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When it comes to starting your own business, restaurants aren’t exactly the easiest choice. Luckily, foodie culture has hit its stride, and restaurant sales have been on the rise for several years now.

It will be a challenge, but as long as you come to the table fully prepared for success, the odds are in your favor. Here’s everything you need to know about starting a restaurant business.

How to open a restaurant.

Let's dive into the step-by-step roadmap of opening a restaurant, addressing everything from securing startup funds and choosing the ideal location, to devising a standout menu.

1. Decide what kind of restaurant to open.

You’ll want to consider many factors when deciding what type of restaurant to start. Pay attention to your target location and what kinds of restaurants find success there, while also avoiding oversaturated markets. Ultimately, you want your restaurant to fill a need.

Your budget is also important to consider. Some types of restaurants require bigger initial investments due to expensive machinery or the space required to execute the idea. Be realistic about what you can afford.

Franchise vs. independent restaurant

For some prospective restaurant owners, a franchise is the way to go. While you may have less creative control and need to pay fees, franchises already come with built-in brand recognition. On the other hand, independent restaurants allow for full creativity and uniqueness, but require more work in terms of establishing your name.

Pros and cons of opening a franchise

Pros and cons of starting an independent restaurant

Consider these factors to decide whether a franchise or an independent restaurant is the right choice for you.

Fast food vs. casual dining vs. fine dining

Each type of restaurant—fast food, casual dining, and fine dining—serves a distinct market and has its own unique set of considerations, pros, and cons. It's crucial to understand these differences when deciding what kind of restaurant you want to open.

Fine dining

Consider opening a restaurant in an area where people enjoy and can afford fine dining. This type of restaurant typically offers high-quality food, a sophisticated ambiance, and a higher price range. Fine dining establishments often come with significant startup costs.

Fast food

If your restaurant is located in a youth-oriented area (Ex: near a college campus) fast food or casual dining might be a better fit. Fast food restaurants serve food that is ordered and served quickly, targeting customers who prioritize convenience over a fine dining experience.

Fast-casual

Fast-casual restaurants, like Chipotle or local food trucks, offer a balance between fast service and higher-quality food, compared to traditional fast food chains like McDonald's or Taco Bell. This concept combines the efficiency of fast food with a more casual dining experience.

Fast-fine

Fast-fine dining is a newer concept that combines the elements of fine dining with more accessible prices and shorter wait times. These restaurants offer creative and elevated dishes, such as gourmet burgers or elevated pizza. Starting a fast-fine dining restaurant is more affordable compared to traditional fine dining establishments, making it a viable option for entrepreneurs with limited investment capital.

2. Create your menu.

Your menu is a crucial element of your restaurant, as it will ultimately determine the type of experience you provide for your customers. It's essential to strike a balance between creativity and practicality when devising your menu.

• Consider incorporating popular dishes and ingredients that appeal to a wide range of tastes.
• Be creative and offer unique items that set you apart from other restaurants in your area.
• Keep in mind the cost of ingredients and equipment needed to execute your menu items efficiently.
• Remember to consider dietary restrictions, such as vegetarian or gluten-free options.

3. Develop a restaurant business plan.

Once you’ve nailed down your idea, you’ll need to create a business plan. This step can feel like a lot of work, but it’s necessary. You’ll need to do extensive research regarding your restaurant’s concept and menu, the market for your restaurant, competitors, your management and employee team, marketing, financial projections, location, and more.

Here are the main components of most restaurant business plans.

1. Introduce your restaurant brand, which includes your logo, colors, and sign
2. Provide an overview of your restaurant concept
3. Give a sample menu with prices
4. Explain your management and employee plan
5. Lay out your restaurant design
6. Analyze your industry and target market
7. Investigate your competitors
8. Offer an analysis of your location
9. Write out a marketing plan
10. Create financial projections

You will rely on this document throughout the creation of your business, and you’re welcome to amend it as time goes on and your goals and projections shift. If you need to raise money from investors for your restaurant or apply for a business loan, your business plan will come in handy.

4. Obtain funding for your restaurant.

There are many options when it comes to finding money to start your restaurant. Whether you want to borrow from a bank, fund the restaurant yourself, or seek out investors, it’s important to explore all of your options before deciding on a funding method.

Bootstrapping

Bootstrapping is a startup funding method that doesn't involve external investors or credit. It aims to self-fund, starting with a small amount of initial "seed money" from personal savings or a friend/family. The business quickly generates revenue and reinvests it for growth.

The benefits of bootstrapping include avoiding debt and maintaining control and equity. However, seed money is limited, resulting in a small initial operation.

Business term loans

Business term loans are a traditional type of commercial loan where a lender provides a lump sum of cash up front, which is then repaid over a set period (the term) with a fixed or variable interest rate. These loans are incredibly flexible and can be used for various purposes, including working capital, business expansion, or purchasing equipment. However, they typically require a solid credit history and demonstrated ability to repay.

SBA loans

The Small Business Administration (SBA) doesn't lend money directly to small business owners. Instead, it sets guidelines and partners with lenders, community development organizations, and micro-lending institutions to provide these loans. SBA loans are renowned for having some of the best rates and terms available, making them a desirable option for many small businesses. They can be used for most business purposes, including long-term fixed assets and operating capital. However, the process for applying and qualifying can be lengthy and complex.

Equipment financing

One of the most significant upfront expenses for restaurant owners tends to be kitchen equipment, from pizza ovens to industrial refrigerators and POS systems. Many business owners use equipment financing to pay for these expensive pieces of equipment so they can maintain their restaurant’s cash flow.

Crowdfunding

Crowdfunding, a funding method where you accept small contributions from many people (like Kickstarter and Indiegogo), is similar to bootstrapping. It allows you to maintain control over your business and avoid debt. This funding is popular with startups selling physical products, as they can offer the product as a reward. Restaurants typically don't use crowdfunding, but it's possible. If you have a decent following or people who support your idea, crowdfunding might work for you.

Finding an angel investor

Startups often struggle to secure funding initially. Traditional banks typically require a couple of years in business before considering a loan, while investors demand proof of viability. This is where angel investors step in. They fund early-stage startups, even if they're risky because they believe in the idea and the people behind it. While accepting their money means giving up ownership, it doesn't need to be repaid if the business fails. However, angel investors may push for rapid growth. Learn more about the pros and cons of angel investors here.

5. Choose a location.

The most important factor when it comes to location is making sure that there’s a market for the type of restaurant you want to open in the place where you want to open it. However, that’s not the only factor.

Central vs. off-the-beaten-path

Typically, building a restaurant in a central, highly trafficked location means more business for you but also far higher rent prices. You may only be able to afford a location that’s a little off the beaten path. This location doesn’t mean you can’t succeed, but it does mean you’ll want to choose wisely. Consider whether this location is in a quieter area that’s easy to get to or a place that’s truly out of the way for most people. Don’t forget that hungry patrons value convenience heavily.

Parking

You might be tempted to snag a prime spot in a downtown area, but if parking is a hassle, that central location could actually hurt you. Consider first whether there’s any space for you to build parking into your restaurant’s design. 

Some restaurant types can get away with little to no parking—for example, food trucks, windows, and restaurants located at or very close to public transportation—but for the most part, no parking is a no-go. Again, this goes back to convenience.

Size

You need to make sure that the size of the lot or building you’re considering is appropriate for the business you want to open. The more involved your food, the bigger your kitchen will need to be. If you’re serving alcohol, you’ll need space for a bar. The equipment you’ll need is very important to keep in mind, as restaurant equipment can eat up more square footage than you’d think.

