The Employee Retention Credit (ERC) is one of the most lucrative tax credits for small business owners. Fortunately, if you had employees on the payroll during the COVID-19 pandemic, you can still claim it retroactively.
To help you understand how you might qualify, let’s review how the ERC works and walk through some practical examples of eligible businesses.
How Does the Employee Retention Credit Work?
The Coronavirus Aid, Relief, and Economic Security (CARES) Act created the Employee Retention Credit in 2020. Its goal was to provide financial relief to small businesses and encourage them to retain their employees.
The ERC works as a refundable tax credit. You can deduct it from your payroll tax liability and pocket any excess amounts. As a result, it’s even more beneficial than a tax deduction, which can only reduce your taxable income.
To be eligible for the ERC during 2020 or 2021, you must pass the following three tests during the period for which you want to claim the credit:
- Your business was a private sector or tax-exempt organization.
- Your business paid qualified wages to employees.
- Your business experienced hardship in one of the following areas:
- You were forced to suspend your business’ operations, including limiting commerce travel or group meetings, fully or partially due to COVID-19 government orders, or
- You experienced a sufficient decline in gross receipts.
Businesses that pass these tests can claim a tax credit for a portion of each employee’s qualified wages. The 2020 limit is 50% of their first $10,000 that year. The 2021 limit is 70% of their first $10,000 per quarter until September 31, 2021, unless you’re a recovery startup business. That’s a maximum credit of $26,000 per employee.
While you can no longer earn the ERC, you still have time to claim it by filing Form 941-X for each eligible quarter. For quarters in 2020, you have until April 15, 2024. For quarters in 2021, the deadline is April 15, 2025.
What are Qualified Wages?
The definition of qualified wages under the ERC is surprisingly complex and deserves additional clarification. Most notably, your average number of employees in 2019 determines which wages qualify for the credit.
If you had 100 or fewer employees on average during 2019, wages paid to all employees in 2020 are qualified. If you averaged more than 100 employees during 2019, only wages paid to employees who weren’t providing services are qualified.
In 2021, the threshold increased to 500 employees. In other words, if you averaged 500 employees or less in 2019, all wages in each 2021 quarter are qualified. If you averaged more than 500 employees in 2019, only those paid to workers not providing services qualify in 2021 quarters.
What is a Suspension Due to a Government Order?
You must also understand what constitutes a full or partial suspension of operations due to a government order. Let’s look at the suspension of operations aspect first. To pass this test, “more than a nominal portion” of your operations must shut down.
For an aspect of your business to be more than nominal in a given quarter of 2020 or 2021, it must meet one of the following tests in the corresponding 2019 quarter:
- Its gross receipts constituted 10% or more of your total gross receipts.
- Hours worked by the portion’s employees were 10% or more of all hours worked.
Finally, a governmental order refers to official proclamations or decrees from the federal, state, or local government that "limit your commerce, travel, or group meetings due to COVID-19.”
What is a Sufficient Decline in Gross Receipts?
Finally, let’s expand upon what constitutes an eligible decline in gross receipts. Unfortunately, the rules are a little different between 2020 and 2021.
In 2020, you can show a sufficient decline in gross receipts for only one continuous period. It starts in the first calendar quarter that your receipts fall below 50% of receipts in the same quarter of 2019. It ends in the quarter after they first rise to 80% of 2019 receipts.
In 2021, you can test for an eligible decline in gross receipts on a quarterly basis. You can claim the ERC for each quarter that your gross receipts are below 80% of receipts for the same quarter in 2019, even if they’re discontinuous.
Employee Retention Credit Examples
As you can see, the ERC eligibility requirements are complicated. To help you understand them, let’s look at some in-depth examples of eligible employers, explain why they qualify for the ERC, and calculate their credit amounts.
Example 1: Partial Suspension
A restaurant had 20 employees on the payroll in 2019, 2020, and 2021. It paid everyone a $40,000 salary each year, even though half of the workers provided no services between April 1, 2020, and December 31, 2020.
The restaurant closed dine-in services to comply with federal social distancing mandates on March 15, 2020, but remained open for take-out. The government order ended on March 30, 2021. Throughout 2019, dine-in services generated 65% of the restaurant’s gross receipts.
As a for-profit business that operated in 2020 and 2021, the restaurant passed the first test for the ERC in both years. Because it continued to pay its workers during the pandemic, it also cleared the second.
Dine-in services generated 65% of the restaurant’s gross receipts in 2019, making it a more than nominal portion of operations. Because the social distancing mandate came from the federal government, it was a qualified government order. That means the restaurant passed the hardship test from March 15, 2020, until March 30, 2021.
Now we can calculate the restaurant's ERC amount. Because it averaged less than 100 employees in 2019, all wages were qualified in 2020. Since everyone had a $40,000 salary, each earned more than $10,000 during the eligible period.
With the ERC limit being 50% of their first $10,000, the restaurant's 2020 ERC is $5,000 for 20 employees, which equals $100,000.
Now, let’s calculate the amount for 2021. Since the restaurant averaged less than 500 employees in 2019, all employee wages qualified in 2021. However, the 2021 ERC limit is 70% of the first $10,000 per eligible quarter. Because the government order ended on March 31, 2021, only the first quarter is eligible in 2021.
