The Employee Retention Credit explained

employee-retention-tax-credit

What it is and how to claim it.

It’s a huge relief that the COVID-19 lockdowns are behind us, right? No more fighting for toilet paper in the aisles of your grocery store.

If you were a business owner during the height of the pandemic, there may be a little more work for you to do, but don’t worry. You’ll like this. You can still apply for and receive the Employee Retention Credit, potentially scoring a nice check. It can be complicated to claim, but we’ve got you covered.


The basics

  • It’s a refundable payroll tax credit that businesses affected by COVID-19 can claim retroactively to potentially receive a sizeable refund
  • You should use a qualified tax professional or tax credit specialist to do this, because there are tons of scams out there

What is the Employee Retention Credit?

The Employee Retention Credit, usually referred to as the ERC, is a refundable payroll tax credit for businesses affected by the COVID-19 pandemic. It was intended to help keep employees on the payroll during a time in which entire industries were shut down for months on end.

👩‍🏫 Note: The ERC is also referred to as the Employee Retention Tax Credit or ERTC. We’ll be using the official name, ERC, in this article, but ERTC is also commonly used, so just remember that it’s referring to the same thing.


So why are we talking about it now? Even though the lockdowns are long gone, businesses that were affected by the pandemic can still retroactively claim the credit on their past tax returns. That “refundable” bit is key here – you’re not just getting random money, you’re getting a refund equal to what you would have saved if you’d claimed the ERC on your original payroll tax returns from 2020 or 2021.

How much is the credit?

The size of your refund is proportional to eligible wages you paid in 2020 and 2021, according to the IRS’s guidelines.

  • For 2020 – 50% of the first $10,000 in eligible wages paid, per employee, for the entire year
  • For 2021 – 70% of the first $7,000 in eligible wages paid, per employee, for each of the first two quarters of the year

Eligible wages, in this case, is anything paid during the times mentioned above, as long as your business qualifies as “COVID affected.” One quick caveat: any wages you paid with Paycheck Protection Program (or PPP) funds don’t count towards the wages used to calculate your ERC refund. No double dipping allowed.

Depending on the size of your workforce and how well they’re paid, this could potentially be quite a bit of money. And since it’s a refund on employer payroll taxes you’ve already paid years ago, it’s pretty much money for nothing and kicks for free – the only cost is claiming the credit and updating your taxes. You can actually get more money back than you would have paid in employer taxes!

What will it cost me to claim?

There are some expenses involved in the process of claiming the Employee Retention Credit, depending on how easy you want the process to be.

  • Your own time and effort. You’re running a business, and hopefully that’s keeping you plenty busy. Make sure you’re able to spare enough of your valuable time to pursue this credit, particularly if you plan to do the calculations and filing yourself.
  • Hiring a tax credit specialist. They typically charge between 15-30% of the expected refund. We think it’s easily worth the cost – more on this later in the article.
  • Paying your CPA to amend your tax returns. If you have a CPA (and you should!), plan on anywhere from 50-100% of their regular rates for them to prepare and file your amended returns, depending on whether they prepared your original income tax returns.
  • Additional tax due on the refund you receive. You’re getting a paycheck and the IRS wants their cut, even if the check is coming from them (you have to admire their consistency). The exact amount will vary depending on things like tax brackets.

If, after factoring in the additional costs, you’re not getting a significant return, the ERC may not be worth it for your unique situation. Talk to your CPA to find out if claiming this credit makes sense for you and your business.

Great, I’m in! What do I need to do?

The IRS is all about process. You’ll need to complete each step listed below, so let’s break it down.

  1. Determine if you qualify
  2. Run the calculations
  3. Amend your payroll tax returns
  4. Receive the check in the mail
  5. Amend your business & individual income tax returns to include the credit

Determine if you qualify

In our experience, if you owned a business during the pandemic, and had employees during that time, you probably qualify. But there are some specifics.

Basically, the IRS is looking for two big criteria to determine ERC eligibility:

  • First, your business needs to have paid wages to employees between March 2020 and June 2021. They don’t need to have been working the entire year, you just need to have paid employees during this time.
  • Second, your business must have been significantly impacted by COVID-19. We’re talking mandatory government shutdowns, supply chain disruptions, or other massive losses of income that can be directly attributed to the pandemic.