Clientele

You’ll need to consider the type of people who frequent the area you want to start your restaurant in, which includes both their taste in food and their purchasing power. You can have the best food in the world, but if the people in your neighborhood can’t afford it, you’ll never be successful. On the other hand, if you’re serving fast food burgers in a neighborhood that’s hyper-health-conscious and mostly vegetarian and vegan, you’ll struggle.

Design

The ambiance of your space depends largely on the location you choose. You need to pay attention to detail when browsing potential spaces to rent. If you’re opening a brunch spot or a cafe, natural light is a must, and a patio or outdoor space doesn’t hurt. If fine dining is your thing, you’ll want a space that’s impressive at first glance, whether for its modern features, its historic charm, or its vaulted ceilings.

Building code

You probably don’t want a space that’s going to involve lots of renovations before you can even get started. Make sure the space you’re looking at is up to code and safe. Also, assess whether or not it’s accessible to people with disabilities. Not only is this the right thing to do, but there are also a number of accessibility guidelines restaurants legally have to meet in order to be ADA-compliant.

6. Licenses and permits for opening a restaurant.

The restaurant business is one of the most highly regulated industries, and as such, you’ll need to secure a number of different licenses and permits before you can open your doors. The exact requirements vary by state, and it’s best to get a lawyer involved to make sure you have everything squared away.

Some of the more common licensing requirements include:

• Business licenses - These are issued at the state level.
• Food handler’s permit - All employees should obtain this.
• Liquor license - This is only for restaurants serving alcohol.
• Music license - This gives you permission to play copyrighted music in your establishment.

The U.S. Small Business Administration is a great resource for more information on applying for business licenses.

7. Designing your restaurant space.

Designing your restaurant space is just as important as crafting your menu. The ambiance and layout of your restaurant can greatly influence your customers' dining experience. Here are some key factors to consider:

• Dining area layout - Your dining area should be spacious and comfortable. Arrange the tables in a way that makes it easy for customers to move around and for staff to serve.
• Kitchen design - The kitchen should be designed for efficiency and safety. You'll need enough space for cooking, food preparation, storage, and dishwashing. The layout should facilitate a smooth workflow.
• Color scheme - Choose a color scheme that matches your restaurant's theme. Different colors can evoke different emotions—for example, reds and yellows are warm and appetizing, while blues and greens are calming.
• Lighting - Good lighting can set the mood for your restaurant. Consider using a mix of ambient, accent, and task lighting to achieve the desired atmosphere.
• Furniture - Invest in quality furniture that is durable, comfortable, and fits your restaurant's style. Remember, comfort can significantly enhance a customer's dining experience.
• Decor - The decor of your restaurant should reflect its concept or theme. This includes art, accessories, and table settings.
• Music and acoustics - The right music can enhance the ambiance of your space. However, it's also important to consider acoustics. Good acoustics can reduce noise levels and make the dining experience more pleasant.
• Restrooms - Don't forget about the restrooms. They should be clean, well-stocked, and accessible to all customers.

Designing your restaurant space is a great opportunity to express your restaurant's identity and create an environment where customers will enjoy dining.

8. Hiring management and employees for your restaurant.

This step is crucial for your restaurant's success. Your team can make or break your startup. Avoid common hiring mistakes like rushing the hiring process, overlooking contract workers, and not accepting support and delegation throughout.

Some tips for hiring include:

• Recruit talented and committed individuals by offering competitive pay and benefits.
• Don't skimp on compensation or hiring quality.
• Match industry rates and provide benefits.
• Identify potential rather than proven success to find valuable contributors without high costs.
• Offer non-monetary perks like upward mobility, employee incentives, and profit-sharing.
• Get creative by partnering with local businesses for discounts.

Common restaurant staff requirements

Running a restaurant requires a diverse set of skills. Depending on your restaurant's size and concept, you may need to hire for several different roles. Here's a quick overview of some common restaurant staff requirements.

• General manager - The general manager oversees the entire operation of the restaurant. They're responsible for hiring and training staff, ensuring customer satisfaction, and managing the restaurant's finances.
• Chef/cook - The chef or cook in your restaurant is responsible for preparing meals. They must be skilled in food preparation and knowledgeable about food safety standards.
• Kitchen staff - This includes various roles such as sous chefs, line cooks, and dishwashers. They assist the chef in food preparation and maintaining kitchen cleanliness.
• Server - Servers interact directly with customers, taking orders, serving food, and handling payments. They should be friendly, attentive, and have excellent communication skills.
• Bartender - If your restaurant serves alcohol, you'll need a bartender. They should have knowledge of a variety of drinks and excellent customer service skills.
• Host/hostess - The host or hostess greets customers as they arrive, escorts them to their table, and manages reservations.
• Busser - Bussers clear tables once customers have finished their meals, making the table ready for the next customers. They often assist servers and host/hostesses with various tasks.

Remember, each of these roles plays a crucial part in your restaurant's success. Therefore, it's important to take the time to find the right people for each position.

9. Finding suppliers for your restaurant.

A key aspect of running a successful restaurant is having reliable suppliers. From food ingredients to kitchen utensils, the quality of what you purchase impacts the overall experience you offer to your customers. Here are some types of suppliers you'll need, and some tips on where to find them.

Types of suppliers you'll need

• Food and beverage suppliers - These are perhaps the most crucial suppliers for your restaurant. You'll need to secure a steady supply of fresh produce, meat, dairy, baked goods, and beverages.
• Equipment suppliers - Your kitchen will need professional-grade cooking equipment, utensils, and appliances. This includes ovens, grills, refrigerators, cutlery, pots, and pans.
• Furniture suppliers - To create a comfortable and inviting environment, you'll need quality furniture. Suppliers can provide tables, chairs, booths, and outdoor seating.
• Cleaning supplies suppliers - Hygiene is paramount in any restaurant. Suppliers of cleaning products and sanitary equipment are therefore vital.
• POS system suppliers - A reliable point of sale (POS) system is crucial for managing orders, receipts, inventory, and sales data.
• Uniform suppliers - If your staff will be wearing uniforms, you'll need a supplier for these as well. The uniforms should be comfortable and stylish, reflecting your brand image.

Where to find suppliers

• Industry trade shows - These events are great opportunities to meet potential suppliers, see their products firsthand, and negotiate deals.
• Online directories - Websites, such as ThomasNet or Alibaba, list thousands of potential suppliers for all kinds of restaurant needs.
• Local farmer's markets - If you're committed to serving fresh, local produce, farmer's markets can be an excellent source for suppliers.
• Wholesale retailers - Stores like Costco or Sam's Club can provide bulk goods at discounted prices.
• Industry associations - Joining a restaurant association can provide you with access to their list of vetted suppliers.

Finding the right suppliers requires time and research. It's important to consider not just the cost, but also the quality of products, reliability, delivery schedules, and communication skills of the supplier. Remember, your suppliers are partners in your business, and their performance can impact your restaurant's success.

10. Launching and marketing your restaurant.

Once everything is in place and you’re finally ready to launch your restaurant, it’s time to publicize and spread the word! You’ll probably want to host a big event for the day or weekend your restaurant opens its doors to bring in new customers, but you should start marketing your restaurant and that launch date far in advance.

Online presence

Digital marketing is huge, and you should have an online presence that includes a website and at least a couple of social media channels. Facebook and Instagram are two of the most popular social media platforms for restaurants.

Spread the word

Consider offering a taste test to local food writers, bloggers, and influencers so they can spread the word. Also, contest marketing is highly effective and a great way to gain new followers. It can be wise to contract a digital marketing specialist to help you with this project.