With $40,000 salaries, each worker earned $10,000 per quarter, so they all reached the cap during the first quarter of 2021. As a result, the restaurant could claim 70% of $10,000 for 20 workers for that year, giving it a $140,000 credit.
Ultimately, the restaurant could claim a $240,000 ERC.
Example 2: Significant Decline in Gross Receipts
A 501(c)(3) charitable organization had 550 employees on the payroll from 2019 to 2021. Each employee had a $60,000 annual salary for all three years.
The charity had 250 employees stop providing services from April 1, 2020, to the end of the year. It put 125 of them back to work on January 1, 2021. The rest resumed working on March 31, 2021.
The organization received the following donations during that three-year period, which were its only gross receipts:
| Year | Quarter 1 | Quarter 2 | Quarter 3 | Quarter 4 | Total |
| 2019 | $25,000,000 | $25,000,000 | $25,000,000 | $25,000,000 | $100,000,000 |
| 2020 | $15,000,000 | $12,000,000 | $15,500,000 | $17,500,000 | $60,000,000 |
| 2021 | $18,500,000 | $21,500,000 | $19,500,000 | $22,500,000 | $85,000,000 |
As a nonprofit organization that continued to operate during 2020 and 2021, this charity satisfied the first requirement for both years. Because it continued to pay wages to its full-time employees in 2020 and 2021, it also met the second one.
The charity also passed the hardship test in both years. It experienced a significant decline in gross receipts starting in the second quarter of 2020. $12 million in gross receipts is less than 50% of the $25 million received in the equivalent quarter of 2019.
The decline continued through 2020 because gross receipts in the remaining quarters never exceeded 80% of the gross receipts in the corresponding 2019 quarters.
In 2021, the charity saw a decline in gross receipts in the first and third quarters. $18.5 million and $19.5 million are less than 80% of the $25 million received each quarter in 2019.
Now we can calculate the ERC amount, starting with 2020. Because the charity averaged more than 100 employees in 2019, only wages paid to workers not providing services were qualified.
The 2020 eligible period was the second quarter through the end of the year. During that time, 250 workers were not providing services. With $60,000 annual salaries, they all earned $10,000 in that period. As a result, the charity could claim $5,000 for each of them, equaling a $1.25 million ERC in 2020.
In 2021, the first and third quarters were eligible for the ERC. However, 125 workers resumed working on January 1, 2021, and everyone else did so by March 31, 2021. Because the charity averaged more than 500 employees in 2019, only wages paid to those not providing services were qualified for the year.
As a result, the charity can claim the ERC for only 70% of the first $10,000 paid to the 125 employees not working in the first quarter. Since they all earned more than $10,000 during that time, the charity’s ERC for the year would be 70% of $10,000 for 125 employees, which equals $875,000.
That puts the charity’s total ERC at $2,125,000.
Apply For the Employee Retention Credit
As you can see, the ERC can be incredibly lucrative. If you qualify but fail to claim your tax credit, you could leave thousands of dollars on the table. Fortunately, it’s not too late to apply, and our easy-to-use application tool can guide you through the process from start to finish. Give it a try today.
Learn More: If you have further questions about the ERC due to unusual business circumstances, our other ERC resources may be able to help:
If you qualify for the Employee Retention Credit (ERC), you could receive thousands of dollars in refundable tax credits for each employee on your payroll during the COVID-19 pandemic. Fortunately, there’s still time for you to claim those funds.
Let’s break down the qualification requirements to help you determine whether your small business is eligible.
What are the ERC Eligibility Requirements?
The Employee Retention Credit eligibility requirements include three primary tests. Regular employers that pass all of them can potentially claim the tax credit for 2020 and the first three quarters of 2021. Here’s what you should know about how they work.
Eligible Organization
The first ERC eligibility requirement is the most straightforward and easiest to clear. You must be an employer that operated a trade, business, or tax-exempt organization during 2020 or 2021.
If you're a small business owner running a company that’s been around since before the pandemic, then you generally don’t have to worry about this test. It primarily prevents governmental entities from claiming the ERC.
Pay Qualified Wages
The second ERC eligibility requirement is where things start to get more complicated. To pass this test, you must have paid qualified wages to your employees. That sounds simple, but the definition of qualified wages varies depending on how many employees your business had on the payroll in 2019.
If your average number of employees in 2019 was below certain thresholds, then the wages you paid to all employees in 2020 and 2021 can qualify for the ERC. If it was above those thresholds, only the wages you paid to workers not providing services are eligible.
For 2020, the threshold is 100 employees. For 2021, the cutoff increased to 500 employees. Note that you should calculate your average number of employees in 2019 on an annual basis, not a quarterly one.
For example, say you had an average of 150 employees on the payroll in 2019. That puts you above the threshold for 2020, and only wages paid to workers not providing services would qualify for the ERC that year. However, you’re below the threshold for 2021, so wages paid to all employees would qualify that year.
Experience Economic Hardship
The third ERC eligibility requirement is the most complex and usually the one that ultimately determines whether or not you can claim the tax credit. To pass this test, you must have experienced economic hardship due to the COVID-19 pandemic in one of the following ways:
- You were forced to suspend your business’ 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.
