ERC Recovery Startup Business: Here's How To Claim Your Refundable Tax Credit

Unlock the potential of your ERC recovery startup business by claiming your refundable tax credit—here's your simple, step-by-step guide!

ERC Recovery Startup Business: Here's How To Claim Your Refundable Tax Credit
Photo by John Schnobrich / Unsplash

The Employee Retention Credit (ERC) is a boon for recovery startup businesses looking to navigate the challenging economic terrain. This federal tax credit incentive was designed to encourage companies to retain their employees during periods of a notable decline in gross receipts or full/partial suspension of business due to government orders. As a recovery startup, you can benefit from this provision if your business was started after February 15, 2020, and if you can demonstrate an average annual gross receipt under $1 million.

An eligible employer for the ERC can save your business a significant amount on payroll taxes. For 2021, under the American Rescue Plan Act, the tax credit equals 70% of qualified wages up to $10,000 per employee per quarter. This means eligible startup businesses can claim up to $7,000 per employee every quarter, a substantial saving that can be redirected toward business growth, infrastructure investment, and innovation. Understanding and leveraging this opportunity can make all the difference to your existing business' financial health.

Recovery Startup Business Definition

A recovery startup business is a new venture established during or following an economic downturn or crisis. Such startups are characterized by their innovative approach to overcoming the challenges posed by the situation, often through leveraging new market opportunities that emerge due to changing consumer behaviors or industry shifts.

Crucially, these recovery startup businesses are not just surviving the crisis but actively working towards revitalizing the economy. They often focus on sectors experiencing accelerated growth due to the situation, such as digital services, remote work solutions, and health and wellness industries. Their agility, resilience, and ability to adapt quickly to the changing landscape set them apart from traditional businesses.

What Are Employee Retention Credit Eligibility Requirements For Recovery Startup Businesses?

Requirement 1: Business Started After February 15, 2020

As a fundamental eligibility factor, the business should have begun operations after February 15, 2020. Companies that pre-date this timeline need to meet the requirement of a recovery startup business.

Requirement 2: Annual Gross Receipts Up To $1 Million

To qualify for the Employee Retention Credit, recovery startup businesses must be at most an average annual gross receipts under $1 million. This ceiling ensures that the benefits of this federal tax incentive are accessible to small and medium-sized startups.

Requirement 3: Significant Decline in Gross Receipts

A recovery beginning business must demonstrate a sizable decrease in gross receipts in the year 2021 compared to the same calendar quarter in the year 2019 to qualify for the refundable tax credit. The deduction must be at least 20% for the company to qualify.

Requirement 4: Full or Partial Suspension Due to Government Orders

Recovery startups may also be eligible for the Employee Retention Tax Credit if government orders have caused complete or partial suspension of their operations. This condition primarily pertains to government restrictions or mandates related to the COVID-19 pandemic.

Remember, the Employee Retention Tax Credit regulations and guidelines can be complex and differ based on specific circumstances. Therefore, it's always advisable to consult with a tax expert or an ERC specialist to ensure you meet the requirements and get the most out of this valuable credit.

Special Rules and Limitations for Recovery Startups in the Employee Retention Credit

While the ERC tax credits provide a substantial lifeline for recovery startups, it's important to note that they also come with special rules and limitations.

Rule 1: Maximum Credit per Quarter

For recovery startups, the maximum ERC that can be claimed is $50,000 per quarter. This limit applies irrespective of the number of employees you have. So while the credit is calculated as 70% of qualified wages up to $10,000 per worker per quarter, your total claim as a recovery startup must be, at most, the $50,000 cap.

Rule 2: Interplay with Paycheck Protection Program (PPP)

Recovery startups that received a PPP loan should know they can't double-dip. This means wages paid with forgiven PPP loan proceeds do not qualify for the ERC. However, you can claim the ERC for wages not covered by the PPP loan, provided other eligibility criteria are met.

Rule 3: Relation with Other Employer Tax Credits

ERC cannot be claimed for the same wages used to claim other employer tax credits. For instance, if you claim a Work Opportunity tax credit (WOTC) or a Family and Medical Leave credit for certain wages, the same wages cannot be used to calculate the ERC.

Limitation 1: Use of Third-Party Payers

Recovery startups using a third-party payer like a payroll service provider or professional employer organization (PEO) should ensure they are the ones claiming the credit, not the third-party payer.

