Is receiving an employee retention credit tax refund check considered taxable income?
As business owners navigate the complexities of the COVID-19 pandemic, employee retention has become a crucial concern. The Employee Retention Credit (ERC), a tax incentive under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, aims to provide relief by encouraging employers to keep staff on payroll during these challenging times.
If you have not already filed, you can still claim the employee retention credit retroactively in 2023, 2024, and 2025.
Key ERC Credit Takeaways You Will Learn:
- ERC Definition & Purpose: A refundable payroll tax credit to support businesses during COVID-19.
- How ERCs Work: Claimed on quarterly tax returns for qualified wages paid during the pandemic.
- Qualifying Criteria: Businesses must meet specific IRS criteria related to COVID-19 impacts.
- Interaction With Other Tax Credits: Understanding how ERC works with PPP and WOTC is crucial.
- Taxable Income and ERC: ERC is not considered taxable income, but has specific reporting requirements.
See Important 2024 Employee Retention Tax Credit Deadline Information at the Bottom of This Article.
Understanding the Tax Implications of the Employee Retention Credit (ERC) Tax Refund
First, we’ll define Employee Retention Credits (ERCs) and how they work for qualifying employers.
Definition And Purpose
The Employee Retention Credit (ERC) is a refundable payroll tax credit introduced by the Coronavirus Aid, Relief, and Economic Security (CARES) Act to support businesses during the COVID-19 pandemic.
Designed as an incentive for small to medium-sized businesses, including tax-exempt organizations, the ERC enables such companies to retain their workforce and maintain stability during these challenging times.
The credit applies to qualified wages paid between March 12, 2020, and December 31, 2021.
How ERCs Work
The Employee Retention Credit (ERC) is a refundable payroll tax credit designed to support businesses experiencing financial setbacks due to the COVID-19 pandemic.
To understand how ERCs work, let’s consider an example. Imagine you own a small business and have experienced a significant decline in gross receipts or were forced to suspend operations due to government orders related to COVID-19.
You may qualify for the ERC and claim it on your quarterly employment tax returns using Form 941. The credit is calculated based on qualified wages paid between March 12, 2020, and December 31, 2021 – specifically, those qualifying wages are paid by an employer for a time when employees are not providing services due to COVID-related circumstances.
If your total employee retention credits exceed your Social Security payroll taxes owed for that quarter or period, you’ll receive a refund from the ERC IRS equaling that excess amount.
Qualifying For ERC
To qualify for the ERC, businesses must meet certain eligibility criteria and pay qualified wages and expenses; read on to learn more about how to claim this valuable tax credit.
Eligibility Criteria
To qualify for the Employee Retention Credit, small to medium-sized business owners must meet specific eligibility criteria set by the Internal Revenue Service (IRS). The criteria include the following:
1. Experiencing a few partial or full shutdowns or partial suspensions of operations due to government orders related to COVID-19, or
2. Having a significant decline in gross receipts during a calendar quarter in 2020 or 2021 compared to the same quarter in 2019.
3. Not receiving a Paycheck Protection Program (PPP) loan from the Small Business Administration.
4. Meeting specific payroll requirements and providing qualified wages to employees during the specified periods.
By meeting these criteria, businesses can take advantage of this valuable tax credit designed to help employers retain their workforce during the pandemic.
Qualified Wages And Expenses
To claim the Employee Retention Credit (ERC), employers must have paid qualified wages deductible expenses to eligible employees. Qualified wages are wages and compensation, including healthcare costs, paid by an eligible employer to an eligible employee between March 12, 2020, and December 31, 2021. Here’s what you need to know about qualified wages and expenses:
– Eligible employers can claim employer credits from the ERC for up to $10,000 in qualified wages per employee per quarter. That means a business with fewer full-time employees can receive a maximum credit of $7,000 per employee for each quarter of eligibility.
– Qualified wages include amounts paid to employees not providing services due to full or partial suspensions caused by government orders related to COVID-19 or significant declines in gross receipts.
– If an employer has more than 500 employees, qualified wages only include amounts paid to employees not providing services due to the COVID-19-related circumstances mentioned above.
– Healthcare costs can be qualified expenses if properly allocated and documented.
– Wages paid with forgiven Paycheck Protection Program (PPP) loan proceeds cannot be considered for the ERC.
By understanding the types of payments that qualify for the ERC and expenses that can be included as part of your claim, your business can maximize its benefit from this valuable tax credit.