Let’s take a closer look at what each of these tests mean.
Suspension of Operations
There are two parts to this test that you must understand. Let’s start with the government order aspect since it’s the most straightforward. It refers to mandates from federal, state, or local regulators that limit your commerce, travel, or group meetings due to COVID-19.
This does not include unofficial recommendations from public servants or self-imposed restrictions. If you’re not subject to a specific government order, you can’t satisfy the hardship requirement through this method.
The second aspect of this test is to have a “full or partial suspension of operations,” which is a bit more complicated. To clear it, you must shut down a “more than nominal portion” of your business.
Upon the initial passage of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, there was a lot of controversy over what this term meant. However, the Internal Revenue Service (IRS) eventually confirmed that a portion of your business must pass one of the following tests to be considered nominal:
- Its gross receipts equaled 10% or more of your total gross receipts
- Its employees worked 10% or more of your workforce’s total hours worked
Once again, these requirements are based on the 2019 calendar year. For example, say you own a restaurant that offers dine-in and takeout services. In 2019, dine-in services generated between 60% and 75% of your annual gross receipts.
Because that aspect of your operation generated more than 10% of your total gross receipts in 2019, it constitutes a more-than-nominal portion of your business. If you stopped offering dine-in services to comply with a government order during 2020 or 2021, you’d be eligible to claim the ERC in that period.
Sufficient Decline in Gross Receipts
As an alternative to showing a suspension of operations, you can prove that you experienced economic hardship through a sufficient decline in gross receipts. This is another complex test, and the rules differ between the 2020 and 2021 calendar years.
In 2020, you can have a decline in gross receipts for only one continuous period. It can cover multiple quarters, but they must be uninterrupted. For example, you couldn’t qualify in the first and third quarters without the second.
An eligible decline begins in the first quarter that your gross receipts fall below 50% of receipts in the same 2019 quarter. It ends in the quarter after your receipts rise above 80% of receipts in the corresponding 2019 quarter.
Meanwhile, in 2021, you can test for a sufficient decline on a quarterly basis. Each one passes the test when its gross receipts are below 80% of gross receipts in the same 2019 quarter. For example, say your business had the following gross receipts:
| Year | Quarter 1 | Quarter 2 | Quarter 3 | Quarter 4 |
| 2019 | $100,000 | $100,000 | $100,000 | $100,000 |
| 2020 | $45,000 | $65,000 | $82,000 | $84,000 |
| 2021 | $78,000 | $81,000 | $75,000 | $85,000 |
In 2020, an eligible decline in gross receipts starts in the second quarter—as $45,000 is less than 50% of $100,000—and continues through quarter three. Quarter four is the only ineligible one that year, as it’s the first quarter after receipts rise above 80% of 2019 numbers.
In 2021, any quarter with receipts below 80% of the receipts in the same quarter from 2019 passes this test. As a result, you’d qualify for the ERC in the first and third quarters, but the second and fourth would be ineligible.
Recovery Startup Businesses
The default ERC eligibility requirements generally apply to organizations established before the COVID-19 pandemic. That’s why so many of them involve comparing 2020 and 2021 numbers to those from corresponding periods in 2019.
However, the American Rescue Plan (ARP) was enacted in 2021 to extend ERC benefits to certain businesses that began their operations in the middle of the pandemic. These companies are known as recovery startup businesses.
If you’re a recovery startup business, the eligibility requirements for the ERC are substantially different than those for regular employers. Here are the requirements your operation must meet to claim the ERC as a recovery startup for a given quarter:
- Start doing business after February 15, 2020
- Have at least one W-2 employee on the payroll
- Average less than $1 million in annual gross receipts during the three-year period ending in the tax year before the quarter
An additional eligibility requirement applies to the third quarter. Namely, you can't pass the decline in gross receipts or suspension of operations tests. If you do, you must claim the credit for that quarter as a regular employer, not a recovery startup business.
To clarify, filing as a recovery startup business in either of these quarters will not prevent you from doing so in the earlier quarters as a regular employer.
Recovery Startup Business ERC Example
Like the regular ERC qualification rules, the recovery startup eligibility requirements are complicated. Let’s look at an example to help you understand how they work.
Say you opened a digital marketing agency on June 1, 2020. You have five full-time employees on the payroll taking home $50,000 salaries, and your new business generated $400,000 in gross receipts by the end of the year.
You started doing business after February 15, 2020, and had multiple W-2 employees on the payroll, so you meet the first two requirements for a recovery startup business. All that’s left is to confirm that you meet the $1-million gross receipts test.
Since you weren’t in business before the 2020 tax year, that’s the only year you must consider here. But because you were only open for part of the year, you have to annualize your numbers.
To do so, divide the $400,000 received in 2020 by the number of months you were open that year, then multiply the result by 12. Since you started doing business on June 1, divide $400,000 by seven and multiply it by 12 to get $685,714. Fortunately, that’s well below the $1 million threshold.
Assuming you don’t pass the decline in gross receipts or suspension of operations tests for the third quarter of the year, you can file as a recovery startup for the third and fourth quarters of 2021.
