just in the production of goods or services and should have been calculated in accordance with the business's method of accounting.
It is also vital to note that a recovering startup business is a business that began operating after February 15, 2020, and had an average annual gross receipt of $1 million or less for the three years before 2020. This is important to understand because a business that had an average annual gross receipt of more than $1 million in the preceding years before 2020 may not be eligible for the ERC as a recovering startup business.
In conclusion, recovering startup businesses that had no prior operations in 2019 or 2020 may be eligible for the ERC. However, it is necessary to meet all the eligibility requirements, which include having no gross receipts for the 2019 calendar year, being in operation for less than one year, having less than $1 million in gross receipts during the 2020 calendar year, and meeting the definition of a recovering startup business.
High Turnover Rate for Employees Per Quarter or Calendar Month
High Turnover Rate for Employees per Quarter or Calendar Month and its Impact on the Employee Retention Credit Eligibility
In the context of Employee Retention Credit (ERC), high turnover rate refers to the rate at which employees are leaving a business within a quarter or calendar month. This factor can have a significant impact on a business's eligibility for the credit, especially when calculating the credit amount.
When determining eligibility for ERC, the IRS considers the number of full-time employees a business had retained during the calendar quarter, which is at least 30 percent less than the same period in 2019 due to COVID-19 pandemic-related factors. In other words, businesses must have experienced a partial suspension of operations during the quarter due to government orders or a reduction in gross receipts by more than 50% compared to the same period in 2019.
Additionally, businesses may also be disqualified from receiving ERC based on their high turnover rate. The threshold for high turnover rate varies depending on whether a business has 100 or fewer full-time employees or 500 or fewer full-time employees.
For businesses with 100 or fewer full-time employees, they become ineligible for ERC if the number of employees who left the business during a calendar quarter exceeds the number of employees in the business at the beginning of that quarter. For businesses with 500 or fewer full-time employees, they become ineligible if the turnover rate exceeds 80% of the average monthly number of employees for any calendar month during the year.
If a business has a high turnover rate but still falls below the threshold for disqualification, the credit amount will be affected. The credit amount is calculated based on 50% of the qualified wages paid to each eligible employee, and the maximum credit amount per employee is $5,000. However, if the business has a high turnover rate, it may have fewer eligible employees, resulting in a lower credit amount.
Some exceptions and safe harbors are available for businesses that experience a high turnover rate. For instance, businesses that pay wages to employees whose employment was terminated due to voluntary resignation or misconduct are not counted towards the qualified wages and, therefore, do not affect eligibility for ERC. Additionally, businesses that have experienced a substantial decline in gross receipts but do not meet the partial suspension requirement may still claim ERC if they meet eligibility requirements.
In conclusion, high turnover rate for employees per quarter or calendar month can impact a business's eligibility for ERC. It is vital for businesses to be aware of their turnover rates and the threshold for disqualification to avoid any penalties and ensure they maximize their credit amount.