Limitation 2: Wages Paid to Certain Relatives

While most wages are eligible for the ERC, there's an exception for wages paid to certain relatives of the employer. This includes children, siblings, and parents, among others.

Remember that tax legislation can be intricate, and staying in compliance with all the rules and limitations of the ERC can be challenging. It's recommended to seek the guidance of a knowledgeable tax advisor who can help you navigate these complexities and maximize your ERC benefit.

Eligible Expenses For Employee Retention Credit

ERC-eligible expenses comprise those costs directly associated with keeping an employee on the payroll. They can be broadly categorized as follows:

  1. Salaries and Wages: Most credit covers employee wages, including salaries, commissions, and tips.
  2. Health Plan Costs: The portion of qualified health plan expenses the employer pays is also eligible for the credit. This includes insurance premiums for health, dental, and vision plans.
  3. Allocated Tips: If your business is in an industry where tipping is expected, like restaurants, the tips given to employees can be included as part of the credit.
  4. Specific Employer Contributions: Contributions made to a 401(k) or similar retirement plan on behalf of an employee can be included as part of the eligible expenses.

Remember, every business is different, and what qualifies as an eligible expense can vary based on specific circumstances. Therefore, it's always advisable to consult with a tax professional to ensure you're accurately calculating your qualified costs for the ERC.

What Are The Benefits Of ERC For Recovery Startup Business

The Employee Retention Credit (ERC) offers several benefits to a recovery startup business:

  1. Cash Flow Boost: The ERC can provide an immediate source of cash, given that eligible employers can get quick access to the credit by reducing employment tax deposits they are otherwise required to make. Also, if the employer's employment tax deposits are insufficient to cover the business claim, the employer may collect an advance payment from the IRS.
  2. Ease of Financial Pressure: For startups struggling to maintain operations due to the financial impact of the pandemic, the ERC can ease some of the pressure by offsetting some staffing costs. This allows businesses to retain employees and continue operations without the added financial burden.
  3. Encourages Job Retention: The ERC gives startups a powerful incentive to retain employees during this challenging period. The credit enables businesses to keep their workers employed by providing substantial funding towards employee wages.
  4. Potential for Future Savings: If the business experiences a loss in one year but profits in the next, it can carry back the loss to offset the taxable income from the profitable year. This means that the ERC could result in future tax savings.
  5. Promotes Economic Recovery: The ERC indirectly supports economic recovery by helping startups stay afloat and maintain their workforce. This is because startups play a crucial role in job creation and innovation, both critical drivers of economic growth.
  6. Flexibility: The ERC provides flexibility for businesses, as it can be claimed quarterly. This lets companies adapt to changing circumstances and take advantage of the credit when it's most beneficial.

Remember, this isn't an exhaustive list, and the benefits can differ based on the specific circumstances of your business. Always consult a tax professional or an ERC specialist to understand how to leverage the ERC best.

Calculation of ERC Tax Credit for 2020 and 2021

ERC Calculation for 2020

For 2020, the Employee Retention Credit was designed to support employers financially affected by the pandemic. This credit is computed based on 50% of the eligible salaries paid to the workers between March 13 and December 31 of the tax year 2020. However, the total credit claimed per employee was capped at $5,000 for the entire year.

Employers had to include all wages given to employees when their operations were either wholly or partially interrupted owing to a governmental order linked to COVID-19 or when they saw a significant decline in gross receipts to assess this.

ERC Calculation for 2021

The rules have changed for the year 2021. For qualified wages paid between dates January 1, 2021, and June 30, 2021, the credit rate was raised to 70% of qualifying wages, and the cap on per-employee credit was increased to $7,000 per quarter or $14,000 for the first two quarters of the year.

For the third and fourth calendar quarters of tax year 2021, the refundable credit calculation remains at 70% of qualifying wages, with the cap at $7,000 per quarter per employee, but the eligibility criteria were adjusted. A business may qualify if it suffered a total or partial shutdown of operations, a sharp decline in sales, or if it qualifies as a recovery startup business, which is defined as a company established after February 15, 2020, and having average annual gross receipts of less than $1 million.

Remember, the definition of qualifying wages can vary depending on the number of employees and the business's specific circumstances, so it's always recommended to consult with a tax professional when calculating your Employee Retention Credits. You can also visit the ERTC Express website and ask for some help.