How to Calculate the Employee Retention Credit

How Does the Employee Retention Credit Work?

The Employee Retention Credit (ERC) is a refundable payroll tax credit designed to lessen the financial strain on small business owners who kept their employees on the payroll during the COVID-19 pandemic.

The credit’s main eligibility requirement is an economic hardship test. To clear it, you must demonstrate that your business experienced a sufficient decline in gross receipts or suspended a more than nominal portion of its operations due to a government order.

Determining whether you satisfy one of those requirements is a fairly involved process. But if you do, then you should be able to claim a tax credit for a percentage of the wages your business paid in 2020 and 2021.

How to Calculate the Employee Retention Credit

Under the regular ERC rules, you can claim a credit for 50% of the first $10,000 in qualified wages you paid each employee during 2020. In 2021, you can claim 70% of each employee’s first $10,000 in qualified wages per quarter. That means you can claim up to $26,000 in refundable tax credits per employee between both years. 

To calculate your ERC amount, you must determine which wages qualify under the credit. That primarily depends on the number of full-time employees you had on the payroll during the 2019 calendar year.

If you had less than 100 employees on average during 2019, then you can treat the wages paid to all your employees as qualified in 2020. If you exceeded that threshold, only the wages you paid to employees not providing services qualify for the ERC that year.

In 2021, the maximum number of employees for the determination increased to 500, but you still base it on your 2019 staff count. In other words, all your wages are qualified in 2021 if you had less than 500 people on the payroll in 2019. Otherwise, only the wages paid to your inactive employees qualify for the credit.

When calculating the qualified wages paid to your employees, you can also add your group health plan expenses. That includes your portion of the costs as the employer and any pre-tax salary reduction contributions from your employees.

How to Calculate the ERC as a Recovery Startup Business

If you started your business during the pandemic, you probably won’t be able to qualify for the ERC through the regular method. After all, most of the default qualification requirements involve analyzing a business’ activities in 2019.

However, you may still be able to qualify for the ERC as a recovery startup business. These are organizations that started doing business after February 15, 2020, average less than $1 million in annual gross receipts, and fail both versions of the economic hardship test in at least the third quarter of 2021.

If you meet these requirements, you can claim the ERC for 70% of the first $10,000 in qualified wages paid to each employee in the third and fourth quarters of 2021. In fact, only recovery startups can claim the credit for wages paid after September 30, 2021.

However, they also have a $50,000 quarterly limit. As a result, you can claim only $100,000 in total for those two quarters as a recovery startup.

ERC Calculation Examples

Now that we’ve covered how to calculate the Employee Retention Credit in theory, let’s walk through a few examples to demonstrate how it works in practice.

Small Employer in 2020

Say you own a restaurant with ten employees on the payroll in 2019 and 2020, each earning a $40,000 annual salary. You continued to pay them all throughout 2020, even though five employees didn’t work after March because you shut down dine-in services to comply with federal social distancing mandates.

Let’s assume that qualifies as a partial suspension of your operation, making you eligible to claim the ERC that year. Because you had less than 100 employees on average in 2019, the wages you paid to all your employees were qualified.

For 2020, you can claim a credit for 50% of each employee’s first $10,000 in qualified wages that year. All your employees reached that limit, so you can claim $5,000 for each one. Because you have 10 eligible employees, you can take a $50,000 ERC that year.

Large Employer in 2021

Say you own a nonprofit organization with 600 employees on the payroll in 2019, 2020, and 2021. Each of them had a base annual salary of $50,000. However, 200 workers stopped providing services from January 1, 2021, to June 30, 2021, during which you paid them only half their usual salaries.

Because you averaged more than 500 employees in 2019, only the wages you paid to those 200 employees who weren’t working are qualified. Let’s also assume you saw a decline in gross receipts during those months that was sufficient for the hardship test.

You can claim 70% of the first $10,000 in qualified wages paid to each non-working employee in the first two quarters of 2021. With 200 employees, that gives you $1.4 million each quarter, resulting in a $2.8 million total ERC.

Recovery Startup Business

Finally, say you start a landscaping business with 10 employees on May 1, 2020. It has less than $1 million in average annual gross receipts and fails the economic hardship test in all periods, making it a recovery startup business.

You pay each of your employees $80,000 in wages yearly. As a recovery startup business owner, you can claim a tax credit for 70% of their first $10,000 in qualified wages for the third and fourth quarters of 2021.

Because all of your workers reached the $10,000 limit each quarter, you can claim $7,000 for each one. With 10 employees, you should be able to take a $70,000 ERC each quarter and a $140,000 credit for the year.

However, your organization is a recovery startup business, so your credit amount can’t exceed $50,000 in a single quarter. As a result, you can claim only $100,000 for the 2021 calendar year.

Apply For the Employee Retention Credit

As these calculations demonstrate, the Employee Retention Credit is an incredibly lucrative opportunity for business owners. If you qualify, you could reduce your federal tax liability by thousands of dollars, potentially resulting in a refund.

It’s too late to earn the ERC, but you still have time to claim the credit retroactively by filing Form 941-X with the Internal Revenue Service for each eligible quarter. The deadline is April 15, 2024, for quarters in 2020 and April 15, 2025, for quarters in 2021.

If you’d like help determining whether you qualify for the ERC, let our convenient application tool walk you through everything. Once you confirm your eligibility, it can also streamline the filing process for you. Give it a try today.

Learn More: If you want to know more about the Employee Retention Credit before you move forward, our other resources may be able to help:

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

_{Information provided on this blog is for educational purposes only, and is not intended to be business, legal, tax, or accounting advice. The views and opinions expressed in this blog are those of the authors and do not necessarily reflect the official policy or position of Lendio. While Lendio strives to keep its content up-to-date, it is only accurate as of the date posted. Offers or trends may expire, or may no longer be relevant.}