A Breakdown Of ERC Requirements And Eligibility Criteria

What are the ERC Eligibility Requirements?

The Employee Retention Credit eligibility requirements include three primary tests. Regular employers that pass all of them can potentially claim the tax credit for 2020 and the first three quarters of 2021. Here’s what you should know about how they work.

Eligible Organization

The first ERC eligibility requirement is the most straightforward and easiest to clear. You must be an employer that operated a trade, business, or tax-exempt organization during 2020 or 2021.

If you’re a small business owner running a company that’s been around since before the pandemic, then you generally don’t have to worry about this test. It primarily prevents governmental entities from claiming the ERC.

Pay Qualified Wages

The second ERC eligibility requirement is where things start to get more complicated. To pass this test, you must have paid qualified wages to your employees. That sounds simple, but the definition of qualified wages varies depending on how many employees your business had on the payroll in 2019.

If your average number of employees in 2019 was below certain thresholds, then the wages you paid to all employees in 2020 and 2021 can qualify for the ERC. If it was above those thresholds, only the wages you paid to workers not providing services are eligible.

For 2020, the threshold is 100 employees. For 2021, the cutoff increased to 500 employees. Note that you should calculate your average number of employees in 2019 on an annual basis, not a quarterly one.

For example, say you had an average of 150 employees on the payroll in 2019. That puts you above the threshold for 2020, and only wages paid to workers not providing services would qualify for the ERC that year. However, you’re below the threshold for 2021, so wages paid to all employees would qualify that year.

Experience Economic Hardship 

The third ERC eligibility requirement is the most complex and usually the one that ultimately determines whether or not you can claim the tax credit. To pass this test, you must have experienced economic hardship due to the COVID-19 pandemic in one of the following ways:

• You were forced to suspend your business’ operations, including limiting commerce travel or group meetings, fully or partially due to COVID-19 government orders, or
• You experienced a significant decline in gross receipts.

Let’s take a closer look at what each of these tests mean.

Suspension of Operations

There are two parts to this test that you must understand. Let’s start with the government order aspect since it’s the most straightforward. It refers to mandates from federal, state, or local regulators that limit your commerce, travel, or group meetings due to COVID-19.

This does not include unofficial recommendations from public servants or self-imposed restrictions. If you’re not subject to a specific government order, you can’t satisfy the hardship requirement through this method.

The second aspect of this test is to have a “full or partial suspension of operations,” which is a bit more complicated. To clear it, you must shut down a “more than nominal portion” of your business.

Upon the initial passage of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, there was a lot of controversy over what this term meant. However, the Internal Revenue Service (IRS) eventually confirmed that a portion of your business must pass one of the following tests to be considered nominal:

• Its gross receipts equaled 10% or more of your total gross receipts
• Its employees worked 10% or more of your workforce’s total hours worked

Once again, these requirements are based on the 2019 calendar year. For example, say you own a restaurant that offers dine-in and takeout services. In 2019, dine-in services generated between 60% and 75% of your annual gross receipts.

Because that aspect of your operation generated more than 10% of your total gross receipts in 2019, it constitutes a more-than-nominal portion of your business. If you stopped offering dine-in services to comply with a government order during 2020 or 2021, you’d be eligible to claim the ERC in that period.

Sufficient Decline in Gross Receipts

As an alternative to showing a suspension of operations, you can prove that you experienced economic hardship through a sufficient decline in gross receipts. This is another complex test, and the rules differ between the 2020 and 2021 calendar years.

In 2020, you can have a decline in gross receipts for only one continuous period. It can cover multiple quarters, but they must be uninterrupted. For example, you couldn’t qualify in the first and third quarters without the second.

An eligible decline begins in the first quarter that your gross receipts fall below 50% of receipts in the same 2019 quarter. It ends in the quarter after your receipts rise above 80% of receipts in the corresponding 2019 quarter.

Meanwhile, in 2021, you can test for a sufficient decline on a quarterly basis. Each one passes the test when its gross receipts are below 80% of gross receipts in the same 2019 quarter. For example, say your business had the following gross receipts:

In 2020, an eligible decline in gross receipts starts in the second quarter—as $45,000 is less than 50% of $100,000—and continues through quarter three. Quarter four is the only ineligible one that year, as it’s the first quarter after receipts rise above 80% of 2019 numbers.

In 2021, any quarter with receipts below 80% of the receipts in the same quarter from 2019 passes this test. As a result, you’d qualify for the ERC in the first and third quarters, but the second and fourth would be ineligible.

Recovery Startup Businesses

The default ERC eligibility requirements generally apply to organizations established before the COVID-19 pandemic. That’s why so many of them involve comparing 2020 and 2021 numbers to those from corresponding periods in 2019.

However, the American Rescue Plan (ARP) was enacted in 2021 to extend ERC benefits to certain businesses that began their operations in the middle of the pandemic. These companies are known as recovery startup businesses.

If you’re a recovery startup business, the eligibility requirements for the ERC are substantially different than those for regular employers. Here are the requirements your operation must meet to claim the ERC as a recovery startup for a given quarter:

• Start doing business after February 15, 2020
• Have at least one W-2 employee on the payroll 
• Average less than $1 million in annual gross receipts during the three-year period ending in the tax year before the quarter

An additional eligibility requirement applies to the third quarter. Namely, you can’t pass the decline in gross receipts or suspension of operations tests. If you do, you must claim the credit for that quarter as a regular employer, not a recovery startup business.

To clarify, filing as a recovery startup business in either of these quarters will not prevent you from doing so in the earlier quarters as a regular employer.

Recovery Startup Business ERC Example

Like the regular ERC qualification rules, the recovery startup eligibility requirements are complicated. Let’s look at an example to help you understand how they work.

Say you opened a digital marketing agency on June 1, 2020. You have five full-time employees on the payroll taking home $50,000 salaries, and your new business generated $400,000 in gross receipts by the end of the year.

You started doing business after February 15, 2020, and had multiple W-2 employees on the payroll, so you meet the first two requirements for a recovery startup business. All that’s left is to confirm that you meet the $1-million gross receipts test.

Since you weren’t in business before the 2020 tax year, that’s the only year you must consider here. But because you were only open for part of the year, you have to annualize your numbers.

To do so, divide the $400,000 received in 2020 by the number of months you were open that year, then multiply the result by 12. Since you started doing business on June 1, divide $400,000 by seven and multiply it by 12 to get $685,714. Fortunately, that’s well below the $1 million threshold.

Assuming you don’t pass the decline in gross receipts or suspension of operations tests for the third quarter of the year, you can file as a recovery startup for the third and fourth quarters of 2021.

Apply for the Employee Retention Credit

The ERC is a refundable payroll tax credit. That means you can subtract it directly from your annual payroll tax liability, and if there’s any left, you can take it to the bank. That makes the ERC significantly more impactful than a tax deduction and too valuable an opportunity to miss.

If you think you satisfy the Employee Retention Credit qualification requirements, there’s still time to claim your funds by filing IRS Form 941-X for each eligible quarter. The deadline is April 15, 2024, for quarters in 2020 and April 15, 2025, for those in 2021.

Fortunately, our ERC application guide can walk you through confirming your eligibility, filing the necessary forms, and securing your funds. Don’t wait–get started today.

Learn More: If you have additional questions about your business’ ERC eligibility due to unusual circumstances, our other resources may be able to help:

• Frequently Asked Questions
• What You Need to Know About the ERC