Interaction With Other Tax Credits
The ERC may interact with other tax credits, such as the Paycheck Protection Program (PPP) and Work Opportunity Tax Credit (WOTC), so businesses need to understand how these credits work together.
Paycheck Protection Program (PPP)
The Paycheck Protection Program (PPP) was established in response to the COVID-19 pandemic as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The program provided loans to eligible businesses that could be forgiven if certain criteria were met, including using at least 60% of the funds for payroll costs.
While PPP loans can provide valuable relief for struggling businesses, it’s important to note that employers who receive a PPP loan cannot also claim the Employee Retention Credit (ERC).
Work Opportunity Tax Credit (WOTC)
Another tax credit that small to medium-sized business owners should know is the Work Opportunity Tax Credit (WOTC). This credit incentivizes businesses to hire individuals from certain targeted groups, including veterans, ex-felons, and those receiving government assistance.
To be eligible for employer status qualifying employee wages qualify for WOTC, and employers must obtain certification from their state workforce agency that the new employee is a targeted group member. Additionally, employers qualify if the employee must work at least 120 hours in their first year of employment.
By taking advantage of both WOTC and ERC, eligible businesses can reduce their taxable income while incentivizing hiring practices supporting diversity and inclusion in the workplace.
Taxable Income And ERC
While the ERC itself is not considered taxable income, important guidelines and requirements are to be followed for claiming this valuable tax credit.
ERC & Income Tax Return
The Employee Retention Credit (ERC) is a valuable tax credit businesses can claim for retaining employees during the COVID-19 pandemic. It’s important to understand what is taxable when the employee retention credit work the tax credit comes to ERCs.
The good news is that the ERC isn’t considered taxable income, and businesses don’t have to pay payroll taxes on any other qualified business income or wages claimed as part of the ERC.
Employer tax credits, such as the ERC, can reduce wages under IRC Section 280C. This means that if an employer claims a tax credit, they must reduce deductions for wages on their income tax return for the same tax year in which they received the income tax credit amount.
To illustrate this concept further, let’s say an eligible employer claimed $10k in qualified wages as part of their ERC claim and received a $5k refundable tax credit. They would need to reduce their total deductions for these employee wages by $5k on their income tax return for that same taxable year because they cannot double-dip by receiving both a deduction and a fully refundable tax credit based upon those same qualified expenses.
Overall, understanding what is taxable when it comes to ERCs will help small to medium-sized business owners make informed decisions about how best to utilize this valuable resource within legal limits while minimizing any potential negative implications at year-end under IRC section 280C rules governing wage reductions relating to employment credits claims made during filing season.
Examination Of IRS Guidelines
To ensure that you properly claim the Employee Retention Credit (ERC) and avoid mistakes that could lead to IRS penalties, examining the agency’s guidelines closely is essential.
According to IRS guidance, eligible employers must meet specific criteria, such as experiencing a significant decline in gross receipts or having been ordered by a governmental authority to fully or partially shutdown during the pandemic.
Qualified wages for ERC purposes include compensation paid between March 12, 2020, and December 31, 2021, but only if qualifying wages were paid while the qualified employee was not providing services due to COVID-19 related circumstances.
For example, A small business owner who experienced decreased revenue in their quarter of eligibility may qualify based on losing more than fifty percent of its gross receipts compared with those from last year’s corresponding calendar quarter.
Forms And Reporting For ERCs
Employers must file Form 941, the quarterly federal tax return, to claim and report Employee Retention Credits (ERCs) and submit Form 8974, which allocates the ERC among related entities that have chosen to aggregate their employment tax liabilities.
Form 941 And Form 8974
To be eligible for employment status claim the Employee Retention Credit, eligible employers must file Form 941, Employer’s Quarterly Federal Tax Return, with the IRS. The ERC is claimed as a credit against Social Security taxes on Form 941. Employers can reduce their deposits of federal employment taxes, including withheld income tax and both the employer and employee share of Social Security tax, by the amount of the ERC they are entitled to claim on Form 941.
Suppose an employer is eligible for a refundable portion of employee retention tax credit under the ERC that exceeds its federal employment tax deposit liabilities reported on Form 941. In that case, it may file Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities. This form helps employers calculate their quarterly payroll tax refundable credit and apply it against any payroll tax liability they owe.
To claim the ERC, employers must maintain documentation supporting their eligibility and credit entitlement. Supporting documentation should include information about qualified wages paid during each quarter they claim the credit.
By correctly filing Forms 941 and 8974 and maintaining adequate documentation, eligible small to medium-sized businesses can receive valuable tax credits to help them retain employees and improve cash flow during difficult times.
