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Home Business Finance Accounting For The Employee Retention Credit
The CARES Act established several financial relief programs to help businesses manage the economic fallout from COVID-19. Among them was the Employee Retention Credit (ERC), which rewards organizations for keeping employees on the payroll during the pandemic.
Unfortunately, accounting for the Employee Retention Credit can be challenging. Many companies will encounter timing issues, and there’s a lack of relevant guidance in the Generally Accepted Accounting Principles (GAAP).
Here’s what you need to know to record the ERC in your financial statements correctly, including how the credit works, how to claim it retroactively, and which accounting models may apply.
The Employee Retention Credit is a refundable payroll tax credit. It reduces your business’ payroll tax expense directly, dollar-for-dollar. If the credit exceeds your liability, you get a refund. That makes it significantly more lucrative than a tax deduction, which only reduces your taxable income.
However, businesses must meet strict requirements to be eligible for the ERC. Generally, these include having a limited number of employees on the payroll and suffering a significant decline in revenue or a suspension of operations during the pandemic.
Established organizations that meet these requirements can receive up to $26,000 in payroll tax credits per employee retained through 2020 and the first three quarters of 2021, depending on the amount and timing of the qualified wages paid.
Companies that opened after February 15, 2020, may also claim the ERC via the provision for “recovery startup businesses” if they have annual gross receipts under $1 million and one or more W-2 employees, though the credit limits are different.
If you didn’t claim the ERC because you thought receiving a Paycheck Protection Program (PPP) loan disqualified you, note that the Consolidated Appropriations Act expanded ERC access to allow recipients of PPP loans that meet certain conditions.
Fortunately, though the window for earning the ERC is now closed, eligible businesses can still claim it by filing an adjusted payroll tax return, Form 941-X, for each qualifying quarter.
Generally, you must do so within three years of filing the original Form 941. However, Forms 941 for a calendar year are considered to be filed on April 15th of the following year if filed before that date.
It’s also highly recommended that you consult a tax professional to help you navigate the process, maximize your benefits, and organize your documentation in case of a future audit.
When you claim the ERC, you must update your financial statements to reflect the credit. Depending on your circumstances, there are three standards you can implement to follow GAAP accounting for the Employee Retention Credit. They include:
All not-for-profit organizations must follow ASC 958, but businesses can generally choose from any of the three options. However, if you accounted for your PPP loans using IAS 20 or ASC 958, you should do the same for the payroll tax credit.
Now, let’s explore how each ERC accounting method works.
When following IAS 20, you should recognize the ERC over the periods in which you recognize the expenses it’s meant to offset. To do so, you must have “reasonable assurance” that you’ll receive the credit.
Having reasonable assurance of an event means its occurrence is probable. In the case of receiving the ERC, you generally cross that threshold when your business meets the credit’s eligibility requirements and pays the necessary payroll costs.
IAS 20 lets you record the ERC on the income statement in two ways. You can show it as a separate credit, such as other income, or by netting it against the related payroll costs. In the latter case, you should include a disclosure explaining the presentation.
The other side of your journal entry to record the ERC would be a debit to reduce your payroll tax liability. If that reduces what you owe below zero, the excess amount shows on your balance sheet as a receivable.
Under ASC 958, you must treat your ERC credit as a conditional contribution. That means you can recognize it on the income statement only once you’ve “substantially met” the conditions to earn it.
That’s a more difficult threshold to cross than IAS 20’s requirement of reasonable assurance, and some judgment is required to determine when you’ve reached it.
At the very least, you must meet the decline in revenue or suspension of service requirements and pay the eligible payroll costs. Preparing and filing the IRS forms to receive the credit may also be required, depending on whether you consider that to be “more than an administrative task.”
Not-for-profit organizations must record the ERC as revenue, while business entities can show it as either grant revenue or other income. However, neither entity type can net the credit against their qualifying costs.
Once again, the other side of the journal entry to record your ERC should be a payroll tax receivable or a debit to reduce your tax liability. Conversely, if you received an ERC advance before substantially meeting the conditions to earn it, you’d show a liability for any unearned portion until you clear the requirements.
If your business accounts for the ERC using ASC 450, you’d treat the credit as a gain contingency. That involves recognizing it on the income statement only once you’ve resolved all uncertainties regarding receipt of the credit and the income becomes “realizable.”
That’s the most restrictive of the three ERC accounting approaches and generally requires deferring recognition of the credit until you’ve received your funds from the IRS or at least a formal letter approving your claim.
Either way, you should then record the credit as a separate account on your income statement like you would under ASC 958 rather than netting it with the related payroll expenses.
The ERC can significantly reduce your payroll tax liability, with up to $26,000 in credits available per employee retained through 2020 and 2021. Even though the window for the ERC is closed, qualifying businesses can still claim the credit retroactively.
Because of the complexity of the ERC accounting rules, the repeated program revisions, and the timing complications, it’s essential that you consult a tax professional for assistance with claiming the credit.
In the meantime, apply for the ERC using our guided online application tool to determine whether you qualify.
Nick Gallo is a Certified Public Accountant and content marketer for the financial industry. He has been an auditor of international companies and a tax strategist for real estate investors. He now writes articles on personal and corporate finance, accounting and tax matters, and entrepreneurship.
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