ERC or Employee Retention Credit is a tax refund claimed by companies for increasing the wages of an employee before the start of the following year. In general, if an employee receives a net wage or salary increase and so the net salary was lower than that of the previous year, the employer must file an ERC claim with the IRS as stated in IRS Form W-2 for wages and salaries for the employer to be eligible for a refund. The amount of the refund is calculated using an employee’s rate of pay plus a one-half of 1% deduction for Federal Insurance Contributions Act (FICA) and Medicare contributions.
When was ERC first introduced?
The U.S. tax code was amended for the first time in the Tax Reform Act of 1986. A credit for wage increase was among the tax reliefs included in the Act. However, the Act had no effect on the refund ability of ERC for the tax year 1987. As a result, only those employees that had additional wages paid to them before the start of the tax year were entitled to a refund.
What is the general rate of refund ability of ERC?
The general rate of refund ability of ERC is 75 percent. However, there are certain conditions, which, if satisfied, may increase the rate of refund ability.
FICA and Medicare contributions must be paid to employees and a decrease of these rates at any time during the tax year, even before the start of the tax year, is a basis of increased refund ability.
An employee who was born on or before January 1, 1954, is eligible for refund ability in the first year of employment only.
The new ERC rate for this tax year is: $1,080.70 for a full-year employee, $1,059.60 for a part-year employee and $902.90 for a seasonal employee.
If an ERC claim is filed and IRS grants the claim, then the employer must refund an amount equal to the refundable amount. The amount to be refunded is based on the worker’s salary plus the following deduction for FICA and Medicare contributions:
For a full-year employee:
• Amount EROI of $2,950.60 for a full-year employee.
• $0.0725 for FICA for a full-year employee.
• $0.6836 for FICA for a part-year employee.
• $0.2879 for Medicare for a part-year employee.
• $0.0373 for Medicare for a seasonal employee.
• $0.0335 for Medicare for seasonal employee.
• $0.0272 for Medicare for seasonal employee.
In addition, employees that received payments in excess of $600 must include this amount as part of the base of the salary or salary before any increase is claimed, subject to certain terms. The following is a list of allowable claims:
- Medical payments exceeding $600
- Long-term disability payments that exceed $600
- Overtime pay exceeding $600
- Lump-sum or severance payments that exceed $600
- Insurance payments exceeding $600
- Contributions for a new child
- Payments in lieu of vacation or sick leave exceeding $600
- Payments for a permanent disability exceeding $600
- Payments for capital expenses exceeding $600
- Pension payments exceeding $600
- Payments for inflation increases
- Recoveries from forfeited vacation or sick time
The following are the allowable deductions:
- Supplemental insurance
- Social security
- Employer-provided medical, dental and vision insurance
- Medical expense deduction for under $1,000 for non-high-income individuals
- Retirement income
If the above deductions are claimed, no additional deduction is allowed for under $1,000 of deductible medical expenses.
How do I calculate the refundable amount of ERC?
In addition to the worker’s base salary, total wages paid to the employee, plus additional wages that were paid on the basis of an increase of employees’ salary from beginning of the year, are used to calculate the wage base and the employee’s EROI.
In some cases, additional wages paid to the employee were due to an increase of employees’ salary from beginning of the year. In such cases, the total additional wages are added to the employee’s base salary and the EROI. If the total additional wages were less than $1,000, no EROI is calculated.
The wage base is then multiplied by the EROI to determine the amount of ERC. ERC is calculated as the difference between the total wages paid to the employee minus the total wages paid for a previous year. If the EROI is greater than 10 for the employee’s base salary, then additional wages for a previous year must be added to the total wages paid to determine the ERC for that tax year.
