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To help curb layoffs during the Coronavirus pandemic, Congress has created a new federal income tax credit for employers that keep workers on their payrolls.

You can’t use both the credit and a Paycheck Protection Program loan, but if you missed out on a loan and are working to maintain your staffing levels, the new Employee Retention Tax Credit may be a good option for your company.

The credit amount equals 50% of eligible employee wages paid by an eligible employer in a 2020 calendar quarter. It's subject to an overall wage cap of $10,000 per eligible employee. Here are the details.

Eligible Employers

Eligible employer status for the 50% employee retention credit is determined on a 2020 calendar quarter basis. The credit is available to employers, including nonprofits, whose operations have been fully or partially suspended during a 2020 calendar quarter as a result of an order from an appropriate governmental authority that limits commerce, travel or group meetings due to COVID-19.

The credit can also be claimed by employers that have experienced a greater-than-50% decline in gross receipts for a 2020 calendar quarter compared to the corresponding 2019 calendar quarter. However, the credit is disallowed for quarters following the first calendar 2020 quarter during which gross receipts exceed 80% of gross receipts for the corresponding 2019 calendar quarter.

To illustrate, suppose ACE, a limited liability company (LLC), reports the following quarterly gross receipts for 2019 and 2020:

In this example, ACE had a greater-than-50% decline in gross receipts for the second quarter of 2020. So, ACE is an eligible employer for purposes of the 50% employee retention credit for the second and third quarters of 2020. For the fourth quarter of 2020, ACE is ineligible for the credit because its gross receipts for the third quarter of 2020 exceeded 80% of gross receipts for the third quarter of 2019.

READ MORE: Deferring Social Security Taxes: FAQs for Employers During the Coronavirus

Eligible Wages

The 50% employee retention credit is available to cover eligible wages paid between March 13, 2020, and December 31, 2020. For an eligible employer that had an average of 100 or fewer full-time employees in 2019, all employee wages are eligible for the credit (subject to the overall $10,000 per-employee wage cap), regardless of whether employees are furloughed due to COVID-19.

For an employer that had more than 100 full-time employees in 2019, only wages of employees who are furloughed or given reduced hours due to the employer's closure or reduced gross receipts are eligible for the credit (subject to the overall $10,000 per-employee wage cap).

For purposes of the 50% employee retention credit, eligible wages are increased to include qualified health plan expenses allocable to those wages.

Important: The amount of wages eligible for the credit is capped at a cumulative total of $10,000 for each eligible employee. The $10,000 cap includes allocable health plan expenses.

Here’s an example:

READ MORE: Help Employees Affected by Coronavirus with Tax-Free Qualified Disaster Payments

Additional Rules and Restrictions

The 50% employee retention credit is not allowed for:

• Emergency sick leave wages or emergency family leave wages that small employers (those with fewer than 500 employees) are required to pay under the Families First Coronavirus Response Act (FFCRA). Those mandatory leave payments are covered by federal payroll tax credits granted by the FFCRA.
• Wages taken into account for purposes of claiming the pre-existing Work Opportunity Credit under Internal Revenue Code (IRC) Section 21.
• Wages taken into account for purposes of claiming the pre-existing employer credit for paid family and medical leave under IRC Sec. 45S.

In addition, the 50% employee retention credit isn't available to a small employer that receives a potentially forgivable Small Business Administration (SBA) guaranteed Small Business Interruption Loan issued pursuant to the Paycheck Protection Program under the CARES Act.

Claiming the Employee Retention Credit

Technically, an eligible employer's allowable 50% employee retention credit for a calendar quarter is offset against the employer's liability for the Social Security tax component of federal payroll taxes. That component equals 6.2% of the first $137,700 of an employee's 2020 wages. (Read more here: Deferring Social Security Taxes: FAQs for Employers During the Coronavirus.) 

But the credit is a so-called "refundable" credit. That means an employer can collect the full amount of the credit even if it exceeds the aforementioned federal payroll tax liability.

The allowable credit can be used to offset all of an employer's federal payroll tax deposit liability, apparently including federal income tax, Social Security tax and Medicare tax withheld from employee paychecks. If an employer's tax deposit liability isn't enough to absorb the credit, the employer can apply for an advance payment of the credit from the IRS. We can help you submit the correct form to the IRS.

The following example shows the mechanics of the refundable credit:

Need Help?

No employer wants to lay off employees during these difficult times, but sometimes it's the only way to stay afloat. The 50% employee retention credit rewards employers that can afford to keep workers on the payroll during the crisis. For more information about this tax saving opportunity, please contact us.

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