Apply for the Employee Retention Credit
The ERC is a refundable payroll tax credit. That means you can subtract it directly from your annual payroll tax liability, and if there’s any left, you can take it to the bank. That makes the ERC significantly more impactful than a tax deduction and too valuable an opportunity to miss.
If you think you satisfy the Employee Retention Credit qualification requirements, there’s still time to claim your funds by filing IRS Form 941-X for each eligible quarter. The deadline is April 15, 2024, for quarters in 2020 and April 15, 2025, for those in 2021.
Fortunately, our ERC application guide can walk you through confirming your eligibility, filing the necessary forms, and securing your funds. Don’t wait–get started today.
Learn More: If you have additional questions about your business’ ERC eligibility due to unusual circumstances, our other resources may be able to help:
The CARES Act included provisions for several financial relief programs to support businesses during the COVID-19 pandemic. One of them, the Employee Retention Credit (ERC), rewards those that continued paying wages despite experiencing decreased revenues or operational shutdowns.
Initially, many taxpayers eligible for the ERC were uncertain whether wages paid to owners employed by their businesses qualified for the payroll tax credit. The Internal Revenue Service (IRS) issued a notice that answers the question definitively, but it can be challenging to decipher.
Here’s a more readily digestible explanation of the guidance to help you understand whether your owner wages qualify for the ERC.
Do Owner Wages Qualify For the ERC?
You probably won’t be able to include owner wages in your calculations when claiming the ERC. The IRS doesn’t expressly forbid it, but its interpretation of familial attribution and constructive ownership rules render most majority owners ineligible. The reasoning behind its position is circuitous, but doesn’t leave room for interpretation.
Previously, the IRS confirmed in its ERC FAQs that wages paid to employees related to their employers aren’t eligible for the ERC. For the purposes of the credit, relatives are defined as the following:
- 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
When the employer is a corporation, a related individual includes any person who has one of the relationships above with a majority owner. A majority owner is an individual who directly or indirectly owns at least 50% of the corporation’s stock.
However, the FAQs make no reference to wages paid to owners or their spouses, which led to the previously referenced confusion among taxpayers. To clarify its stance, the IRS issued Notice 2021-49.
Notice 2021-49 asserts that the constructive ownership rules for determining who is considered a majority owner of a corporation apply to the ERC. These rules state that an individual is considered to own, by extension, all stock their family members own. Family members include ancestors, siblings (whole or half), and lineal descendants.
Here’s where things get a little confusing. The notice then alleges that applying these rules to the ERC means that wages paid to majority owners with living siblings, ancestors, or lineal descendants don’t qualify for the tax credit.
Here’s the logic: If you’re a majority owner, your siblings, ancestors, and lineal descendants are also considered majority owners. Because they’re considered a majority owner, you’re related to a majority owner. As an employee related to a majority owner, your wages aren’t eligible for the ERC, per the original exclusion in the FAQs.
Ultimately, you must have no living ancestors, siblings, or lineal descendants to claim the ERC for your wages as a majority owner. Alternatively, you can be a minority owner with less than 50% ownership in your corporation after taking the family attribution and constructive ownership rules into account.
Note: Since only corporations can pay wages to their owners, they’re the only employers relevant to this discussion. If your business operates under any other legal entity structure, then owner compensation is automatically disqualified from the ERC.
Examples of Owner Wages and the ERC
The rules regarding owner wages and their eligibility for the ERC can be frustratingly abstract. Let’s discuss some examples to help you understand whether you can claim the ERC for your owner wages.
Owner Wages Ineligible
Corporation A is an employer that can claim the ERC for qualified wages paid in 2020. During that period, it paid wages to John, who owns 60% of Corporation A’s stock. John has a wife named Susan and a daughter named Mary, both of whom also work for the company.
Because Mary is related to John, a majority owner, her wages don’t qualify for the ERC. In addition, as his family member, she’s also considered a majority owner. Because John is related to Mary, a majority owner, neither his nor his wife’s wages qualify for the ERC.
Owner Wages Eligible
Corporation B is an employer that can claim the ERC for qualified wages paid in 2021. During that period, it paid wages to Lisa, who owns 100% of Corporation B’s stock. Lisa has no living ancestors, siblings, or lineal descendants. Her husband, Chris, also works for Corporation B.
Lisa is a majority owner, but she has no relatives who meet the requirements to share her status by extension. As a result, qualified wages paid to her and her husband are eligible for the ERC if the amounts satisfy the other requirements to be treated as qualified wages..
Apply For the ERC
The ERC can be incredibly lucrative, with the potential to reduce your payroll tax liability by $26,000 for each employee retained through 2020 and 2021. The window to earn the credit is closed, but eligible businesses can still claim the credit retroactively. Even if your wages don’t qualify due to the owner exclusion, you may still be eligible for a credit if you had employees on the payroll during the pandemic.
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.
How Does The Employee Retention Credit Work?
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.
How To Record The Employee Retention Credit In Your Financial Statements
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:
- International Accounting Standards (IAS) 20, Accounting for Government Grants
- Accounting Standard Codification (ASC) 958-605, Not-for-Profit Entities – Revenue Recognition
- ASC 450, Contingencies
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.
ERC Accounting Under IAS 20
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.
ERC Accounting Under ASC 958
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.
