Background and Purpose of the Employee Retention Credit
The Employee Retention Credit was established by the CARES Act in March 2020 in response to the economic impact of the COVID-19 pandemic. Its primary objective is to encourage employers across the U.S. to keep workers on the payroll despite operational challenges caused by government-mandated shutdowns or sharp revenue declines. Subsequent legislation, including the Consolidated Appropriations Act of 2021 and the American Rescue Plan Act, expanded and refined the credit, broadening eligibility and increasing credit amounts in certain periods.
The ERC played a crucial role in supporting businesses through unprecedented economic disruptions by providing a refundable tax credit against certain employment taxes, helping reduce the risk of large-scale layoffs and stabilize the workforce.
How the Employee Retention Credit Works
Employers eligible for the ERC can claim a refundable tax credit based on a percentage of “qualified wages” paid to employees during eligible periods. Qualified wages include salary or hourly wages plus a portion of employer-paid health insurance costs.
The credit amount varies by calendar quarter and year:
- For 2020: Credit was 50% of qualified wages up to $10,000 annually per employee.
- For 2021: The credit increased to 70% of qualified wages per quarter, with the maximum amount raised to $7,000 per employee per quarter for the first three quarters.
Employers claim the ERC by reporting wages on their quarterly Form 941, the federal employment tax return. The credit is refundable, meaning if the credit amount exceeds the employer’s payroll tax liability, the IRS will refund the difference.
Eligibility Requirements
To qualify for the ERC, an employer must meet at least one of the following:
- Full or Partial Suspension: Government orders partially or fully suspended business operations during a calendar quarter due to COVID-19.
- Significant Decline in Gross Receipts: A decline of at least 50% (2020) or 20% (2021) in gross receipts compared to the same quarter in 2019 or a prior quarter.
Eligible employers include private businesses of any size, nonprofit organizations, and certain self-employed individuals who maintain payrolls. However, businesses that received Paycheck Protection Program (PPP) loans must follow specific coordination rules to avoid double benefits—wages counted toward PPP loan forgiveness cannot also be claimed for the ERC.
Practical Examples
- A restaurant shuttered due to state-mandated dining restrictions continues to pay staff and claims the ERC for wages during closures.
- A retail store experiences a 60% drop in sales compared to the previous year and qualifies by demonstrating significant revenue decline without any government-ordered shutdown.
- A nonprofit organization with canceled fundraising events retains their employees and claims the credit on wages paid during that period.
Tips for Employers Claiming the ERC
- Maintain detailed records supporting eligibility, including government orders, financial statements showing revenue declines, and payroll documentation.
- Consult qualified tax professionals to navigate complex eligibility rules, especially if the business received PPP loans.
- Consider filing amended Form 941 returns if you discover eligibility after initial filing periods.
- Avoid claiming the same wages for multiple credits to comply with IRS rules and avoid penalties.
Common Mistakes to Avoid
- Assuming eligibility without verifying significant revenue loss or operational suspension.
- Double-counting wages for both ERC and PPP loan forgiveness.
- Missing IRS deadlines for claiming or amending payroll tax returns.
- Confusing the ERC with other employee tax incentives such as the Work Opportunity Tax Credit or Paid Sick Leave credits.
Frequently Asked Questions
Q: Can an employer claim the ERC if business operations are fully open?
A: Yes, if the employer qualifies based on a significant decline in gross receipts, they can claim the ERC even without a government shutdown.
Q: What is the timeframe for claiming the ERC?
A: The credit applies to qualified wages paid from March 13, 2020, to December 31, 2021, with some legislative extensions allowing claims on amended returns.
Q: Can an employer claim the ERC and receive PPP loans?
A: Yes, but wages used for PPP loan forgiveness cannot be counted toward the ERC simultaneously.
Q: Is the ERC refundable?
A: Yes, if the credit exceeds payroll tax liability, the employer receives the difference as a refund.
Summary Table: Employee Retention Credit Overview
| Aspect | Details |
|---|---|
| Established | CARES Act, March 2020 |
| Eligible Employers | Businesses of all sizes, nonprofits, some self-employed |
| Qualifying Criteria | Government suspension of operations or significant gross receipts drop |
| Credit Percentage | Up to 70% of qualified wages (varies by year and quarter) |
| Maximum Credit per Employee | Up to $7,000 per quarter in 2021 |
| Applicable Timeframe | March 13, 2020 – December 31, 2021 (primarily) |
| Tax Forms | Form 941 federal payroll tax return, amendments allowed |
For additional information about payroll taxes and how they relate to the ERC, see our Payroll Taxes guide. For loan forgiveness details, check our article on Business Loan Forgiveness.
Authoritative Resources
- IRS Employee Retention Credit FAQs: https://www.irs.gov/coronavirus/employee-retention-credit
- U.S. Department of the Treasury: https://home.treasury.gov/policy-issues/coronavirus/assistance-for-american-workers-and-families/employee-retention-credit
These sources provide official and updated IRS guidance on claiming and understanding the ERC as of 2024.