On-the-ground marketing

While social media is important for publicizing your restaurant, on-the-ground marketing within your community is critical. Hang flyers around the neighborhood and inside other local businesses, and ask your friends to tell everyone they know.

Offer incentives

Spreading the word only goes so far. You have to offer an incentive for people to come and try something new. Host a launch party that’s packed with freebies, like samples, a live DJ, a giveaway, and more. Team up with local artists or artisans to host a pop-up in your restaurant. The more you collaborate, the further your network will spread.

Customer loyalty

You can also consider implementing a customer loyalty program, so that all of these new people feel compelled to come back to your restaurant. Most casual dining spots go with punch cards, whereas more upscale establishments might consider starting a points system of some sort. Opening a restaurant is an enormous task. However, with proper planning and preparation, it’s possible to make all of your culinary dreams come true. Looking into funding for your restaurant? Learn more about restaurant business loans.

With 10 million new small businesses opening their doors in the U.S. in 2021-2022—the highest years on record—a Lendio study reveals the top industries for starting a business. 

As the U.S. experiences this small business boom, Lendio analyzed which industries are most likely to grow and succeed in the next decade, helping to answer the question: What industry should new entrepreneurs explore?

Key findings

Lendio analyzed four metrics to determine the best industry to start a business, gauging the growth potential, ease of getting started, and longevity of the opportunity. Specifically, Lendio explored analysis on employment projections, production rate, 10-year survival rate by industry sector, and overall startup costs.

Our key findings include: 

• Healthcare opportunities remain hot. Five of the top industries that made the list are within the healthcare sector. Real estate, software publishing, office administration, print publishing, and manufacturing also made the cut.
• Agriculture, manufacturing have the best survival rates. Commodities, healthcare, and real estate rounded out the list with the highest survival rates compared to others.
• Professional, scientific, and technical services come in at the lowest cost of entry. Not far behind are construction and agriculture, clocking in with the lowest cost to start or acquire.

Top industries to start a business.

1. Home healthcare services

With the percentage of Americans over the age of 65 projected to reach over 20% of the population by 2040, it’s no surprise home healthcare is an industry with a big growth trajectory, expected to grow at an accelerated rate over the next 10 years. There are many factors that are driving this growth, including an increasing demand for medical services and home care benefits for Medicare recipients.

2. Outpatient care centers

Similar to home healthcare, an increase in the aging population is driving demand for outpatient care, which normally includes healthcare services that don’t require hospital admittance, such as X-rays, bloodwork, and routine checkups. For the population in general, technological advancements in the medical industry are producing a faster and more accessible patient experience for all ages. Moreover, demand for more local outpatient facilities has grown significantly in the post-pandemic period.

3. Individual and family services

Welfare assistance for individuals and families is a growing necessity. The U.S. market was valued at $233.6 billion in 2022, and the global market is expected to reach $2 trillion by 2030, at a compound annual growth rate (CAGR) of 10.8%. According to the U.S. Department of Health & Human Services, nearly half of the U.S. population lives in what is called a “health professionals shortage area,” with an estimated 8,326 mental health practitioners needed. 

4. Software publishers 

In today’s tech-powered world, software and software as a service (SaaS) are in high demand, especially at the enterprise level. Businesses are continuously looking for ways to streamline data and processes, which often leads to high payouts for publishers and developers. And demand for software is only expected to grow in the coming years, with revenue forecasts for the software industry are expected to reach more than $414 billion by 2028.

5. Computer systems design and related services

Staying on the tech train, these services help design, support, and update computer hardware and software for other businesses. Evolving applications of software and a need for robust technological systems in a number of industry sectors contribute to the forecasted growth of this industry, which is estimated to be around 26% over the next 10 years.

6. Office administrative services

Any business owner can attest to the need to—and importance of—effectively running day-to-day operations. Tasks such as bookkeeping, hiring and logistics, to name a few, are often immediate needs. It’s expected that this industry will grow up to 10% year over year in 2023, with continued growth forecasted in the years beyond. As businesses expand and tap into new markets, having the right service provider for everyday tasks becomes a necessity, as advanced technology and interconnectivity across the globe lead the charge.

7. Medical and diagnostic laboratories 

The U.S. medical and diagnostic laboratory services market is increasingly competitive among large and small providers. People need to know if they’re healthy, and these facilities provide the necessary analyses of bodily fluids, genetic testing, and more for healthcare professionals to determine this. Rising rates of chronic illnesses, such as diabetes, cancer, and heart disease, are increasing demand in this industry. Industry revenue in the U.S. reached up to $71 billion in 2022 and is expected to grow to $141 billion by 2030. 

8. Physician offices

The height of the pandemic exposed many points of weakness in the medical industry, including a shortage of physicians, nurses, staff, and equipment to handle the sudden influx of patients. Looking towards the future here, improved accessibility and a greater influx of in-person visits will drive an explosion in demand for more private practitioners, such as family medicine, internal medicine, and pediatrics. 

9. Publishing industries

Reading is power, and increasing numbers of consumers like to read on the go, making digital print a growing medium. But physical print still remains an important part of the industry and the preferred outlet for readers. Textbooks also continue to create consistent growth for the printed word. However, transitioning to digital media, at least partly, has expanded revenue streams for publishers. Audiobooks in particular have increased their share of the U.S. book market over the past 10 years, reaching $1.8 billion in 2022, making it the fastest-growing segment within the industry. 

10. Management, scientific, and technical consulting services

Running a business can get complicated, so across different sources, companies turn to the experts more often than not. From improving processes to lowering maintenance and operational costs, these providers help drive efficiency and develop strategies. The market value was valued at  $316.6 billion in 2021, and that is expected to more than double by 2031, to $814.6 billion.

Runners up

1. Real estate

The current housing market is muddied with rising interest rates. But it’s beginning to rebound, forecasted to grow at a CAGR of 4.7% from 2023 to 2028. While this industry encompasses both residential and commercial real estate, residential real estate accounts for the largest share of revenue in the United States, with a market volume projected at around $88.91 trillion for 2023. Although this industry is highly competitive, it’s relatively easy to break into—required courses and certifications take around four to six months, on average, to complete. However, reaching high earnings will take a lot of hard work and dedication. 

2. Motor vehicle manufacturing

Even though the automotive industry was one of the most affected by the pandemic, the lack of sales ultimately led to an increase in inventory. More cars means more sales opportunities, so the market is expected to go up and to the right. That—coupled with advances in technology, rapid urbanization, and a push toward electric vehicles—will lead to greater opportunities for revenue generation. 

Methodology

We used publicly available data from a variety of federal government sources to identify the best industry in which to start a business in 2023. Our examination included:

• Projected growth in output and employment by industry from 2022 to 2032. Selected industries must have a positive projected growth in output. (Bureau of Labor Statistics)
• Ten-year survival rates of businesses starting in 2012. (Bureau of Labor Statistics)
• Amount spent to start or acquire a business excluding costs of $1 million+ Census.gov 

Final thoughts

Your chosen industry can have an effect on your day-to-day operations, revenue projections, and timelines, as well as growth over time. As you choose your business venture, consider crucial aspects of running a business, such as overall production costs, location, and consumer demand.

Regardless of the industry you’re in, a business owner faces a unique set of challenges. If you work through these with a solid plan in place and the right amount of capital to give you a financial lifeline, you’ll be in a better position to achieve long-term success.

The IRS announced an immediate moratorium on processing new Employee Retention Credit (ERC) claims on September 14, 2023. The moratorium will last through at least the end of the year in an effort to protect small business owners and taxpayers from scams and fraudulent claims.

As a small business owner, you may be wondering what this moratorium means for you and your business. Here’s everything we know and how you may still be able to apply for the ERC during the moratorium.