ERC Accounting Under ASC 450
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.
Apply For The ERC
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.
After the start of the Covid-19 pandemic in March 2020, Congress passed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), which provided numerous aid packages for both individuals and businesses. Part of the legislation was the Employee Retention Credit, which was designed to provide impacted businesses with a tax credit to help fund employee wages. Subsequent legislation extended this credit to 2021 as well.
In order to maximize your credit for both 2020 and 2021, it's important to fully understand (and document) your company's eligibility based on the ERC shutdown test. Here's everything you need to know in order to qualify.
Employee Retention Credit Eligibility Requirements
As a credit, the ERC directly reduces your business's tax obligation. You may be eligible for the credit due to either a full or partial suspension of your operations. Even essential businesses with impacted revenue may be eligible.
In order to increase your chances of getting approved based on basic IRS guidance, it's important to be as detailed as possible in your application. Learn the eligibility requirements, plus our best tips for submitting your application for the ERC.
General ERC Eligibility Requirements
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
ERC Government Shutdown Tests
So, how do you determine if your business experienced a full or partial suspension due to a government order? In general terms, a suspension constitutes a government order having an impact on operations in either hours or service capacity. 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 were limited in hours and service capacity, they may still qualify as a partial suspension. This ERC shutdown test may seem straightforward at first, but there are a lot of murky areas that have been addressed by the IRS.
Your business was essential but supplier shutdowns impacted operations. Even if your business was considered essential throughout the pandemic and wasn't subject to shutdown orders, you may still have experienced a shutdown if your suppliers were unable to make deliveries of critical goods or materials due to a governmental order that caused the supplier to suspend its operations. Documenting these negative setbacks that hurt your revenue could help qualify as a partial suspension.
Your business was required to reduce operating hours due to a governmental order. The ERC partial suspension test acknowledges that some businesses may have scaled back on hours or the scale of operations in part rather than in full due to a governmental order. An example would be a business where part of the staff was able to work remotely, but other operations required in-person work and was shut down.
Alternatively, a dine-in restaurant that switched to carry out and delivery during the pandemic would be considered a partial shutdown since their operations were reduced but not completely stopped.
Your business operated in multiple jurisdictions with varying degrees of shutdowns based on location. According to the IRS, this would still be considered a partial shutdown. It's important to note all states and locales in which you operated, since some may have had stricter shutdown rules than others.
Shutdown Impact
Once you’ve determined if you experienced a full or partial shutdown, the IRS wants you to prove you were affected greater than 10%. Here’s how that works.
The Size Test
The size test for ERC qualification means that more than a nominal portion of your operations were suspended because of the government order, you can qualify for the tax credit. This is measured by either a reduction greater 10% of the total gross receipts or a greater than 10% reduction in the total employee service hours for the specific quarter measured year over year.
The Effect Test
Another way you can qualify after a partial or full shutdown is the effect test. To meet the effect test, the IRS has said that you either have to demonstrate that the suspended portion of your business made up a greater than 10% portion of total operations, or that modifications made to the business due to governmental orders resulted in a greater than 10% impact to your ability to provide goods or services to your customers. For example, a restaurant had to limit occupancy to 50% due to a governmental order and could only seat guests in every other booth. Or, a dance studio had to cut group lessons and only offer one-on-one classes due to a governmental order. In each of these scenarios, the business would pass the effect test.
Best Practices to Demonstrate ERC Shutdown Eligibility
It's not too late for eligible businesses to apply for the Employee Retention Credit. To claim the 2020 credit, the application must be submitted by April 15, 2024. The deadline for the 2021 credit is April 15, 2025. IRS form 941-X is required to claim eligible employee wages.
However, the IRS has left quite a lot of gray area in terms of guidelines for the ERC shutdown test and has also noted that it doesn't plan to issue any further guidance. So it's important to be as thorough as possible when applying for the credit in order to maximize your tax savings.
Lendio can help you apply for this tax credit. Here are some of the things to include in your application.
- Revenue activities: Explain your business operations and how you typically bring in revenue.
- Changes in income-producing strategies: Include details on how you adjusted your operations throughout the pandemic in order to continue bringing in cash flow.
- Total revenue: Analyze exactly how much your revenue fell between 2019 and 2020 on a quarterly basis.
- Operating locations: Be specific with all the different states and jurisdictions in which you operated.
- Employee working hours: Talk about any changes in employee scheduling and number of hours of work that had to be adjusted in order to comply with social distancing best practices.
- Sales metrics: Give color to exactly how your business sales were impacted. Perhaps your foot traffic significantly dropped or you had difficulty closing sales over video or phone compared to in-person meetings.
- Vendor disruptions: Even essential businesses experienced disruptions, particularly from other vendors who may not have continued smooth operations. List out vendor names, dates, and specific challenges and setbacks your business experiences because of third parties.
While the government passed multiple COVID relief packages for small businesses, including the CARES Act, the quick action often left questions about eligibility requirements. For restaurant owners, many wondered whether tips are included in the Employee Retention Credit. To address this valid concern, the IRS released guidance on when tips are considered qualified wages for the ERC, which also applies to businesses that have already filed for the ERC.
