IMPORTANT: Congress is considering legislation that, if enacted, would make several changes to the employee retention credit (ERC). Most notably, the legislation would retroactively bar the filing of any new/additional ERC claims after January 31, 2024. Please consult a professional tax advisor with any ERC-related questions or concerns.
The Employee Retention Credit (ERC) was created to provide financial relief to businesses that kept employees on their payroll while operations were impacted during the COVID-19 pandemic.
Although the ERC only applies to wages paid in 2020 and part of 2021, employers can still take advantage of it; however, there are some caveats and considerations small business owners should be aware of.
Considerations when claiming ERC
The ERC is a refundable payroll tax credit, which means that employers may be able to receive a payment from the government even above and beyond payroll taxes owed during certain periods of 2020 and 2021.
Per ERC rules, to qualify, a business must have been impacted by a full or partial suspension of operations due to pandemic-related government orders, experienced a significant decline in gross receipts during 2020 or certain parts of 2021, or qualified as a recovery startup business in the third or fourth quarter of 2021. Eligible companies may be able to claim up to $7,000 per employee per quarter for Q1 through Q3 of 2021, and up to $5,000 per employee for the 2020 calendar year.
While this credit is not reported as taxable income, it does require an adjustment to reduce your wage expense that was reported in the year the qualified wages were paid, be it 2020 or 2021, by the amount of credit you claimed. For employers amending payroll tax returns now to claim the ERC, this will require amending prior year income tax returns.
While the ERC was intended to be a generous tax credit, Matthew Kelley, VP of Consultancy at Experian Employer Services, warns that employers who are retroactively claiming it need to closely follow its rules to avoid risks associated with an improper claim. Taxpayers should be fully prepared when filing for the ERC to make sure their credit claim can stand up to an audit.
“The IRS has trained a few hundred agents to start reviewing these claims and asking questions,” Kelley said. “They've provided announcements and notices to indicate to taxpayers their intent to audit. And we expect that the audit activity will only increase over the next few years.”
To prevent any issues, Kelley recommends employers ensure they meet all eligibility requirements and calculate their gross revenue correctly.
Employers who are claiming the credit will need to use Form 941-X, which is used to amend quarterly payroll tax returns.
However, due to a significant backlog at the IRS, employers should prepare for a long waiting period before receiving their money back — upwards of six to 12 months, according to Kelley’s estimate. In the meantime, businesses that need the funds sooner should look for other options such as a bridge loan, which can get cash in hand fast, or tax credit insurance, which can protect your claim.
Mistakes to avoid when claiming ERC
Two common mistakes Kelley sees small business owners make fall into two extremes: believing your business doesn’t qualify when it does and, alternatively, claiming the credit when you are ineligible to do so.
Many entrepreneurs don’t believe they qualify because they didn’t have a significant decline in gross revenue; however, the credit still could be of great benefit to them.
Two common mistakes Kelley sees small business owners make fall into two extremes: believing your business doesn’t qualify when it does and, alternatively, claiming the credit when you are ineligible to do so.
On the other hand, some business owners aren’t cautious enough and choose to overlook the rules of eligibility. Particularly, many don’t fully understand the rule around a full or partial suspension of operations due to government order. Instead, they believe that a variety of challenges and impacts, regardless of their connection to government orders, are enough to qualify, which is often not the case.
Kelley warned that by falsely claiming the ERC, businesses will not be able to satisfy an audit, which could ultimately be detrimental and result in penalties. A mistake in claiming the ERC means you could be on the hook for the cost of the credit, plus penalties and interest.
IRS audit activity — what to know and how to prepare
IRS audits of ERC claims are underway. If employers are interested in pursuing this tax credit, they should understand the process for these audits and how they can best prepare in the event their claim is audited.
The IRS Information Document Request (IDR) is generally in line with expectations as set in IRS Notice 2021-20, Section N. “Substantiation Requirements.” Employers must be prepared to show evidence of a partial suspension of operations due to a government order including the language from the order and an explanation of how the order is related to their business disruption. Additionally, individual auditors have been applying the ‘more than nominal’ standard as a requirement, not a safe harbor.
Employers should expect a possible audit of their ERC claim to be a conversation with an auditor who is not necessarily familiar with the nuances of their specific circumstances or the nature of the ERC itself. An auditor has likely not spent the past three years working through general ERC nuances.
How to determine your eligibility
Not sure if you’re eligible to retroactively claim the ERC? Following these steps can help you make that determination:
- Work with a financial expert. Because qualification rules can be confusing, working with an expert ensures that a business only claims the credits they are eligible for.
- Be realistic about your business disruptions. In speaking with an advisor, businesses should consider the nature of their pandemic-related business operation disruptions and how that might impact their eligibility for the ERC. “[Do these disruptions] rise to the level of a partial suspension due to a government order, or is that simply a supply chain mishap due to the economic climate that was occurring at that time period?” Kelley said. “There's a big difference on an audit of whether it was due to a government order or it was just due to a decrease in demand.”
- Ask your advisor why you do or don’t qualify. Kelley advised entrepreneurs to be proactive when working with their advisors to claim this tax credit by asking important questions such as, “Why do I qualify for the tax credit?” or, alternatively, “Why don’t I qualify?”
How Experian Employer Services can help
Business owners who question whether or not they qualify for the ERC can seek expert help through Experian Employer Services, which offers dependable end-to-end Tax Credit Management Services. With Experian Employer Services, small businesses are backed by a knowledgeable team who works to determine their eligibility and ensure data is accurately recorded and wages are correctly calculated.
The claim process begins with account executives who determine if there’s a chance a business may qualify. If so, the client is handed off to a project team that looks at its aggregation and gross receipts, and analyzes the business’s operational suspension, according to Kelley. From there, the team calculates and determines whether the business qualifies.
“We provide our clients with an opportunity to review our work at every step,” Kelley noted.
As a business owner, you’ll likely have questions as you begin the process of claiming your ERC. However, you don’t have to go through it alone.
Get the help you need from knowledgeable experts through Experian Employer Services.