What we know.

We know that the IRS is continuing to process ERC applications that were received prior to the moratorium. However, processing times will be longer, the IRS advised in its Sept. 14, 2023 update — potentially going from a 90-day turnaround to 180 days or more. The agency has increasingly shifted its focus to review claims for compliance concerns and recently announced that thousands of ERC claims have been referred for audit. It is also working on hundreds of criminal cases on promoters and businesses filing suspicious claims. 

Payouts for these previously filed claims will continue through the moratorium, but at a slower pace due to the more in-depth compliance reviews. This payout period will extend to 180 days from its previously standard processing goal of 90 days, according to the IRS. However, a payout may take even longer if its claim requires the IRS to further review or audit it.

The IRS is implementing this more scrutinous compliance review period to protect businesses from facing penalties or interest payments that stem from bad claims that aggressive marketers pushed.

For any business owners wanting to submit claims after September 14, 2023, while the IRS is not reviewing new applications until at least January 1, 2024, you can still submit an ERC claim during the moratorium.

Applying for the ERC.

Small business owners planning to submit an ERC claim after September 14, 2023 should ensure that their businesses are eligible for the tax credit prior to filling out the stringent application.

Pay qualified wages.

First, ensure that your business paid qualified wages to your employees. The definition of qualified wages varies depending on the amount of employees your business had on the payroll in tax years 2020 and 2021.

For tax year 2020, the IRS defined a small business as a business that averaged 100 or fewer full-time monthly employees in 2019. For tax year 2021, it expanded the definition to include businesses that averaged 500 or fewer full-time employees in 2019.

Larger employers can claim the ERC but only for wages and some healthcare costs paid to employees who did not work.

Small businesses can claim the credit for all employees, whether they worked during the period or not.

Government-mandated full or partial suspension.

Your business must have been impacted by either a government-mandated lockdown or decrease in revenue to be eligible for the ERC. You can qualify if your business was impacted by a full or partial suspension of operations due to a government COVID-19 order during any quarter (this includes restrictions on hours or capacity).

This area of eligibility criteria can be complex, so make sure to work with a vendor who is familiar with government orders, their impact, and the timeframe they were enacted.

Significant decline in gross receipts.

If your business experienced a “significant decline” in gross receipts as defined by the IRS, then it can be eligible for the ERC. For tax year 2020, a significant decline means that gross receipts for a quarter are less than 50% compared to the same period in 2019. For the first 3 quarters in 2021, a significant decline means quarterly receipts are less than 80% compared to the same period in 2019.

If your business did not see a 20% decline in gross receipts in the first 3 quarters of 2021 compared to 2019, you can also elect to use the immediately preceding quarter for comparison. This means that if a business’s Q2 of 2021 isn’t eligible compared to Q2 of 2019, it can instead use Q1 or 2021 and compare it to Q1 of 2019 to meet eligibility requirements.

Recovery startup business.

The ERC was amended in 2021 by The American Rescue Plan to let newer businesses gain access to the tax credit. A recovery startup business is defined as one that opened after February 15, 2020, and has annual gross receipts under $1 million. As long as you meet these two criteria and have one or more W2 employees, you don’t have to meet the other eligibility requirements. If your business qualifies as a “recovery startup business,” you can apply for the credit for Q3 and Q4 of 2021, and your business can receive a maximum of $50,000 in ERC per quarter.

If your business meets these requirements, then it may be eligible for the ERC. When applying, make sure that you have gathered thorough records proving wages paid, gross receipts, government orders, and other required documentation. Please note that businesses that improperly claim the ERC will be required to pay it back, potentially with penalties and interest.

Applying for the ERC during the moratorium period.

You should consult an accountant or tax professional prior to filling out any forms. They will help guide your business through this stringent and potentially confusing process. 

You can apply for the ERC during the moratorium period through Lendio. We’ll help you identify what documents you need to claim the ERC. We’ve partnered with ERC and tax experts to aid you in the complex application process. They can help navigate you through tricky tax laws and avoid costly mistakes while calculating the full tax credit that you qualify for. After your application is complete, we’ll file your ERC claim with the IRS.

Please note that this process will be extended significantly due to the moratorium. While you will be able to submit your application to the IRS prior to January 1, 2024, it will not be reviewed until after that date (and with more stringent compliance review terms).

If you have additional questions regarding the ERC and/or the ERC moratorium period, check FAQ resources from the IRS and Lendio.

The Paycheck Protection Program (PPP) and Employee Retention Credit (ERC) were created to help businesses stay afloat during COVID-19. If the pandemic has had a negative impact on your small business, you might wonder whether you can take advantage of both of these programs. Keep reading to find out.

Key Points:

• The PPP was a forgivable loan. The ERC is a refundable tax credit.
• The PPP loan program is no longer available. The ERC can still be claimed retroactively.
• Businesses that received a PPP loan can still apply for the ERC.
• Employee wages used to receive PPP loan forgiveness cannot be used in your ERC claim.

What Is the Paycheck Protection Program?

Established by the CARES Act and administered by the U.S. Small Business Administration (SBA), the PPP offered loans of up to $10 million to small businesses that faced financial hardship as a result of COVID-19. 

As long as you qualified, you could have received a loan for up to 2.5 times of your average monthly payroll costs. The loan can be forgiven completely if you file a forgiveness application and show you used the proceeds to cover rent, utilities, payroll costs, and other qualifying expenses.

What is the Employee Retention Credit?

The ERC is a refundable payroll tax credit for qualified wages paid to employees in 2020 and 2021. It was created under the CARES Act and administered by the Internal Revenue Service (IRS) to encourage businesses to retain their employees during the pandemic. 

You may qualify if you experienced partial shutdowns due to government orders or significant declines in quarterly gross receipts due to COVID-19. If you meet certain eligibility criteria, you can claim as much as $5,000 per employee in 2020 and as much as $21,000 per employee in 2021.

Differences Between PPP and ERC

While the PPP and ERC were both designed to support businesses that have struggled financially as a result of the pandemic, there are several noteworthy differences between these two programs.

Type of Funding

The PPP offers a forgivable loan. If you used the funds on payroll, rent, and other qualifying expenses, you wouldn’t have to pay it back. In the event you used part of the loan for non-qualifying reasons, that portion won’t be forgiven. You’ll have to repay it with a fixed interest rate of 1% over a period of either two or five years. The ERC, on the other hand, is a tax credit you won’t have to repay.

Funding Time

If you qualified for the PPP loan, you would have received the funds via direct deposit, usually within ten days of approval. The ERC, however, will be distributed to you after you file Form 941-X and the IRS has reviewed your claim. The IRS will process the credit you’re owed and send you a check. The IRS can take anywhere from 3-6 months+ to process your credit. We highly recommend reserving your place in line now by filing the necessary paperwork with the IRS.

Cost 

It was free to apply for the PPP loan. You would only incur a cost if you don’t use the loan proceeds on qualifying expenses and must pay it back. There’s no governmental fee to receive the ERC either. It’s a tax credit that you can receive by filing an amended payroll tax form for each of the tax periods that you qualify for. The only expense you may face will be service charges if you ask an accountant or tax professional to assist in preparing and filing your tax forms.

Eligibility 

The eligibility requirements for the ERCwere updated in 2021. 

2020 qualifications:

• Qualifying wages of up to 100 full-time employees
• A decrease in gross revenue of at least 50% compared to the corresponding quarter in 2019
• Or either a full or partial suspension of business operations created by a government mandate 

2021 qualifications:

• Qualifying wages of up to 500 full-time employees
• A decrease in gross revenue of at least 20% compared to the corresponding quarter in 2019
• Or either a full or partial suspension of business operations created by a government mandate

PPP loan requirements included:

• A small business with 500 employees or less
• The business was operational before February 15, 2020
• For second-draw loans, the business must have used up previous loan funds and demonstrate a 25% or more reduction in gross revenue.