Documentation And Record Requirements
To claim the Employee Retention Credit (ERC), eligible employers must keep accurate documentation and records of qualified wages, including dates, amounts, and the number of full-time equivalent employees. Here are some things to consider for proper documentation and record-keeping:
1. Maintain employment tax records that show the number of qualified wages paid to each employee during each quarter.
2. Keep copies of any forms or applications submitted, including Form 941 and Form 8974.
3. Save all payroll records showing employee participation in health plans or other benefits that impact ERC calculations.
4. Document how COVID-19 related circumstances caused reduced business operations or a shutdown that resulted in reduced revenue.
By maintaining comprehensive documentation and accurate records, businesses can help ensure they are eligible for the ERC while avoiding potential issues with the Internal Revenue Service (IRS). Businesses need to work with a tax professional who can provide guidance on these requirements and assist with claiming the credit accurately.
Tax Tips For Claiming ERC
To ensure the proper claiming of ERC, keeping accurate records and seeking professional guidance from a tax expert or accountant is recommended.
How To Claim The Refundable Tax Credit
To claim the Employee Retention Credit, eligible employers must follow these steps:
1. Determine whether you qualify for the ERC based on the eligibility criteria and qualified wages paid.
2. Report the ERC for each calendar quarter using Form 941, Employer’s Quarterly Federal Tax Return.
3. Claim maximum credit for the ERC on your tax return by filing Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities, with your income tax return.
4. Keep detailed records to support your claim for the ERC, including documentation of qualified wages paid and the number of full-time employees.
5. Consider working with a tax professional to ensure you claim the credit correctly and maximize your benefits.
Remember that not receiving funds from the ERC does not affect your employees’ eligibility for unemployment benefits or other COVID-19 related assistance programs. By claiming this valuable tax credit, eligible businesses can reduce their payroll taxes and improve their cash flow during these challenging times.
Common Mistakes To Avoid
As a small or medium-sized business owner, it is important to avoid common mistakes when claiming Employee Retention Credit (ERC). Here are some of the most common mistakes to avoid:
1. Failing to understand eligibility requirements: Make sure you understand the eligibility requirements for the ERC, including what types of businesses are eligible and which employees are considered qualified wages.
2. Incorrect calculation of ERC credit and qualified wages: Ensure that you are correctly calculating both the full ERC credit amount and the number of qualified wages, as this can affect how much ERC you can claim.
3. Forgetting to reduce deductions for wages: Remember that to claim the ERC, you must reduce deductions for wages on your income tax return for that year.
4. Not keeping proper documentation: Keep accurate records and documentation related to your ERC claim in case of an audit.
5. Failure to claim all available tax credits: It is important not to miss out on other available tax credits, such as the Paycheck Protection Program or Work Opportunity Tax Credits, which could impact your total credit amount.
By avoiding these common mistakes, small to medium-sized business owners can maximize their potential ERC claim and ensure they receive all available tax credits for their businesses.
State Tax Implications
Businesses in states like California and New York should be aware of their state’s tax implications when claiming the Employee Retention Credit, as these states have specific guidelines on calculating and reporting ERC taxable income.
California State Tax
Regarding California state tax, businesses must note that the Employee Retention Credit (ERC) is not taxable against gross income for state and federal purposes. However, employers in California will need to subtract qualified wages from their gross income for a payroll tax credit under the statewide alternative minimum tax (AMT).
Additionally, suppose a business has already claimed any other type of employee retention or hiring credit on its state return. In that case, it may have to adjust its AMT calculation based on how much of those credits were attributable to qualified wages paid during the ERC period.
New York State Tax
New York State tax follows federal guidelines regarding Employee Retention Credits (ERC). This means that ERC is not taxable income and can be used to offset New York State payroll taxes paid by such taxpayers elsewhere.
However, it’s important to note that there are specific requirements that businesses must meet to claim this credit on their state income tax returns. For example, for qualifying businesses, wages must be paid to employees who live or work in New York State. The business must have a valid employee identification number with the state.
ERC And Business Strategy
Businesses can strategically utilize the Employee Retention Credit to improve their cash flow and profitability during these uncertain times, making it a valuable tool for maintaining financial stability.
Impact On Cash Flow And Profitability
The ERC can significantly impact a business’s cash flow and profitability. The credit directly reduces the payroll taxes owed, potentially significant savings for eligible employers.
Furthermore, by retaining employees during challenging times, businesses can avoid the costs of hiring and training new staff members. This is especially important for small to medium-sized enterprises that rely heavily on their workforce to stay competitive.
