Understanding Employee Retention Tax Credit Calculation
The employee retention tax credit (ERTC) is a refundable credit designed to encourage employers to retain employees during periods of economic hardship. The ERTC offers financial relief for eligible employers, allowing them to offset wages and stay in business. In this article, we will provide an overview of the ERTC calculation method, eligibility criteria, and how it can benefit your organization.
Determining ERTC Eligibility
Before diving into the specifics of ERTC calculation, it's essential to determine whether or not your organization is eligible for the credit. Eligibility depends on several factors, including:
- Employer size
- Trade or business operations
- Government orders affecting operations
- Decline in gross receipts
Note that self-employed individuals are not eligible for the ERTC. However, households employing certain workers, such as nannies or housekeepers, may qualify.
Employer Size
The definition of employer size varies depending on the year in question. For 2020, companies with 100 or fewer full-time employees are considered small employers, while those with more than 100 employees are deemed large employers. In 2021, the threshold increased to 500 employees, with companies having 500 or fewer full-time employees qualifying as small employers.
Trade or Business Operations
Employers must be carrying on a trade or business during the calendar quarter to qualify for the ERTC. Nonprofit organizations and governmental entities may also be eligible under specific circumstances.
Government Orders Affecting Operations
An employer qualifies for the ERTC if they experienced a full or partial suspension of operations due to a governmental order related to COVID-19. Examples include stay-at-home orders, social distancing mandates, and restrictions on gatherings.
Decline in Gross Receipts
Another eligibility criterion is the decline in gross receipts compared to the same calendar quarter in 2019. In 2020, employers must have experienced a 50% or more reduction in gross receipts to qualify. For 2021, this threshold was lowered to a 20% or more decline in gross receipts.
Calculating Employee Retention Tax Credit
The calculation of the ERTC depends on the employer's size, as previously mentioned. Once you've determined your organization's eligibility, follow these steps to calculate your tax credit:
- Determine the number of eligible employees
- Calculate the qualifying wages for each employee
- Apply the applicable ERTC rate
Determining the Number of Eligible Employees
For small employers, all employees' wages are considered eligible, regardless of whether they continued working or not during the period of economic hardship. However, large employers can only claim the ERTC for employees who were not providing services during the relevant period.
Calculating Qualifying Wages
Qualifying wages include salaries, hourly wages, commissions, and tips paid to employees, up to certain limits. For 2020, the maximum amount of qualified wages per employee is $10,000 annually. In 2021, the limit increased to $10,000 per quarter, with a maximum annual cap of $40,000.
In addition to regular wages, employers may also include the cost of providing health benefits to employees. However, certain payments, such as sick leave and family leave wages covered under other tax credit provisions, should not be included in the calculation.
Applying the ERTC Rate
The final step in calculating the ERTC is applying the appropriate credit rate. For 2020, the credit rate is 50% of qualifying wages, while in 2021, it increased to 70%. This means that for every dollar spent on eligible wages in 2020, employers can claim a credit of $0.50, whereas they can claim $0.70 per dollar spent in 2021.
For example, if an employer paid $8,000 in qualifying wages to an employee in 2020, the ERTC would be $4,000 (50% of $8,000). In contrast, if the same employer paid the same amount in 2021, the credit would be $5,600 (70% of $8,000).
ERTC and Paycheck Protection Program Interaction
It's important to note that employers who received a Paycheck Protection Program (PPP) loan may still be eligible for the ERTC. However, they cannot claim both PPP loan forgiveness and the ERTC for the same wages. To navigate this interaction between the two programs, consult with a tax professional or financial advisor to ensure compliance and maximize your organization's benefits.
In summary, the employee retention tax credit offers valuable relief for eligible employers during times of economic hardship. Understanding the eligibility criteria and calculation method can help businesses make the most of this refundable credit to retain their workforce and maintain operations. Be sure to consult with a tax professional to ensure accurate calculations and adherence to all regulations.