Keep in mind that when we say wages, we mean W-2 wages paid to an official employee. Self-employed wages shown on your Schedule C won’t count and neither do payments to an independent contractor (usually reported to the contractors on Form 1099-NEC). If you own 50% or more of the business, your wages won’t count towards the ERC calculations either.

Another key detail: even if your business grew during the pandemic, you can still qualify if it also took COVID-related losses such as government shutdowns and supply chain disruptions. Did you wait longer to get something because of a supply chain issue? Great, you probably qualify.

Run the calculations

Once you’ve determined that you’re probably eligible for a credit, the logical next step is to calculate how large your refund will actually be. Unfortunately, it’s not exactly a simple process. While we like to keep things straightforward, checking the rules and running the calculations aren’t. You pretty much have two options on doing this part:

  • Have an expert do it for you. In our opinion, working with a specialist is an easy win – we’ve walked through this in more detail below. For now, just know that these calculations are free up-front: you only pay the specialist if you end up claiming the credit.
  • Do it yourself. You should start with reviewing the IRS’s website, which will have the information you need to fill out and submit the appropriate forms. Keep in mind that this is a difficult and complex process, even for tax professionals, and it carries a high audit risk if something goes wrong. But it’s still technically doable if you’re extremely careful and detail-oriented.

Amend your payroll tax returns

Once you’ve determined you’re eligible for the credit, it’s time for the fun part: paperwork. You’re looking file Form 941-X, the Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund, for each quarter you are claiming the credit.

If you’re doing this on your own, you’ll want to grab your original payroll tax returns, download the amended Form 941-X, and send them off in the mail (don’t forget to send them certified mail with return receipt). Your accountant or CPA might be able to help you amend the returns, although that sometimes depends on whether or not they performed the original calculations themselves.

If you’re working with a tax credit specialist, their fee covers filing the amended payroll tax returns for you (with your approval and signature).

By the way, your amended payroll tax returns must be filed by April 15, 2024 (for 2020 ERC) or April 15, 2025 (for the 2021 ERC). This may seem like a long time, but it's not. Because of how long it's been taking the IRS to process these claims, we highly recommend you get moving now to make sure there's no hiccups along the way.

Receive the check in the mail

Good things come to those who wait! In this case, it may take a while for all the paperwork to get sorted out.

If you’re using a tax credit specialist, it will usually take 4 to 6 weeks to process your paperwork and file the amended payroll tax returns, but the waiting game continues after that. The IRS marches to the beat of their own drum, and it could take between 6 and 12 months for the credit to arrive. That’ll be an old-fashioned check in the mail, too – no direct deposit option for this one.

The earlier you get it done, and the more accurate your information is, the easier and faster it’ll be for the IRS to process and approve everything. That’s another great reason to work with a professional.

You’ll be getting several things in the mail, by the way: your refund checks (nice!) and tax notices detailing how much you received and why. You should compare the checks, the notices, and the amended returns you filed to make sure everything matches.

If you used a tax credit specialist, this is where you write them a check. You’ll also want to hang onto part of that refund to cover any additional income taxes.

Amend your business and individual income tax returns

Although you’re receiving your refund in 2023 or 2024, the credit is considered income on the tax returns you filed during the pandemic. That means you’ll have to amend your 2020 and/or 2021 income tax return to reflect that you are now claiming a credit.

For S-corporations or partnerships (or LLCs that have elected to be taxed as S-corps or partnerships), you need to amend the business’s income tax return – Form 1120-S or Form 1065, respectively. Additionally, since these are pass-through entities whose owners report their share of the income on their individual income tax returns – Form 1040 – those will need to be amended as well. Remember, if your business has multiple owners, all of you will need to amend your tax returns!

For those that file a Schedule C (sole proprietorships), it’s a bit simpler. Just amend your individual Form 1040 and you’re good to go.

If you or your business are located in a state that collects income tax, you’ll need to amend that return as well. And if you or your business filed in multiple states? Well, it actually depends – your CPA will be able to walk you through what’s needed here.

👩‍🏫 Note: Successfully claiming the ERC means retroactively increasing your pandemic-era income, which also means you could technically owe penalties and interest on late tax payments on your new income. However, the IRS has a special abatement process to eliminate the penalties and interest as long as it’s directly related to the ERC. Ask your CPA and they’ll make sure you jump through the right hoops.