Decision-making And Planning Considerations
When considering taking advantage of the Employee Retention Credit (ERC), businesses should weigh the benefits against other tax credits and relief programs.
Specifically, businesses must decide if they want to apply for the Paycheck Protection Program (PPP) or the Work Opportunity Tax Credit (WOTC). While these options have comparable benefits, each has different eligibility criteria and requirements that may impact a business’s decision-making process.
For example, businesses cannot claim both ERC and PPP loans in combination. At the same time, WOTC offers tax credits for hiring employees from certain targeted groups, such as disabled veterans or ex-felons.
Conclusion and Summary Answering the Question: Are Employee Retention Credits Taxable Income?
In conclusion, the Employee Retention Credit (ERC) is a valuable tax credit that can help businesses retain employees during these challenging times. Not only does it provide financial relief for eligible employers, but it also helps to ensure job security and stability for employees.
While ERCs are not considered taxable income, certain guidelines and forms are necessary to claim the credit accurately.
Good news. There is still time to file! The employee retention tax credit can still be claimed retroactively and there is still time to file, even in 2023, 2024, and 2025 for the past tax years.
Employee Retention Tax Credit (ERC / ERTC) Help: Claim Up To a $26,000 Refund Per Employee for Your Business
Disaster Loan Advisors™ can assist your business with the complex and confusing Employee Retention Credit (ERC) and Employee Retention Tax Credit (ERTC) program, without you having to pay an excessive percentage of your hard earned ERC refund.
DLA doesn’t charge a percent like many companies do. Our flat fee structure is fair and reasonable based on the amount of work involved. Keep More of Your Refund™
Depending on eligibility, business owners can receive up to $26,000 to $33,000 per employee based on the number of W2 employees you had on the payroll in 2020 and 2021.
The ERC / ERTC Program is a valuable IRS tax credit you can claim. This is money you have already paid to the IRS in payroll taxes for your W2 employees.
Schedule Your Free Employee Retention Credit Consultation to see what amount $ of employee retention tax credit your company qualifies for.
ERC Deadline Urgency in 2024
April 15, 2024 Deadline for the 2020 ERC Tax Year
The deadline is coming up for the final opportunity to retroactively claim your business Employee Retention Credit for the past 2020 tax year. With the April 15, 2024 deadline fast approaching, we urge you; don’t let this final chance pass!
While not all businesses will qualify, as it depends on multiple factors per IRS Rules and Guidelines, you might be leaving significant financial relief on the table from prior COVID impact to your business during the past 2020 and 2021 business operation years.
Last year, in September 2023, the IRS temporarily paused processing ERC Claims for the remainder of last year. We at Disaster Loan Advisors (DLA) predicted this over one year ago when we made this ERC video warning business owners. See the ten-minute mark of the video for details.
TAKE ACTION NOW IN 2024
Even though the IRS has temporarily paused processing, you will still want to check eligibility and file now (if you qualify) because once the IRS will resume processing, ERC tax credit claims are processed in the order they are received.
If you haven’t previously filed for the ERC Credit, it is worth scheduling a phone call to at least explore your possible eligibility from both the past 2020 and 2021 business tax years. Contact us today for a deep-dive analysis to determine if your business qualifies one or more quarters from the 2020 and / or 2021 tax years.
As a leading dedicated member of the Tax and Accounting Team at Disaster Loan Advisors™, Mark focuses on unlocking the ERC Tax Credit's potential for eligible firms that qualify, providing strategic advice, and detailed guidance to ensure substantial financial recovery and growth. His methodical approach to client engagement includes comprehensive deep-dive analysis, customized consultation and guidance, and a commitment to achieving tangible results for each business served.
Disaster Loan Advisors™ (DLA) offers a comprehensive suite of services designed to navigate the complexities of the Employee Retention Tax Credit (ERC) program, ensuring that qualified businesses leverage the maximum possible benefit with minimum hassle. Unlike some firms that charge exorbitant contingency or percentage-based fees (often between 10% to 30% of your ERC refund), DLA operates on a fair and reasonable, transparent flat-fee structure that aligns with the IRS's guidelines.
If you are looking for an ERC Company that believes in providing professional ERC Services and value for small business owners, in exchange for a fair, reasonable, and ethical fee for the amount of work required, Disaster Loan Advisors™ is a good fit for you. STAY SAFE. STAY COMPLIANT. KEEP MORE OF YOUR REFUND.™
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