The Employee Retention Credit: The Good, the Bad, & the Ugly

May 14, 2023

The 2020 pandemic has been tough on businesses. We've had to deal with shortages of everything from food to toilet paper. But one thing that's not in short supply is the Employee Retention Tax Credit (ERTC or ERC, if you leave out “Tax”).

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This allows employers to reduce their payroll taxes by up to 50% (up to $10K per employee) during the pandemic period. The idea is for companies to get back some of what they're sacrificing in order to keep employees at home.

This article explores topics including:

  • What is the ERC?
  • How is it calculated?
  • How does a business qualify?
  • Things to Avoid before filing
  • Questions to Ask Yourself

What Is the ERC?

The ERC is a tax credit designed to support businesses through operational issues due to COVID. This program was initially passed in the original CARES Act, but it has been modified, changed, and updated more than any other program from that period.

As a result of all this, attempts to learn whether or not you qualify can get extremely confusing. Even worse, some people may be taking somewhat aggressive positions on it—without being fully aware of the risks that they are taking.

At the end of the day, the ERC is a refundable payroll tax credit designed to reward businesses for retaining employees through severe operational challenges due to COVID.

How Much Is Available Through the ERC?

  • In 2020, you were eligible for a maximum credit of 50% of up to $10,000 of wages paid per employee. This translates to $5,000 per employee.
  • In 2021, you were eligible for a maximum credit of 70% of up to $10,000 of wages paid per employee for the first three quarters. That means a possible $21,000 per employee.

As you can see, these are not small numbers. So, how does a small business qualify for the Employee Retention Tax Credit?

Is Your Business Eligible?

There are two main methods to qualify for the ERC:

1. Revenue: if your business substantially decreased income, you may qualify. Let’s look closely at what “substantial” means here. First, you must compare your revenue against the 2019 numbers, going quarter by quarter. If in any quarter of 2020 you had a 50% decline in receipts for the period, you may be eligible. Meanwhile, if in any quarter of 2021, you had a 20% decline in receipts for the period, you may be eligible. This only applies to Q1-Q3.

2. Partial or Full Suspension of Business Activities: You may be eligible even if you did not have the revenue declines above. If you were partially or fully shut down by a federal, state, or local government order due to COVID, that counts, as well. The government’s definition of a full shutdown is fairly straightforward; think of a bar or nightclub ordered to close its doors indefinitely.

However, a partial shutdown can be more nuanced. For example, if you operate a restaurant and your dining area was closed, but your drive-thru and takeout business still operated, you may still qualify. This is a substantial limit to your business operations. Conversely, if you operate an essential business like a grocery store and your salad bar was shut down, this is less of a suspension of your business activities. So, it may not be enough to qualify.

As you can see, both of these metrics can be fairly subjective. Nevertheless, I think they illustrate the point of how integral the suspended activity must have been to your trade or business. To make things even more complicated, additional factors also come into play when determining whether or not you endured a partial suspension.

However, thankfully, if you experienced any of the following, you may also qualify:

  • Supply Chain Disruptions. Did your suppliers’ problems with COVID have a material impact on your business?
  • Equipment/Facilities. Were you unable to access certain equipment necessary for your daily operations?
  • Reduction. Were your services or their quality reduced for your customers as a result of a COVID shutdown?
  • Hours: were your hours cut by ordinance (and not self-imposed)?

As you can see, partial suspensions are not defined well enough to be clearly understood in every case. Your ability to qualify depends heavily both on your specific circumstances and how you were impacted operationally. These are the two main ways to qualify. However, two additional items merit inclusion.

3. New Trade or Business: Finally, you may also be eligible for a credit if you started a new Trade or Business after February 15th, 2020. This method of qualifying only applies to Q3 and Q4 of 2021; it is limited to $50,000 per quarter or $100,000. However, the upside is that it doesn’t have the same suspension and revenue rules.

You may qualify if you started a new trade or business—even a separate business operated from an existing entity. This part is very particular, but you may qualify as long as there is a definable difference.

4. The Paycheck Protection Program (PPP): As one final note, when the program began, you could not be eligible for both the PPP and the ERTC. However, one of the newer updates to the CARES Act changes this. It’s now possible to qualify for both programs. You can’t use the same wages for ERTC and PPP funds, but generally speaking, you may still qualify for both programs.

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What It All Means

To summarize, you may qualify if your business...

  • Had a substantial decline in revenue
  • Was shutdown by government order
  • Launched during this time period

These are the criteria, even if you used the PPP.

The Sum Total

As you can imagine, the vague nature of a partial suspension can lead to some creative interpretations of what qualifies. Meanwhile, Uncle Sam keeps a little more specific: if it was not a direct government order relating to COVID that shut you down, your closing or partial closure probably doesn’t qualify.

One of the most common applications that stretch the bounds of plausibility is to say that CDC guidelines qualify you. A guideline is nowhere near as compelling as a government order and does not qualify.

So, remember: if something sounds too good to be true, it may be. This is pure supposition, but I would not be surprised to hear news about heightened IRS audits related to the Employee Retention Tax Credit in a few years.

The best way to verify your business’ qualifications for the ERTC may simply be to go over your case with a fiduciary financial advisor. We have the tax planning small business owners need. Reach out to Ironclad Wealth Management through Calendly, by email, or on our website today.

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