Can You Get Employee Retention Credit and PPP?

Initially, a business that received a PPP loan was not eligible for the ERC. Thanks to the Consolidated Appropriations Act of 2021, however, a business that received a PPP loan may also apply for the ERC retroactively back to 2020. 

The caveat, however, is that you can’t use the wages that qualify you for PPP loan forgiveness to determine your ERC amount. You’ll need documentation that proves you’re not “double dipping” and using both programs to cover the same wages. 

Let’s say you used your PPP funds to pay for $50,000 in wages and you expect to qualify for forgiveness. In this scenario, you can’t use those wages that have been forgiven to calculate your ERC.

How to Apply for PPP and ERC

You can no longer apply for a PPP loan, but you can still fill out an application for the ERC. If you’d like to claim the ERC, you can do so on Form 941-X. Don’t hesitate to consult a tax professional for assistance.

How to Maximize the PPP and ERC

There are a few ways you can maximize the benefits of both the PPP and ERC, including: 

• If you included non-payroll costs in your PPP loan forgiveness application, show you used a minimum of 60% of the total loan on payroll. This way you’ll be eligible for full forgiveness. 
• In the event you don’t list qualifying non-payroll costs on your application, you must prove that you used 100% of the loan amount on payroll to get your loan completely forgiven.
• Provide detailed explanations to help the tax professional you work with understand exactly how the government orders impacted your business. This will help them maximize the amount you qualify for.
• Don’t forget to separate the total payroll costs you used for the PPP loan from the total payroll costs you list with the ERC. This can help you avoid getting denied for using the same payroll costs for both programs.
• Use a tax professional vs. filing yourself. Though you may pay money, these professionals often understand the program much better than you ever could on your own. As a result, they often can help you qualify for more money than you would on your own. They also will help ensure that you file the credit correctly so that in the event of an audit all of your i’s are dotted and t’s are crossed.

Reap the Benefits of the PPP and ERC

If you previously applied for PPP, there’s no reason not to apply for the ERC. By doing so, you can mitigate the financial losses you may have incurred during the pandemic and set your business up for future success. 

Have you heard of the Employee Retention Credit (ERC)? For business owners who endured the COVID-19 pandemic and the economic roller-coaster it brought, the ERC was meant to provide financial relief and keep their workforce employed. Now, even though the economic impacts of the pandemic have subsided, business owners like you can still take advantage of this tax credit. To find out if you qualify and how the Employee Retention Credit works, read our answers to the Employee Retention Credit FAQs below.

General overview questions

What is the Employee Retention Credit (ERC)?

The ERC is a tax credit. This means, when applied, the ERC will reduce the total amount of taxes a business owes to the Internal Revenue Service (IRS). The ERC was part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) which was passed in March 2020 by the U.S. Congress. It was intended to lessen the pandemic's economic impact on businesses and encourage them to retain employees as much as possible. 

The ERC is a fully refundable tax credit. This means, that if your business’ ERC is greater than your federal employment taxes, it could create a negative federal tax liability for a business and result in a tax refund. At the very least, it could lower the amount of taxes your business pays—at most, you could receive a refund check. 

Am I eligible for the Employee Retention Credit?

To be eligible to receive the Employee Retention Credit, you must meet the following criteria:

• Your business is a private sector or tax-exempt organization that carried out business in 2020 and/or 2021. 
• Your business paid qualified wages to employees in 2020 and/or 2021.
• Your business experienced hardship in one of the following areas:
• You were forced to suspend your business’s operations, including limiting commerce travel or group meetings, fully or partially due to COVID-19 government orders, or
• You experienced a significant decline in gross receipts beginning in the first quarter of 2020.

Since you’ll be required to prove your business’s eligibility, knowing the definitions of a partial business suspension or a significant decline in gross receipts is critical.

A partial business suspension is one in which total employee hours fall below 10% of the business’ typical total employee hours. An example of a partially suspended business would be a restaurant that could no longer welcome dine-in customers but continued to provide carry-out or delivery services. For more details on full vs. partial suspension of business, click here.

A significant decline in gross receipts is when a business’s gross receipts started dropping in the first quarter of 2020 to 50% or less of the gross receipts of the business in the first quarter of 2019. For more details on the definition of a decline in gross receipts, visit the IRS page on the topic.

Learn More: Employee Retention Tax Credit: is your small business eligible?

What exceptions or restrictions should I be aware of in the ERC?

A few other exceptions exist to the guidelines above. For example: 

• Self-employed individuals may not claim the credit based on their earnings, but they can for wages paid to any employees they may have. 
• Certain tribal government organizations or entities might be considered eligible. 
• Businesses that received Paycheck Protection Program (PPP) loans from the government can claim the tax credit, but not for wages that were paid using a PPP loan.
• Businesses that receive tax credits under the Families First Coronavirus Response Act (FFCRA) employer-paid leave requirements can’t count qualified leave wages in their ERC calculations. 
• Businesses cannot count wages they’ve attributed to the R&D tax credit in their ERC calculation.

For more information on these and other exceptions, visit the IRS page on this topic.

How is the Employee Retention Credit determined?

A business’ ERC amount is determined based on its qualified employee wages and the year in which those wages were paid. Here’s how it works:

• For wages paid from March 13 to December 31, 2020, the tax credit is worth 50% of qualified employee wages. The highest amount that would be considered qualified employee wages for any one employee is $10,000 for the entire year. Following that math, the maximum credit a business can get per qualified employee is $5,000 (i.e., 50% of $10,000). 
• For wages paid in 2021, the tax credit is higher: 70% of qualified employee wages. The highest amount of qualified wages paid that would be considered for any one employee is also larger: $10,000 per month. Therefore, the maximum credit a business can receive for 2021 is considerably larger than for 2020. Important note: businesses can claim the credit for the first three quarters of 2021 only, not the fourth.

It’s worth noting here that qualified health plan expenses—defined as amounts paid or incurred by the business that are allocable to employees’ qualified wages to provide and maintain a group health plan, but only as they are excluded from employees’ gross income—are also factored into these wage figures.

To get the full details on how the ERC is determined, visit the IRS page on the topic.

Can I still take advantage of the ERC?

Yes. If you want to take advantage of the 2020 ERC, you can apply until April 15, 2024. Likewise, the 2022 ERC will not lapse until April 15, 2025.

How do I apply for the ERC?

To apply for the Employee Retention Credit, you should file an amended Form 941X as part of your quarterly federal tax return for any 2020 or 2021 quarter in which your business was eligible for the ERC.

Qualification questions

What is a recovery startup business?

Originally, the ERC was only available to established small businesses that experienced significant declines in revenues or operational shutdowns due to COVID-19. The American Rescue Plan (ARP) amended the ERC eligibility requirements to extend the credit to newer businesses. These are known as “recovery startup businesses.”

To claim the ERC as a recovery startup business, your operation must meet the following requirements:

• Started doing business after February 15, 2020
• Averaged less than $1 million in annual gross receipts during the three-year period ending before the quarter
• Not be otherwise eligible for the ERC through a decline in gross receipts or an operational shutdown

Recovery startup businesses with one or more W-2 employees on the payroll can claim the ERC and receive up to $50,000 in total credits per quarter for the third and fourth quarters of 2021.

Learn More: How to qualify as a recovery startup business for ERC in 2023

What qualifies as a government shutdown for Employee Retention Credit?