Here's everything you need to know about counting tips as qualified wages for this important tax credit.
What Businesses Qualify For the Employee Retention Credit?
Before jumping into whether tips count as wages, make sure your business is eligible for the Employee Retention Credit. The food and hospitality industries were among the most impacted by the pandemic. Many restaurants and other related small businesses that survived and have employees who receive tips as income are likely eligible to meet these requirements.
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
Businesses impacted by the pandemic may qualify under either full or partial suspension of operations. For instance, restaurants that switched from sit-down service to curbside pickup would qualify under a partial suspension. And if your business had locations in multiple jurisdictions, you could still apply based on the government restrictions experienced in some states, even if other states in which you operated were more relaxed.
Are tips qualified wages for the employee retention credit?
In most cases, tips do count as qualified wages, with just a minor exception. Notice 2021-49 from the IRS clarified that tips are included as qualified wages eligible for the employee retention credit as long as they exceed $20 in one calendar month. Under the IRS definition, tips can include cash or any other form of payment. So for each month an employee earned $20 or more in tips, that money can be included in their qualified wages to help qualify for an additional amount from the Employee Retention Credit.
What about the FICA tip credit?
Another clarification from the IRS confirmed that small businesses claiming tips as qualified wages are also eligible to claim the same wages for the FICA tip credit. This credit is available via IRS Form 8846. It allows food industry businesses to receive a tax credit on the social security and Medicare taxes paid on any tip income that's over the federal minimum wage. Your business can still claim the Employee Retention Credit while simultaneously claiming the FICA tip credit as well.
What if your restaurant already applied for ERC?
Even if your small business already applied for the Employee Retention Credit without including eligible tip wages, it's not too late to take advantage of this update. You can resubmit Form 941-X as an amendment to your previous tax filing for eligible years.
Note that the application deadlines for the ERC are April 15, 2024 for the 2020 tax year and April 15, 2025 for the 2021 tax year.
Lendio's tax partners have the necessary expertise to make sure you maximize this tax credit opportunity. Our platform integrates with your HR and payroll systems so you can avoid manually gathering and entering relevant documentation.
A hard inquiry takes place when you apply for financing—like a loan or a credit card—and a lender reviews your credit report during the application process. Hard inquiries have the potential to damage your credit score. But that doesn’t mean you have to worry about a credit score drop every time you seek new credit. And you shouldn’t be afraid to apply for financing when you want or need it either.
The subject of credit inquiries—especially hard credit inquiries—causes many misunderstandings. Here’s what you need to know about how hard inquiries really work and how to protect your credit score from damage.
What are inquiries on your credit report?
Consumer credit reporting agencies like Equifax, TransUnion, and Experian can only share your credit file details with those who have a permissible purpose to view that information. The Fair Credit Reporting Act (FCRA) outlines who is allowed to access your credit information and when. The same federal law also requires a credit reporting agency to let you know anytime it grants anyone else access to your sensitive personal credit information.
A credit bureau informs you that someone has reviewed your credit information by placing a record of the access on your credit report. That record is called a credit inquiry.
What is a hard credit pull?
A hard credit inquiry—also known as a hard credit pull—is a type of credit inquiry that has the potential to impact your credit score in a negative way. However, if a hard inquiry does affect your credit score, any damage is typically minimal.
Below are some common examples of hard credit inquiries.
- Loan applications
- Credit card applications
- Applications for lines of credit
- Applications for credit limit increases
“When you apply for a credit card or any other type of loan (a mortgage, auto loan), you give the issuer or lender permission to check your credit report to assess your ‘creditworthiness’,” says CNBC contributor Elizabeth Gravier. “In essence, your potential lender is looking to see how likely you are to pay back the money you borrowed. The healthier credit history you have, the less risk you demonstrate, and the greater the likelihood you’ll qualify for that new credit card or loan.”
While you don’t need to totally avoid hard inquiries, you should be aware that they appear in your credit history.
How do hard inquiries affect your credit score?
Hard credit inquiries can often impact your credit score in a negative way. When they do, however, the impact is typically slight.
Consider FICO® scores as an example. The “new credit” category of your credit report is worth 10% of your FICO score. And the number of hard inquiries that have appeared on your credit report in the last 12 months is one of the factors that influences this credit score category.
It’s also important to note that inquiries only factor into your FICO score for 12 months. FICO also ignores all inquiries that took place in the last 30 days when calculating your score.
Consumer credit scoring models like FICO and VantageScore also don’t penalize consumers for rate shopping for certain types of loans. With FICO scores, you can apply for multiple mortgage, auto, or student loans within a 45-day period and the scoring models will treat applications for the same type of loan as a single inquiry. (Note: Some older FICO scores only allow for a 14-day rate-shopping period.)
How many points will a hard inquiry lower your credit score?
A new hard inquiry on your credit report won't cause you to lose a specific number of points from your credit score. And some hard inquiries might not result in a credit score point loss at all. According to FICO, one additional hard credit inquiry takes away less than five points from most people's FICO score. Of course, a large number of hard credit inquiries in a short period of time could lead to potential credit problems. Excessive applications for new accounts is considered to be risky behavior by credit scoring models. And too many hard credit inquiries could signal to potential lenders that you might be in financial trouble.