What if I’m self-employed? Self-employed employees are not eligible for refundable tax credits. What if I have multiple ERC claims filed? If more than one ERC claim is filed with the IRS in a given tax year, the IRS will issue a single refundable amount to each claim based on its relative EROI. However, the following must be taken into consideration:
- Refundable income
- Health insurance contributions
- Health insurance expense deduction
- Medicare tax deduction
- Overtime pay
- Medical expenses
- Capital expenses
- Changes to working conditions
A significant change in a worker’s working conditions during the tax year may require recalculation of his or her EROI. Once the EROI is recalculated, you will need to provide documentation to the IRS. This documentation should include evidence of any changes in the working conditions, such as health insurance contributions or changes in overtime.
Why ERC might not be refundable for certain employees
Any worker with a pre-existing condition and the costs of health care covered by the worker’s employer would not be eligible to claim ERC if his or her EROI was negative. This also applies to any worker whose OPM is not high enough to make ERC repayable.
No refundable tax credit for workers with low EROI
For those who are not eligible for a refundable tax credit, the following policies apply:
- Low EROI-eligible workers may still be eligible for reduced taxes. To qualify for a reduced tax rate, a worker must have an EROI of at least 1.2.
- Employers may claim a deduction for the ERC for low EROI workers by making an ERC payment on their behalf.
- The amount paid must be greater than half of the tax for the lowest-income tax rate.
- All workers with EROI lower than 1.2 may qualify for the Earned Income Tax Credit but would not be eligible for ERC.
Benefits of Employee Retention Credit
A major benefit of the tax credit is that it encourages workers to remain with their current employers for as long as their employers want them. Therefore, it can increase overall job satisfaction and job retention in the long run. However, it is not a cure-all.
There are many reasons why workers may choose to leave their jobs. Employees can choose to leave for a variety of reasons, such as:
- Increasing family needs
- Losing a job or experiencing a layoff
- Pending promotion or salary increase
- Competition with other employers
- Workplace hazards, such as injuries, disease or unsanitary conditions
- Loss of a benefit
- Increased hours or changing work assignments
- Discontentment with their supervisor
- Willingness to earn more money
- Using your tax refund to increase your retirement savings
Benefits of Employee Retention Credit are generally tax-deductible and must be paid by the employee. The IRS also notes that wages must be paid for at least five consecutive months from the end of the tax year. In addition, ERC payments must be for the IRS required minimum and must be regular and non-cash. Note that the IRS requires proof of payment, such as a W2 or 1099, or Form 4772. While the ERC may be helpful, it is important to consult a tax professional if you are having difficulties in substantiating the ERC claim.
In summary, the IRS is proposing the following changes to the ERC rules: Eligibility for the ERC would be expanded to include most workers. The EROI would be recalculated every year by the Internal Revenue Service. Employers would be able to claim a deduction for the ERC. Taxable wages would be reduced to as little as 25% of the amount of wages paid.
Other proposals that the IRS is considering for 2022 include:
- Allowing employers to include pre-tax overtime pay in the calculation of EROI.
- Limiting the IRS to accepting proof of wage payments.
Proposals for 2019: The IRS is looking at allowing the IRS to accept electronic check payments. It’s also considering the following:
- A limit of $30 on payment installment plans or prepayment penalties.
- The amount of ERC payment that can be made by wire transfer or money order would be reduced.
- The IRS would require the employer to include more information on a tax return.
- The IRS is proposing to require employers to use the ERC information on the Form W-2 and to enter it directly into the computer.
The bottom line
There are many benefits of the IRS employee retention tax credit, and the best thing you can do is to use the credit as much as you can. However, it’s important to remember that the credit is limited in amount to offset the difference in your taxable income and the EROI of the employee. So, only claim the credit as much as you can for your situation.
If you were to use the credit at a level that would fully offset your taxable income, you would still be eligible to claim the credit. You can learn more about employee retention tax credit by visiting the IRS website or by talking to an enrolled agent. Moving forward, all taxpayers should be aware of the potential tax implications of these proposed changes. Our tax professionals will be available for questions and consultation with you. Hope to see you soon.