Businesses that experienced a full or partial suspension of their operations due to an order from a governmental authority may be eligible for the ERC. If a business faced a direct order to fully suspend their business, then they qualify under the ERC. If a business or portion of a business was deemed essential, but was limited in hours and service capacity, they may still qualify as a partial suspension depending on the level of reduction in capacity or reduction in hours.

Learn More: Navigating the Employee Retention Credit (ERC) shutdown test

What are qualified wages for the ERC?

Qualified wages include full or part-time W-2 employee salaries as well as certain health plan expenses. For "small employers" with less than 100 employees in 2020 and less than 500 employees in 2021, all wages paid to your workers qualify. For "large employers" who fall above those thresholds, only wages paid to employees who weren't working qualify.

Learn More: Qualified wages for the Employee Retention Credit

Are tips qualified wages for Employee Retention Credit?

In Notice 2021-49, the IRS confirmed that the definition of qualified wages for the ERC includes cash tips received by an employee in a calendar month that amount to $20 or more, assuming all other requirements to treat them as qualified wages are satisfied.

Cash tips include tips employees receive directly from customers, tips from other employees under tip-sharing arrangements, and tips charged to credit and debit cards distributed to employees.

Learn More: Tips and the Employee Retention Credit

Are owner’s wages considered qualified wages?

The IRS has stated that wages paid to employees related to their employers aren’t qualified wages for the ERC. When the employer is a corporation, related employees are those who have one of the following relationships with a majority owner:

• A child or a descendant of a child
• A brother, sister, stepbrother, or stepsister
• The father or mother, or an ancestor of either
• A stepfather or stepmother
• A niece or nephew
• An aunt or uncle
• A son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law

In Notice 2021-49, the IRS clarified further that constructive ownership and familial attribution rules apply when determining related parties. As a result, ancestors, whole or half-siblings, and lineal descendants of majority owners are also considered majority owners for purposes of the ERC.

The notice concludes that majority owners with living relatives are, therefore, effectively related to majority owners, and their wages aren’t qualified for the ERC. In other words, majority owner wages can't be qualified wages unless they have no living ancestors, siblings, or descendants.

Minority owner wages can qualify for the ERC, assuming they own less than 50% of the company after accounting for the attribution laws.

Learn More: Are owner's wages considered qualified wages?

Can I still qualify for the ERC if my business was profitable?

You can still claim the ERC if your business generated a profit during the 2020 and 2021 tax years. However, you must have experienced a substantial decline in gross receipts or suspended operations due to a government order to be eligible unless you’re a recovery startup business.

An employer experienced a significant decline in gross receipts for 2020 if its quarterly revenues dropped below 50% of the revenues earned in the same quarter in 2019. It remains eligible for the ERC until the end of 2020 or the 2020 quarter after gross receipts reach 80% of the gross receipts for the same quarter in 2019.

For 2021, an employer has a significant decline in gross receipts for each quarter in which gross receipts were less than 80% of the same quarter in 2019.

Can I still qualify for the ERC if I didn’t pay income taxes?

The ERC is a refundable payroll tax credit designed to offset employment taxes. As a result, the status of your income tax return generally doesn’t affect your ability to qualify for it. If you didn’t pay income taxes for 2020 or 2021 because your business earned a net loss for the tax year, you can still claim the ERC for any eligible quarters.

Because it’s a refundable credit, not paying payroll taxes doesn’t prevent you from claiming the ERC, either. If the ERC reduces your liability below or further below zero, you’ll receive a refund from the IRS.

Do nonprofits qualify for the ERC?

Nonprofits can qualify for the ERC. Like for-profit businesses, they generally must show that they experienced a significant decline in gross receipts or suspended their operations due to a government order to be eligible.

Tax and logistics questions

Is the Employee Retention Credit taxable income?

No, the ERC is not taxable income. It’s a refundable payroll tax credit that directly offsets your payroll taxes. In many cases, the credit will exceed your total payroll tax liability, resulting in a refund. Regardless, you should not include the ERC amount in your gross income for tax purposes.

However, an IRS notice confirms that the ERC is subject to deduction disallowance rules. That prevents you from taking a deduction on your income tax return for wages used to claim the ERC. If you claim the ERC, you must reduce your wages expense for the qualifying period by the credit amount, effectively increasing your taxable income.

For example, say you paid $80,000 in qualified wages during 2020. In 2023, you retroactively claim a $30,000 ERC for the year, resulting in a refund. You would amend your 2020 income tax return and reduce your wages expense to $50,000, increasing your taxable income for that year. However, the refund wouldn’t be taxable.

Learn More: Is the Employee Retention Credit taxable income?

Is there a deadline to claim the Employee Retention Credit?

Because the period to earn the ERC is passed, businesses must now claim the credit retroactively by filing a Form 941-X for each eligible quarter. The deadline to file 941-X is three years from the filing date of the original Form 941.

Fortunately, the IRS considers all Forms 941 for a calendar year to be filed on April 15 of the subsequent year, even if you filed it before that date. As a result, the deadline to claim the ERC for quarters in 2020 is April 15, 2024. For quarters in 2021, the deadline is April 15, 2025.

Are ERC and ERTC the same thing?

ERC and ERTC are abbreviations for the same thing. ERC is short for Employee Retention Credit, while ERTC is an abbreviation for Employee Retention Tax Credit. They’re both references to the refundable payroll tax credit implemented by the CARES Act to reward businesses for continuing to pay employees’ wages during COVID-19.

How will I receive my Employee Retention Credit refund?

You should receive a separate check in the mail from the IRS for each quarter in which you claimed the ERC and generated a refund.

Does the Employee Retention Credit have to be paid back?

Unlike funds from the Paycheck Protection Program (PPP), the ERC is not a loan. It’s a refundable tax credit, and you don’t have to pay it back. There’s no need to apply for forgiveness, either. If it generates a refund, it’s automatically yours to keep.

Does the IRS audit ERC credits?

The IRS has already begun auditing ERC claims. The passage of the American Rescue Plan in 2021 extended its window to review the ERC from three years after filing to five. There’s an additional focus on the tax credit due to elevated fraud risks.

Though you may not be subject to an ERC audit, it’s best to assume that you will and prepare accordingly. Consider consulting a Certified Public Accountant (CPA) or another tax professional for help.

When should I expect my ERC refund?

On average, you can expect your refund within three to six months of filing. However, some taxpayers may wait a year or more to receive their checks, depending on their filing date and credit size.

Unfortunately, there’s no way to know for sure. The IRS is still experiencing delays in processing claims due to a backlog caused by its shutdowns during the pandemic.

Can I still apply for the ERC during the moratorium?

You can still apply for the ERC during the moratorium period, however, please note that your application will not be reviewed until at least January 1, 2024.

How do I avoid ERC scams?

A common ERC scam charges an upfront fee to see what you qualify for through the ERC. Legitimate vendors won't charge you just to see if you qualify. Other red flags include promising that everyone can qualify, promising more money than other filers and not doing thorough research, calculations and due diligence.

The Employment Retention Credit is a potential financial benefit that no business owner can afford to pass up. However, to ensure that your business qualifies for this tax credit and secures the full credit amount it’s entitled to, we strongly recommend working with ERC experts, such as Lendio's ERC partners.

Get a tax refund for your sick days.

If you missed work due to COVID-19-related reasons, the government wants to pay you back—even if you were self-employed. You may be eligible for a tax credit from the Internal Revenue Service (IRS)—and this credit is available now, retroactively, for lost income/work in 2020 and 2021. 