Therefore, it’s wise to limit your credit applications. You should aim to apply for loans and credit cards for which you’re likely to qualify. It’s also smart to avoid seeking too much new credit at once.
How long do hard inquiries last on credit reports?
As mentioned, the Fair Credit Reporting Act (FCRA) requires consumer credit reporting agencies to disclose when they allow others to access your credit information. Depending on the type of credit inquiry, the FCRA may require it to remain on your credit report for anywhere from 12 to 24 months. As a matter of policy, some credit bureaus opt to leave all hard inquiries on consumer credit reports for up to two years.
What is a soft inquiry?
It’s important not to confuse hard inquiries with soft inquiries. A soft credit inquiry can also appear on your credit report as a record that someone has accessed your credit. Yet the key difference that sets the two types of inquiries apart from one another is the fact that soft inquiries will never damage your credit score.
Below are some common examples of soft credit inquiries.
- Checking your own credit report
- Employment-related credit checks
- Account maintenance credit checks (from current creditors)
Additionally, only you can see the soft inquiries that appear in your credit file. If a lender pulls a copy of your credit report, it will see only hard inquiries. Soft inquiries are not visible to potential lenders.
The bottom line.
As a small business owner, having good personal credit can be an asset when you apply for business financing. So, it’s wise to pay attention to the factors that influence your personal credit scores, including hard credit inquiries.
You shouldn’t be afraid to apply for new credit when you want to borrow money for yourself or your business. Yet it does make sense to be strategic. Before you seek new credit, take the time to research financing options to discover the best solutions for your situation.
You may also want to review your credit to learn where you stand prior to applying for new credit. It’s also helpful to discover which lenders have qualification criteria you are likely to satisfy. (For example, if a lender requires excellent personal credit and your personal credit score is fair, the loan probably isn’t a good fit.)
Putting in extra effort to review your credit and research financing options up front might help you avoid additional (and unnecessary) hard credit inquiries. And you might also discover some great financing solutions for yourself or your small business at the same time.
When you're a small business owner, keeping your finances organized is crucial to your success—and it all starts with a good system for tracking your business expenses. Expense tracking is the gateway to cutting costs, improving cash flow, and optimizing your deductions during tax time.
Long gone are the days of balancing a checkbook and keeping an Excel spreadsheet. Now, there are dozens of tools out there that help business owners automate expense tracking and harness financial data that can level up your business. Here are some of the best tips and tools for tracking your small business expenses.
How to Track Business Expenses
- Open a Business Bank Account
- Get a Business Credit Card
- Get an Accounting App
- Evolve Your Tracking Methods
- Keep Your Business Receipts
- Record and Categorize All of Your Expenses
- Consider Consulting an Accountant for Tax Planning
1. Open a Business Bank Account
Many businesses start as solo operations, and owners in these situations often focus on gaining traction and ignore everything else. It’s easy to create an accounting nightmare for yourself when that causes you to neglect the accounting function early on.
Business owners often run into this problem after a year or so of operations when they have to file their taxes for the first time.
For example, they might look back at the year and find they have no idea how large a tax deduction they can take for their travel expenses because each trip included some unknown amount of personal expense transactions. Come tax season, you won't have to dig through your statements and transactions to determine which expense was for your groceries and which was for your new office desk.
To avoid that issue, open a business bank account before you do anything else. Split your business and personal expenses as soon as possible by opening up separate accounts for your company. That usually includes a checking account and a credit card.
That said, they don’t have to be official business accounts, which may have different requirements or costs than personal ones. You can still use a card in your name as a sole proprietor. Just keep your funds separate to create a distinct paper trail.
You'll also get perks like checks with your business name on them, which makes your transactions appear more professional. Opening a business account and keeping it in good standing will help you build a business banking relationship as well, which may help you out when it comes to apply for a business loan.
2. Get a Business Credit Card
Contrary to popular belief, it’s not usually necessary to keep the receipts for all your business expenses. Feel free to ditch that messy shoebox crammed full of paper copies.
While business owners used to need those receipts for tax expense reporting purposes, they’re not as beneficial anymore. You generally only need to have documentation that proves the following:
- What you purchased
- When you purchased it
- How much it cost you
Fortunately, as long as you make your business purchases with dedicated business accounts, you’ll usually find all of that information in your bank statements and credit card bills.
Nowadays, you’d likely only need to keep an expense receipt if you want more insight into a transaction than a line item on a statement could give you.
For example, if you paid $1,500 to Amazon you might not be able to tell what it was for from your business credit card bill. You may need a receipt to document that $1,000 was for your new computer while $500 was for supplies.
However, you still don’t need to keep any receipts in paper form. It makes them far too easy to lose or damage beyond legibility. Take pictures of them instead and save the images in a folder for your records or auto-upload it to your bookkeeping software.
3. Categorize Your Expenses
Whether you complete your business purchases with a credit card, debit card, or cash, you need to have a system for categorizing them. It’s not enough to know that your business spent $500 last week. You need to keep track of which deduction to take.
In general, there are three ways to do this. The old-fashioned way is to keep a document or spreadsheet and manually log every transaction there. If your business pays for things in cash, you'll have to use that method.
