Employee Retention Credits: A Simple Guide


Brendan Tuytel


Reviewed by

Patrick Iyere, EA


April 22, 2023

This article is Tax Professional approved


Employee retention credits are a type of payroll tax credit that reduce the amount of federal and social security taxes you have to pay. These tax credits were extended into 2021. The revenue reduction requirement was lowered and businesses that received a PPP loan are now eligible to apply. Eligible businesses can continue to claim the credits for wages paid in 2020 and 2021 by amending the payroll returns for those quarters. However, the IRS has warned taxpayers to be wary of ERC scams, where non-eligible businesses are encouraged to apply for ERC credits. More on this later.

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Employers with fewer than 500 employees are eligible for payroll tax credits if they keep their employees on payroll throughout the COVID-19 crisis.

Read on to learn about how you can significantly lower your federal quarterly payroll tax bill.

What are tax credits?

Every pay period, you withhold a certain amount of an employee’s earnings—called qualified wages. This money is for federal unemployment (or FUTA) tax which is reported on IRS Form 940, and social security reported on IRS Form 941 or Form 944. Payroll tax credits—like the Employee Retention Credit—let you keep some of this money by reducing the federal taxes and social security you have to pay.

If your tax credit exceeds the amount of tax you’re required to pay, you can get a check in the mail for the difference.

For example, if your quarterly payroll tax bill is $10,000 and you’re eligible for a $6,000 tax credit, your tax payment will be reduced to $4,000. If your tax credit is $12,000 on a tax bill of $10,000, you can get a $2,000 check.

Employee Retention Tax Credits

The CARES Act introduced tax credits for maintaining your payroll. In 2020, it entitled employers to a credit worth 50% of the qualified wages of employees.

For 2021, the employee retention credit (ERC) is a quarterly tax credit against the employer’s share of certain payroll taxes. The tax credit is 70% of the first $10,000 in wages per employee in each quarter of 2021. That means this credit is worth up to $7,000 per quarter and up to $28,000 per year, for each employee.

Am I eligible for the Employee Retention Tax Credit?

To be eligible for the employee retention tax credit, employers have to prove they either:

  • Suspended operations fully or partially due to a COVID-19-related shut down order
  • Show a 20% or greater decline in gross receipts in the same quarter of the prior year

What is the tax credit amount?

If you qualify for this credit, you can receive up to $7,000 per employee, per quarter. The tax credit is already available, but the program ends on December 31st, 2021.

The amount of the tax credit is equal to 70% of the first $10,000 in qualified wages per employee in a quarter.

Note: Qualified wages do not include sick leave. This means you can take advantage of both credits mentioned in this article.

How do I receive the tax credit?

Your tax credit is taken off your quarterly payroll tax bill. However, if your tax credit is greater than the amount paid in FUTA tax, you can receive a check from the IRS by filing Form 7200.

ERC Scams

As another tax season approaches, the IRS is warning taxpayers of ERC scams, where ineligible businesses are contacted and encouraged to apply for ERC.

The scammers not only charge you a fee to apply for the credit, but they also collect senstive business information that leaves your business exposed to a risk of idenitity theft. In the event that you claim the credit when you are not eligible for it, the IRS may hold you responsible for not only paying back the credit, but also any penalties and interest associated with this.

While the IRS Criminal Investigation Division is cracking down on ERC scammers, there are a few ways you can avoid falling for this scam -

  1. Do your due diligence. Whenever you are claiming a tax credit, make sure to do your own research to ensure you are eligible for the tax credit. The official IRS website always provides eligibility information for tax credits and how to claim them - ensure you read this material well.
  2. Be wary of ERC promotions/marketing materials. Scammers generally use aggressive marketing tactics to lure in taxpayers, and force taxpayers to act quickly which often results in the business falling for the scam. If someone is telling that you are eligible for the credit without knowing anything about your business, it is likely that they are unreliable.
  3. Do not share your personal identifiable information. You should not share your SSN, business EIN, or any other identifiable information with an organization or individual you do not know or trust. If you are choosing to work with a third-party, ensure you do all the background research necessary to determine the legitimacy of the service they are offering.

What to do if you fell for this scam?

If you believe you have been a victim of this scam and incorrectly claimed the ERC credits, the IRS encourages you to amend your tax return with the correct figures. Employers should also report instances of fraud and IRS-related phishing attempts to the IRS at phishing@irs.gov and to the Treasury Inspector General for Tax Administration at 800-366-4484.

We recommend regularly checking the IRS Dirty Dozen which lists the most common tax scams during tax filing season to keep your business protected.

Credits for paid sick leave

Announced on March 18, 2020, the Families First Coronavirus Response Act (FFRCA) introduced a tax credit for paid leave of employees directly affected by COVID-19. This covers anyone in quarantine, sick from COVID-19, caring for an individual with COVID-19, or caring for a child due to school closure or the closure of child care facilities due to COVID-19.

These credits have been extended to March 31, 2021 as part of the Consolidated Appropriations Act. As of December 31, 2020, employers are no longer required to provide the paid leave. However, they can voluntarily provide paid leave and receive the tax credit.

Am I eligible for the paid sick leave tax credit?

If any of your employees take leave related to either contracting COVID-19, a period of quarantine, or caring for someone affected by COVID-19, you qualify for tax credits towards covering their wages.

What is the tax credit amount?

If an employee is required to self-isolate and is unable to work from home, you can receive a credit for 80 hours of 100% paid sick leave.

If an employee has to take leave to provide care to someone affected by COVID-19, they are also eligible for paid leave. You can receive a credit for 80 hours of paid sick leave at 2/3rds of their pay.

How do I receive the tax credit?

The tax credit you receive for paid leave will be deducted from your quarterly payroll tax bill, reducing the amount you owe.

For example, if you are required to deposit $10,000 in payroll taxes but you paid out $8,000 in paid sick leave, a deposit of only $2,000 is required. If the paid leave amount is greater than the payroll tax amount, businesses can file Form 7200 to request the remaining amount in the form of a check.

Essentially, the amount you spend on COVID-related paid leave can be completely removed from your payroll taxes.

How do I apply for and receive credits?

The IRS is depending on you to self-report tax credits on Line 13 of Form 941. If the credits are in excess of your tax bill, fill out Form 7200 to apply for any additional credits greater than your quarterly FUTA tax bill in the form of a check.

This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. Bench assumes no liability for actions taken in reliance upon the information contained herein.
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