If you’re filing a state return, most states won’t abate penalties or interest, but we still recommend you ask – they’ve been known to be kind!


Working with a third party to claim your ERC

We’ll lead with the important part here: you should be working with a third-party tax credit specialist. They live and breathe this stuff, they know all the rules, and this can be a very frustrating and confusing ordeal if you attempt it on your own.

Our clients have had a lot of success working with ERC Specialists, and we recommend trying them out.

Why work with a third party?

Taxes can be confusing on the best of days, and claiming the ERC is a special kind of complicated, particularly now that you have to go back and amend old returns. That’s no easy task, and with so many moving parts, it can be difficult to predict every outcome.

Working with a tax credit specialist isn’t required, but they can help ensure accuracy and maximize your refund. It’s also a much faster and easier process with professional help.

Cost

A tax credit specialist will usually charge somewhere in the neighborhood of 15-30% of the credit they help you claim. ERC Specialists, our preferred partner on this one, charges 15%.

But don’t worry, you don’t pay up front. Similar to how attorneys handle certain lawsuits, you only pay once you actually receive your tax refund. If you don’t get paid, neither do they.

Make sure you thoroughly read your contract, so you understand exactly what you’re signing up for.

Why your CPA won’t do this for you

We get asked about this a lot, and we want to make sure you know why CPAs don’t provide this service. Just like how it works in other professions, CPAs usually specialize in specific areas, such as tax compliance and tax strategy. Producing long reports, tailored to a specific tax credit like the ERC, may not be their thing.

That’s why most CPAs, just like us, will partner with a tax credit specialist that can help you out more directly. This is standard practice in the tax credit world, with specialists covering a variety of areas such as cost segregations or research and development credits.

Be aware of ERC scams

The IRS releases a list called the “Dirty Dozen” every year, warning taxpayers about the 12 worst tax scams to watch out for. Unfortunately, whenever there’s an opportunity for a big payday, the scammers come running. And for the past several years, ERC scammers have made the list.

Shady promoters run ads on radio and the internet pushing anyone and everyone to try and claim the ERC – with their help of course – regardless of whether or not they actually qualify. When somebody does actually qualify for the ERC, the scammers will encourage them to make claims beyond their actual eligibility. For example, they might encourage their victims to claim wages that they paid with the help of PPP loans which, as discussed above, is definitely not going to fly with the IRS.

Of course, these scammers charge a generous fee (usually up front) and leave taxpayers high and dry when it turns out they don’t qualify for as much as they were led to believe. They may even be harvesting your personal information to sell to even shadier characters!

Filing fraudulent claims with the IRS can land you in some legal hot water, so it’s extremely important to make sure you’re working with someone you can trust. Even if you’re able to resolve the situation, it will be a prolonged hassle that you’re much better off avoiding.

How do I recognize a scammer?

Luckily, with a little time and patience you can avoid these unscrupulous “tax professionals” and find an actual competent specialist.

Search for reviews online and see what people are saying. Any mention of a scam is a red flag but be aware of subtler clues like too many 5-star reviews with the exact same phrasing.

Find out if anyone you know has worked with them, and how it went. Pay extra attention to the results, not just the experience. Scammers are often friendly, professional, and easy to work with, just like a genuine tax credit specialist.

And finally, look for trusted sources (like your good friends at DiMercurio Advisors) who have done the work for you and vetted the tax credit specialist. Many CPAs have strong relationships with third parties like ERC Specialists that we mentioned above, and they can point you in the right direction.

Transparency is important to us, so we’d like to let you know that if you utilize ERC Specialists, we earn a small referral fee directly from them. This does not increase the fee they're charging you, it just reduces the amount of the fee they get to keep.


The bottom line

If you kept your staff on the payroll through the effects of the COVID-19 pandemic, the Employee Retention Credit is your pat on the back for contributing to the economy. It takes a little time and effort to navigate the paperwork required to claim the credit, but it’s a lot of money. Working with a specialist can get you the payday you want with minimum stress.

Got any other tax or accounting questions at your business you’d like help figuring out? Schedule a call with the experts at DiMercurio Advisors.

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