The Family First Coronavirus Response Act, also called FFCRA, was signed into law in March 2020, and among other things, addressed paid sick leave and unemployment benefits. One of the many benefits of the FFCRA was that it provided tax credits to eligible self-employed individuals — including 1099 and gig workers— for sick days and family leave related to the COVID-19 pandemic. 

This tax credit is different from a deductible, as it directly reduces the total tax owed to the IRS. You can apply for this credit retroactively for 2020 and 2021, which means you could still receive a check in the mail if you haven't already claimed it.

What is the FFCRA tax credit for self-employed individuals?

The FFCRA is widely known among employers with W-2 employees, as they can provide paid time off or sick leave to their workers based on specific circumstances outlined in the following section. However, many self-employed individuals, such as 1099 contractors or consultants, may not be aware that they are also eligible for this COVID-19 tax credit, and it can be applied retroactively.

How does the FFCRA work?

The FFCRA is a tax credit that allows employers to get reimbursed for time you weren’t able to work due to the effects of COVID-19. Here are some of the reasons you could qualify. They don’t all have to apply to you, but if one or more of these things happened to you, you are likely eligible. You should apply if missed work because you were:

1. Following a federal, state, or local quarantine or isolation order
2. Advised by a healthcare provider to self-quarantine
3. Experiencing coronavirus symptoms and were seeking a medical diagnosis
4. Caring for a child or other individual, who was subject to a government-issued or self-quarantine restriction, as described in #2
5. Caring for a child whose school or daycare was closed or unavailable
6. Obtaining a COVID-19 vaccination
7. Recovering from illness related to the COVID-19 vaccine
8. Seeking or waiting for the results from a  COVID-19 test

Note: Criteria 6-8 only apply from April 1, 2021, through September 30, 2021. 

If you were an employee on the W2 form in 2020 or 2021, your employer might have already claimed the maximum credit, making you ineligible. However, if you were both self-employed and a W2 employee, you could qualify for a tax credit under FFCRA, provided your employer didn't already claim the maximum FFCRA tax credit.

How much money will I get from the FFCRA as a 1099 contractor or self-employed individual?

If eligible, you can receive up to a maximum of $32,220 in tax credits, which consists of:

For the period of April 1, 2020, through March 31, 2021:

10 days of emergency paid sick/family/medical leave

• Taking care of yourself: Claim the lower of either your average daily self-employment earnings or $511 per day
• Taking care of someone else: Claim the lower of either 67% of your average daily self-employment earnings or $200 per day

50 days of emergency paid sick/family/medical leave

• Daycare or school closure: Claim the lower of either 67% of your average daily self-employment earnings or $200 per day 

For the time period of April 1, 2021 - September 30, 2021, you may receive an additional 10 days of paid sick leave and 60 days of family leave. 

Am I eligible for the FFCRA credit? You might qualify if you:

1. Were a 1099 contractor or self-employed individual anytime between March 2020-September 2021;
2. AND Took unpaid sick leave to care for yourself or a family member;
3. OR Had to stay home to provide childcare due to a government-issued or self-quarantine restriction. 

How will I receive my COVID-19 FFCRA credit?

Most applicants will have the option to receive a direct deposit via ACH for 2021 tax returns. For 2020 returns, the tax credit amount will be delivered via a mailed check from the IRS. (Disclaimer: delivery method is dependent on not having any outstanding tax liabilities.

If you had employees on the payroll during the COVID-19 pandemic, you could claim up to $26,000 in tax credits for each one, using the Employee Retention Credit (ERC). However, your credit amount depends on the qualified wages paid to your workers. 

To help you determine how much you can claim, let’s explore what counts as qualified wages for the Employee Retention Credit.

What are Qualified Wages For the Employee Retention Credit?

The Employee Retention Credit is a refundable payroll tax credit designed to provide relief to businesses that paid their employees despite facing economic strain from the COVID-19 pandemic.

You must meet a hardship requirement to claim the credit unless you’re a recovery startup business. That means experiencing economic strain in the form of a decline in your gross receipts or a suspension of your operations.

If you’re eligible, you can claim the ERC for a portion of the qualified wages you paid each employee in 2020 and 2021. More specifically, you can claim 50% of their first $10,000 in 2020 and 70% of their first $10,000 in each quarter of 2021, excluding the fourth. That’s a total of $26,000 each.

In addition to employee salaries, qualified wages include certain health plan expenses you incurred to maintain their group health plan, plus whatever costs they covered through pre-tax salary reduction contributions.

There may also be limitations on which employees qualify for the credit. If you meet the criteria to be a “large employer,” you can claim only the credit for the qualified wages you paid to those not providing services in 2020 and 2021. Here’s how it works:

If you had less than 100 employees on average in 2019, then the wages you paid to all your employees are qualified for 2020. If you averaged more than 100 employees, then only the wages you paid to employees who weren’t working are qualified that year.

For the 2021 tax year, the threshold increased to 500 employees. Wages paid to all your workers are qualified, if you averaged less than 500 in 2019. Otherwise, only non-working employee wages are qualified for 2021.

Examples of Qualified Wages

Like many aspects of the Employee Retention Credit, the qualified wages rules are complicated and challenging to grasp in the abstract. To help you understand how they work, let’s look at a few practical examples.

Qualified Wages for Small Employers

Say you own a cleaning business that’s had ten employees on the payroll since 2015. Each receives a $35,000 salary and costs you $5,000 in qualified health plan expenses annually. Three stopped providing services between September 31, 2020, and March 31, 2021, but you kept them all on the payroll.

In 2020 and the first three quarters of 2021, you have a significant enough decline in gross receipts to be eligible for the ERC. And because you only had ten employees on average in 2019, you’re considered a small employer in both years.

As a result, you can claim the ERC for the qualified wages you paid to all your employees. Fortunately, with $35,000 in salaries and $5,000 in health plan expenses, each earns $10,000 in eligible compensation per quarter, just enough to maximize your credit.

In 2020, you can claim 50% of the first $10,000 for ten employees, which is $50,000. In 2021, you can claim 70% of the first $10,000 for ten employees each quarter. That’s $21,000 for each employee in 2021, which is $210,000.

Qualified Wages For Large Employers

This time, say you own a cleaning business that’s grown large enough to operate across the state, with a whopping 750 employees on the payroll. However, 250 of your workers provided no services between September 31, 2020, and June 30, 2020. 

For simplicity's sake, we’ll assume that they each have $40,000 in qualified compensation per year, and you experience a decline in gross receipts that makes you eligible for the ERC in all periods.

Because you averaged 750 employees in 2019, you’re considered a large employer for 2020 and 2021. As a result, you can only consider qualified wages paid to workers not providing services when calculating your tax credit amount.

In 2020, you can claim 50% of the first $10,000 paid to the 250 workers that stopped working on September 31. All would have earned $10,000 apiece in that final quarter of 2020, so you could claim $1.25 million in tax credits that year.

In 2021, you can claim 70% of the first $10,000 paid to those same workers in each of the two quarters they weren’t providing services. As a result, you can claim $14,000 for 250 employees that year, which is $3.5 million.

Can Owner Wages Qualify For the ERC?

If you structure your business as a corporation, you can pay yourself an annual salary. That raises the question of whether or not owner wages qualify for the Employee Retention Credit.

Unfortunately, the answer is probably not. It isn’t strictly forbidden, but it’s unlikely that you’ll meet the requirements to be able to do so. If you’re a majority owner with more than 50% of the stock, you’d need to have no living ancestors, siblings, or descendants.

If you’re a minority owner with less than 50% of the stock, your wages should be eligible if you don’t share ownership with your relatives. That all seems a little arbitrary, so let’s explore the reasoning.

