What the Employee Retention Credit Actually Is

The Employee Retention Credit (ERC) is a refundable tax credit that the federal government created to help businesses keep workers on payroll during specific periods when revenue dropped or operations were disrupted. Unlike a deduction, which reduces your taxable income, a refundable credit directly reduces the taxes you owe — and if the credit is larger than your tax bill, the IRS sends you the difference as a refund.

The credit was introduced in 2020 under the CARES Act and has been modified several times since. The amount you can claim depends on how many employees you had during the may have access to period and whether your business met the conditions that triggered the credit. The IRS treats ERC refunds differently from ordinary refunds because the money comes from a specific tax credit, not from overpayment of regular income tax.

Key Takeaways

  • The ERC is a refundable tax credit, meaning if it exceeds your tax bill, the IRS sends you the excess as a refund rather than carrying it forward.
  • You can claim the credit only for quarters when your business experienced a significant revenue decline or was subject to a government order that limited operations.
  • The credit amount per employee per quarter varies by year — it was $5,000 in 2020 and $5,000 in 2021, with different rules for each period.
  • You cannot claim the ERC for wages you also claimed as a deduction on your tax return or for wages covered by a Paycheck Protection Program (PPP) loan that was forgiven.
  • The IRS has specific forms and schedules for claiming the credit, and the process differs depending on whether you are amending a prior return or claiming it for the first time.

The may have access to Periods and Revenue Tests

The ERC was available for specific quarters between March 2020 and December 2021. The first may have access to period was March 13, 2020, through December 31, 2020. The second was January 1, 2021, through June 30, 2021. A third period ran from July 1, 2021, through December 31, 2021, with modified rules.

To claim the credit for any quarter, your business had to meet one of two tests. The gross receipts test required that your total business revenue in that quarter was at least 20 percent lower than the same quarter in 2019. For example, if your business earned $100,000 in Q2 2019, you would need to show that Q2 2020 revenue was $80,000 or less. The government order test

The rules for the third period (July through December 2021) changed. Businesses could still use the gross receipts test, but the threshold became 20 percent lower than the same quarter in 2019 for the first time. Alternatively, businesses could use a modified test comparing the quarter to the same quarter in 2020, which was useful for businesses that had already recovered by 2021.

How Much You Can Claim Per Employee

The credit amount depends on which quarters you are claiming and how many employees you had. For 2020, the credit was $5,000 per employee per quarter for the first and second quarters combined (March through June 2020). For the third and fourth quarters of 2020 (July through December), the credit increased to $5,000 per employee per quarter.

In 2021, the credit was $5,000 per employee per quarter for the first half of the year (January through June). For the second half of 2021 (July through December), the credit increased to $5,000 per employee per quarter. The credit applies only to wages paid to employees, not to owner compensation or contractor payments.

The total credit you can claim is limited by the number of full-time employees you had. The IRS defines a full-time employee as someone who worked an average of at least 30 hours per week. If you had 50 or fewer full-time employees, you could count all wages paid to all employees. If you had more than 50 full-time employees, you could count only wages paid to employees who were not providing services due to the government order or revenue decline.

Wages You Cannot Use for the ERC

You cannot claim the ERC for the same wages twice. If you already claimed a deduction for wages on your tax return — such as under the Work Opportunity Tax Credit or any other tax benefit — you cannot also claim the ERC for those wages. You must reduce the ERC by the amount of any other credits or deductions you claimed for the same wages.

Wages covered by a forgiven Paycheck Protection Program (PPP) loan are also ineligible for the ERC. When the PPP rules changed in late 2020 to allow businesses to claim both the PPP forgiveness and the ERC, the IRS required that you subtract PPP-covered wages from your ERC calculation. If you claimed the ERC for PPP-covered wages and later received PPP forgiveness, you must amend your return to remove those wages from the credit.

How to Claim the ERC on Your Tax Return

If you are claiming the ERC for the first time on your current-year return, you will use Form 941-X (Adjusted Employer's Quarterly Federal Tax Return for Wages Paid to Employees) if you are amending a prior return, or you will report it on your regular Form 941 if you are claiming it on a return you have not yet filed. The form requires you to identify each quarter you are claiming, the number of employees, the total wages for that quarter, and the credit amount.

You will also need to complete Schedule R (Part III) if you are claiming the ERC. This schedule asks you to identify which test you used (gross receipts or government order) and to provide supporting documentation. For the gross receipts test, you need to show your revenue for the may have access to quarter and the same quarter in the prior year. For the government order test, you need to provide a copy of the government order or documentation showing how it affected your business.

If you already filed your return without claiming the ERC, you must file an amended return using Form 941-X for each quarter you want to claim. The IRS processes amended returns more slowly than original returns, and you may wait several months for a response. You can file Form 941-X going back three years from the date you filed your original return, or two years from the date you paid the tax, whichever is later.

The Difference Between ERC Refunds and Other Tax Refunds

An ERC refund is treated as a credit refund rather than an overpayment refund. This distinction matters because the IRS processes credit refunds through a different system and may take longer to issue them. The IRS has also increased scrutiny of ERC claims, particularly for businesses that claimed large credits relative to their size or for claims filed after the initial wave of applications.

When you receive an ERC refund, the IRS will send you a notice explaining the amount and the quarters it covers. If you claimed the credit on an amended return, the notice will show the adjustment to your prior-year tax liability. Unlike a standard overpayment refund, which you can typically receive within weeks, an ERC refund can take several months because the IRS verifies that you met the may have access to conditions before releasing the funds.

Common Mistakes That Delay or Reduce ERC Refunds

One frequent error is claiming wages that were also covered by a forgiven PPP loan. Even though the rules now allow both, you must subtract the PPP amount from your ERC calculation. If you claimed the full ERC without reducing it for PPP wages, the IRS will reduce your refund when it processes your return.

Another mistake is failing to document the government order or revenue decline. The IRS requires specific evidence: for the gross receipts test, you need actual revenue figures from your accounting records; for the government order test, you need the text of the order or a contemporaneous record showing how it affected your operations. Without this documentation, the IRS may deny the credit entirely or reduce it.

Claiming the credit for employees you did not actually have during the quarter is also common. You must count only employees who were on your payroll during the quarter you are claiming, not employees you hired after the quarter ended or employees you had in other years.

Frequently Asked Questions

Can I claim the ERC if I received a PPP loan?

Yes, but you must reduce your ERC by the amount of wages covered by the PPP loan. If your PPP loan covered $50,000 in wages and you would otherwise claim $60,000 in ERC wages, you can claim only $10,000 for the ERC. You do not need to repay the PPP loan or the ERC if you claimed both correctly.

What if I already filed my tax return without claiming the ERC?

You can file an amended return using Form 941-X for each quarter you want to claim. You have three years from the date you filed your original return, or two years from the date you paid the tax, whichever is later. Amended returns take longer to process than original returns, typically several months.

Do I need to provide documentation when I claim the ERC?

Yes. You must keep records showing either your revenue decline (for the gross receipts test) or the government order that limited your operations (for the government order test). The IRS may request these documents during processing or in a later audit. Without documentation, your claim may be denied.

What happens if the IRS denies my ERC claim?

The IRS will send you a notice explaining why the claim was denied. You can respond to the notice with additional documentation or request an appeal. If you disagree with the decision, you can file a claim in Tax Court or the U.S. Court of Federal Claims, though this requires legal representation and involves significant time and cost.

Can I claim the ERC for wages I paid to myself as a business owner?

No. The ERC applies only to wages paid to employees, not to owner draws, distributions, or compensation you paid to yourself. If you are a sole proprietor or partner, you cannot claim the credit for your own compensation.