How to prepare for the early end of the employee retention tax credit

The most significant tax impact of the approval of the Infrastructure Investment and Jobs Act on November 15, 2021, is the early termination of the employee retention tax credit program. Created as part of the Coronavirus Aid, Relief and Economic Security Act, the ERTC was meant to encourage businesses to retain employees via a tax credit offered through the end of 2021.

However, the infrastructure bill moved the end date of the incentive up from Jan. 1, 2022, to Oct. 1, 2021, meaning small and midsized businesses will be unable to collect the credit for wages paid after Sept. 30, 2021. The early termination of the ERTC will raise an estimated $8.2 billion from businesses overnight, according to the Joint Committee on Taxation.

While the ERTC’s maximum credit per employee was originally $28,000, accelerating the end of the credit retroactively to October 1, 2021, effectively reduces the maximum credit available to eligible employees to $21,000.

This unanticipated retroactive early end of the ERTC has complicated the recovery of thousands of small businesses. Many small companies who have planned budgets based on receiving the credit through the end of 2021 are now scrambling. Businesses that retained Q4 taxes for October and November 2021, for example, in anticipation of receiving the ERTC for the quarter, will need to repay those amounts. 

Understanding ERTC

The ERTC was originally established in the CARES Act in March 2020. It was then extended and expanded in the $900 billion pandemic relief bill passed in December 2020, and again during the American Rescue Plan in March 2021. 

What is ERTC? It is a fully refundable payroll tax credit that eligible businesses can claim for wages paid to employees in 2020/2021 during the pandemic. It aims to help employees retain employees on their payrolls.

How does the credit work? Affected employers can claim ERTC from the beginning of the COVID-19 pandemic, wherein they receive a refund of up to $5,000 per employee in 2020 and up to $7,000 per employee per quarter in 2021. 

Unlike the Paycheck Protection Program and other retention credits extended by Congress, ERTC funding is realized as a direct cash tax refund. This provided latitude to business owners in how they used the funding to bounce back from the fallout of the COVID-19 pandemic. In fact, many companies reinvested in the business, including revamping business models and considering technology upgrades to operate in the evolving digital economy, absorbing increased supply costs and wage increases.

How did it perform? Awareness of ERTC has only recently begun gaining steam after it was extended through the end of 2021 and its eligibility extended to businesses who also have received a paycheck protection loan. Still, even before all that, the IRS by the end of February had processed 102,422 tax returns for 2020 claiming employee retention credits totaling $4.5 billion.

Next steps

While the ERTC program without a doubt helped the hardest-hit businesses stay afloat, its retroactive suspension creates potential issues for businesses, particularly those who remained eligible for the credit in October and early November 2021.

Here’s how you can prepare for possible tax consequences ensuing from the premature end of ERTC:

Reassess eligibility

It’s a retroactive change, so the first thing organizations should do is immediately and thoroughly vet their eligibility to ensure they have maximized the periods still covered under current tax law.

Determine whether your business qualifies

Despite being eligible for the ERTC, many businesses have still not filed their claims. This is mainly because of the complexity of the program due to multiple revisions of guidance documents, and the abundance of misinformation among the public.

To clarify, businesses can be eligible if they:

A) Saw a significant decline in gross receipts.

B) Experienced full or partial suspension of the operation due to government orders or mandates in the wake of COVID-19.

Be ready to pay some taxes back

If you have been reducing employment tax withholdings at your business in anticipation of claiming the ERTC in the fourth quarter of 2021, be ready to pay the money back.

Be mindful of the Build Back Better Act

A large number of tax provisions are still making their way through Congress under the Build Back Better Act. Make sure to evaluate your tax position as soon as possible to avoid any adverse impacts to your business or estate.