The Internal Revenue Service (IRS) ruled that wages you pay to employees related to majority owners of your company don’t qualify for the ERC. A majority owner of a corporation owns at least 50% of the company’s stock. Their relatives are people with whom they have one of the following relationships:

• Child or a descendant of a child
• Brother, sister, stepbrother, or stepsister
• Father or mother, or an ancestor of either
• Stepfather or stepmother
• Niece or nephew
• Aunt or uncle
• Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law

The IRS has also ruled that “constructive ownership and familial attribution” rules apply to this situation. These state that people own the stock of their living ancestors, siblings, and descendants, by extension.

As a result, through slightly circular reasoning, any majority owner with at least one of these relatives is technically related to someone with majority ownership by extension. Therefore, their wages are ineligible for the ERC.

Example of Ineligible Majority Owner Wages

Say that you own 100% of Corporation A. You also have a big family, including a daughter. Because she has a qualifying relationship with you, a majority owner, the IRS also considers her a majority owner of Corporation A by extension.

Unfortunately, as her father, you have a qualifying relationship with her, too. And because she’s a majority owner, any wages paid to you are ineligible for the ERC.

Example of Ineligible Minority Owner Wages

This time, say you own 34% of Corporation A. However, you share ownership of the company with your two siblings. Each owns half the remaining shares, with 33% ownership each.

Because you’re all siblings, the IRS treats you all as if you own each other’s shares for the sake of the ERC. That means each of you effectively owns 100% of the company due to family attribution rules, making you all majority owners by extension.

As a result, each of you has a qualifying relationship with a majority owner, and none of the wages paid to you qualify for the ERC.

Apply For the Employee Retention Credit

Eligible employers who paid qualified wages to their employees during 2020 and 2021 can claim thousands of dollars through the ERC. While the period to earn the credit has passed, you still have time to claim them retroactively before the deadline.

Learn More: If you have more questions about the Employee Retention Credit or qualified wages, our other resources may be able to help:

• Frequently Asked Questions

The Employee Retention Credit is among the most lucrative tax credits available to small business owners in 2023. However, it can be pretty tough to navigate, especially the credit calculation.

Let’s discuss how to calculate the Employee Retention Credit in detail, walk through a few practical examples, and explore some background information to help put everything into context.

How Does the Employee Retention Credit Work?

The Employee Retention Credit (ERC) is a refundable payroll tax credit designed to lessen the financial strain on small business owners who kept their employees on the payroll during the COVID-19 pandemic.

The credit’s main eligibility requirement is an economic hardship test. To clear it, you must demonstrate that your business experienced a sufficient decline in gross receipts or suspended a more than nominal portion of its operations due to a government order.

Determining whether you satisfy one of those requirements is a fairly involved process. But if you do, then you should be able to claim a tax credit for a percentage of the wages your business paid in 2020 and 2021.

How to Calculate the Employee Retention Credit

Under the regular ERC rules, you can claim a credit for 50% of the first $10,000 in qualified wagesyou paid each employee during 2020. In 2021, you can claim 70% of each employee’s first $10,000 in qualified wages per quarter. That means you can claim up to $26,000 in refundable tax credits per employee between both years. 

To calculate your ERC amount, you must determine which wages qualify under the credit. That primarily depends on the number of full-time employees you had on the payroll during the 2019 calendar year.

If you had less than 100 employees on average during 2019, then you can treat the wages paid to all your employees as qualified in 2020. If you exceeded that threshold, only the wages you paid to employees not providing services qualify for the ERC that year.

In 2021, the maximum number of employees for the determination increased to 500, but you still base it on your 2019 staff count. In other words, all your wages are qualified in 2021 if you had less than 500 people on the payroll in 2019. Otherwise, only the wages paid to your inactive employees qualify for the credit.

When calculating the qualified wages paid to your employees, you can also add your group health plan expenses. That includes your portion of the costs as the employer and any pre-tax salary reduction contributions from your employees.

How to Calculate the ERC as a Recovery Startup Business

If you started your business during the pandemic, you probably won’t be able to qualify for the ERC through the regular method. After all, most of the default qualification requirements involve analyzing a business’ activities in 2019.

However, you may still be able to qualify for the ERC as a recovery startup business. These are organizations that started doing business after February 15, 2020, average less than $1 million in annual gross receipts, and fail both versions of the economic hardship test in at least the third quarter of 2021.

If you meet these requirements, you can claim the ERC for 70% of the first $10,000 in qualified wages paid to each employee in the third and fourth quarters of 2021. In fact, only recovery startups can claim the credit for wages paid after September 30, 2021.

However, they also have a $50,000 quarterly limit. As a result, you can claim only $100,000 in total for those two quarters as a recovery startup.

ERC Calculation Examples

Now that we’ve covered how to calculate the Employee Retention Credit in theory, let’s walk through a few examples to demonstrate how it works in practice.

Small Employer in 2020

Say you own a restaurant with ten employees on the payroll in 2019 and 2020, each earning a $40,000 annual salary. You continued to pay them all throughout 2020, even though five employees didn’t work after March because you shut down dine-in services to comply with federal social distancing mandates.

Let’s assume that qualifies as a partial suspension of your operation, making you eligible to claim the ERC that year. Because you had less than 100 employees on average in 2019, the wages you paid to all your employees were qualified.

For 2020, you can claim a credit for 50% of each employee’s first $10,000 in qualified wages that year. All your employees reached that limit, so you can claim $5,000 for each one. Because you have 10 eligible employees, you can take a $50,000 ERC that year.

Large Employer in 2021

Say you own a nonprofit organization with 600 employees on the payroll in 2019, 2020, and 2021. Each of them had a base annual salary of $50,000. However, 200 workers stopped providing services from January 1, 2021, to June 30, 2021, during which you paid them only half their usual salaries.

Because you averaged more than 500 employees in 2019, only the wages you paid to those 200 employees who weren’t working are qualified. Let’s also assume you saw a decline in gross receipts during those months that was sufficient for the hardship test.

You can claim 70% of the first $10,000 in qualified wages paid to each non-working employee in the first two quarters of 2021. With 200 employees, that gives you $1.4 million each quarter, resulting in a $2.8 million total ERC.

Recovery Startup Business

Finally, say you start a landscaping business with 10 employees on May 1, 2020. It has less than $1 million in average annual gross receipts and fails the economic hardship test in all periods, making it a recovery startup business.

You pay each of your employees $80,000 in wages yearly. As a recovery startup business owner, you can claim a tax credit for 70% of their first $10,000 in qualified wages for the third and fourth quarters of 2021.

Because all of your workers reached the $10,000 limit each quarter, you can claim $7,000 for each one. With 10 employees, you should be able to take a $70,000 ERC each quarter and a $140,000 credit for the year.

However, your organization is a recovery startup business, so your credit amount can’t exceed $50,000 in a single quarter. As a result, you can claim only $100,000 for the 2021 calendar year.

Apply For the Employee Retention Credit

As these calculations demonstrate, the Employee Retention Credit is an incredibly lucrative opportunity for business owners. If you qualify, you could reduce your federal tax liability by thousands of dollars, potentially resulting in a refund.

It’s too late to earn the ERC, but you still have time to claim the credit retroactively by filing Form 941-X with the Internal Revenue Service for each eligible quarter. The deadline is April 15, 2024, for quarters in 2020 and April 15, 2025, for quarters in 2021.

If you’d like help determining whether you qualify for the ERC, let our convenient application tool walk you through everything. Once you confirm your eligibility, it can also streamline the filing process for you. Give it a try today.

Learn More: If you want to know more about the Employee Retention Credit before you move forward, our other resources may be able to help:

• Frequently Asked Questions
• What You Need to Know About the ERC