What Is Employee Retention Credit?

The Employee Retention Credit (ERC) is a refundable tax credit introduced under the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020. Designed to encourage employers to retain employees during periods of economic disruption caused by the COVID-19 pandemic, the ERC offered eligible businesses a significant financial incentive in the form of payroll tax relief. The credit underwent multiple changes through subsequent legislation, which expanded its scope and modified its eligibility rules.

While the ERC is no longer available for wages paid after 2021, it remains relevant due to its impact on past tax filings and ongoing eligibility for retroactive claims through amended returns.

Purpose and Origin

The ERC was part of the federal government’s broader economic response to the pandemic, aimed at mitigating mass layoffs and supporting businesses struggling to maintain operations during lockdowns and economic slowdowns. Its primary goal was to provide a financial buffer for employers that chose to retain workers despite significant revenue declines or mandatory suspensions of operations.

Introduced by the CARES Act in March 2020, the credit was one of several pandemic-era relief measures, initially overshadowed by the more popular Paycheck Protection Program (PPP). However, later legislation—especially the Consolidated Appropriations Act of 2021—made significant changes, allowing businesses that received PPP loans to also claim the ERC under certain conditions, boosting interest and participation.

Eligibility Requirements

Eligibility for the ERC varied depending on the calendar year and the legislation in effect at the time. In general, a business or tax-exempt organization qualified if it experienced either:

• A full or partial suspension of operations due to government orders related to COVID-19, or
• A significant decline in gross receipts compared to the same calendar quarter in 2019.

In 2020, a significant decline meant gross receipts were less than 50% of what they were in the same quarter of 2019. Once receipts rose back above 80%, eligibility for that period ended.

In 2021, the threshold was modified. Employers qualified if their gross receipts were less than 80% of the comparable quarter in 2019, making it easier to qualify.

Additionally, eligibility depended on employer size. In 2020, the rules distinguished between employers with 100 or fewer full-time employees and those with more. In 2021, that threshold increased to 500 employees. The distinction affected which wages qualified—those paid to working employees vs. those not providing services.

Credit Amounts and Covered Wages

The value of the ERC varied between 2020 and 2021:

• In 2020: Employers could claim 50% of qualified wages, up to $10,000 per employee for the year, resulting in a maximum credit of $5,000 per employee.
• In 2021: The credit increased to 70% of qualified wages, up to $10,000 per employee per quarter for the first three quarters of the year, allowing for a potential credit of $21,000 per employee across the year.

Qualified wages included both salary and certain employer-paid health plan expenses. The definition of wages and qualifying periods was a key factor in calculating the credit.

Interaction with Other Relief Programs

Initially, employers who received PPP loans were ineligible for the ERC. This changed with the Consolidated Appropriations Act of 2021, which allowed PPP recipients to also claim the ERC, provided the same wages were not counted for both benefits. Employers needed to carefully allocate wages to avoid double-dipping, often requiring detailed recordkeeping and amended tax filings.

Other programs, such as the Families First Coronavirus Response Act (FFCRA) and Shuttered Venue Operators Grant (SVOG), also interacted with the ERC, limiting the use of wages for multiple credits or funding sources. Employers had to be cautious when applying these provisions together.

Filing and Claim Process

The ERC was claimed by filing IRS Form 941, the employer’s quarterly federal tax return. Employers could reduce their required deposits of payroll taxes to account for the anticipated credit. If the credit exceeded the employer’s payroll tax liability, the excess was refundable, meaning the IRS would issue a payment.

For employers who discovered eligibility after filing, or who wanted to correct previous filings, Form 941-X (Adjusted Employer's Quarterly Federal Tax Return) allowed for retroactive claims. Due to processing delays and increased scrutiny, amended ERC claims could take several months for review and payment.

Common Challenges and Compliance Issues

As interest in the ERC grew, so did the complexity of claiming it. Many employers faced challenges in determining eligibility, especially around government orders, revenue calculations, and defining qualified wages. The IRS issued multiple rounds of guidance, including notices and FAQs, to clarify these points.

In late 2022 and into 2023, the IRS began warning about aggressive marketing tactics from third-party ERC consultants promising large refunds without adequate documentation. In response, the agency increased audits and compliance efforts, especially for claims that appeared inflated or unjustified. Employers are now advised to retain thorough records and consider working with qualified tax professionals before filing or amending returns.

Program End and Retroactive Claims

The ERC expired for most employers at the end of the third quarter of 2021. A narrower group of businesses known as "recovery startup businesses" could claim the credit through the end of 2021.

Despite the expiration, eligible businesses can still claim the ERC retroactively. The statute of limitations for filing amended returns (Form 941-X) generally provides three years from the original filing date, which gives employers until 2024 or 2025, depending on when the initial return was filed.

The Bottom Line

The Employee Retention Credit provided a substantial financial benefit to employers who retained staff during the economic disruptions caused by COVID-19. Though the program has ended, it remains relevant due to the availability of retroactive claims and the need for accurate documentation. Employers considering an ERC claim should evaluate eligibility carefully and ensure compliance with IRS guidance to avoid potential audits or penalties.