However, there’s little reason to pay for anything in cash anymore. If you want to make tracking business expenses easy, always use a credit or debit card and create an electronic record for your transactions.
That opens up two other options for categorizing business expenses, both of which are superior to tracking things by hand. Namely, you can let either your bank or accounting software assign each expense category, manually updating them only when necessary.
Which option makes more sense for you depends on your needs. If you have a relatively low volume of expenses and little complexity, you can probably use your bank account or credit card statements to stay organized.
However, the more sophisticated your business transactions become, the more likely you’ll need bookkeeping software to stay organized. This makes it much easier to adjust your digital records directly.
4. Schedule Regular Check-Ins
Many business owners are uninterested in managing the financial side of things. They start their companies because of ambition or passion, and bookkeeping is significantly less exciting. As a result, it’s easy to procrastinate on the issue.
Unfortunately, tracking business expenses isn’t something you can neglect for long. Do you remember your days back in school when you received year-long projects? If you started at the last minute, you’d never be able to catch up in time.
Business expense management is a lot like that. You have the whole year to get your financial records in order, and you can’t afford not to use that time. Procrastination causes all sorts of problems, such as:
- Forgetting the purpose or details of expenses
- Compounding any early accounting mistakes
- Creating a massive headache for yourself during tax season
Conversely, if you stay on top of your bookkeeping from day one, everything goes much smoother. Expenses are fresh in your mind when you categorize them, fixing mistakes earlier prevents you from making them again, and you don’t need to rush at tax time.
Ideally, you should check in with your business expenses every month. If you don’t have enough activity to make it worthwhile, you can use a quarterly schedule instead.
You should generally check your expenses at least quarterly because that’s how often you need to make estimated tax payments. If you don’t know how much taxable income you had in the last quarter, you might not know how much you need to pay.
5. Finalize Your Financial Statements
Ultimately, business owners track their transactions to translate them into a balance sheet and income statement. These documents detail your business finances, including assets, liabilities, revenues, and expenses.
At the end of every year, you’ll need to update your financial statement to reflect the activity from the previous twelve months. Readers can use them to determine how much you earned or lost and your subsequent financial position.
Your financial statements essentially define your business, and you’ll need them to inform many different processes, including:
- Calculating your annual tax liability
- Assessing the success or failure of your operation
- Determining whether you qualify for a business loan
Bookkeeping software is especially helpful at this stage. Creating your balance sheet or income statement in a spreadsheet is laborious and makes you susceptible to human error. You have to build the formulas yourself, and one mistake can throw everything off.
Meanwhile, bookkeeping software like Lendio's software can automatically categorize your transactions, generate your financial statements, and then update them in real-time in connection with invoicing software. Give it a try today!
6. Analyze Your Business Expenses
Once you have an accurate idea of your business’s spending trends, you have everything you need to pinpoint potential problems. More specifically, you can look for areas where you’re spending more than you’d like and make adjustments as needed.
Overspending doesn’t necessarily mean you were irresponsible with your budget like it would in your personal life. It could also mean you ran into surprise operating expenses or that costs ended up being higher than you expected.
As a result, tracking expenses can help you develop more accurate expectations, learn lessons from variances, and find areas where you can save money. For example, you could plan future estimated tax payments using your current revenues and expenses.
Bookkeeping software is also great for this kind of analysis. You can use it to facilitate many beneficial activities, like generating an expense report, comparing multiple data ranges, or drilling down into a financial statement.
7. Consider Consulting an Accountant for Tax Planning
With accurate financial records in hand, you can start to refine your tax strategy. If your business is sufficiently sophisticated, with reasonably high revenues and expenses, it’s often worth visiting an accountant for advice.
That doesn’t mean you have to hire one as an employee. Many small businesses don’t have the cash flow or the need to do that. Just reach out to a Certified Public Accountant (CPA) office and contract them out to help you with your tax strategy.
With an organized business expense tracking system and clean financial statements, any CPA would be happy to work with you. It makes their job much smoother, saving them time and you, money.
They can help you lower your tax liability each year by reorganizing your business’s legal structure, finding all potentially deductible expenses, and leveraging contributions to tax-advantaged accounts.
Reap the Rewards of Meticulous Tracking
Tracking all your business expenses is a lot of hard work—but it’s well worth the cost. With accurate expense data, you’ll be able to create dependable budgets, cash flow forecasts, and financial reports. You’ll know where you’re overspending and what expenses you need to cut or adjust to turn a profit.
With historical data to look at, you’ll know when the seasonal sales are coming and when the expenses tend to accumulate. Knowing this, you can prepare your business with a cash cushion or with the right small business loan.
Come tax season, you’ll be relaxed (or more relaxed) knowing the hard work is already behind you. If you choose to hire an accountant to handle your taxes, you’ll pay a smaller bill since they’ll have far less to do. Plus, you’ll take advantage of more tax deductions and credits, lowering your tax burden and saving your business extra cash.
Often, becoming a profitable business doesn’t require you to double your sales—it requires you to cut your costs. With expense-tracking data to guide your decisions, you’ll be able to confidently remove unnecessary expenses and prioritize the costs that move the needle. No, expense tracking isn’t always the flashiest administrative task, but it’s a necessary one.