How To Determine Qualified Wages For The Employee Retention Tax Credit

If you’re a small business owner interested in claiming the Employee Retention Credit (ERC), an important part of calculating your credit is understanding qualified wages.

This post focuses on qualified wages for the Employee Retention Credit. We’ll discuss what counts as qualified wages, what doesn’t count as qualified wages, and how to calculate the amount of your ERC using qualified wages. Keep reading to learn more.

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What Are Qualified Wages For The Employee Retention Credit? The Quick Answer

Qualified wages are wages that were paid to employees and are used to calculate the ERC. When you apply for the ERC, qualified wages are used to determine the amount of your refund. Qualified wages are wages paid between March 15th, 2020, and September 30th, 2021. Businesses that qualify as recovery startup businesses may also have qualified wages for October 1, 2021, through December 31, 2021.

What Wages Qualify For The Employee Retention Credit?

There are several different kinds of wages that are counted when you qualify for the ERC. This includes salaries, tips, and even certain benefits.

Before calculating qualified wages, you first need to determine if you qualify for ERC by paying wages during a full or partial business shutdown or after experiencing a significant decline in gross receipts. Here’s what you need to know.

Wages Paid During A Full Or Partial Suspension Of Business Operations

If your business experienced a partial or full suspension OR experienced a significant decline in gross receipts and you continued to pay your employees, your business may qualify for the ERC. Here’s a breakdown of qualified wages for 2020 and 2021:

• Qualified wages for 2020 must have been paid between March 15th, 2020, and December 31st, 2020
• Qualified wages for 2021 must have been paid between January 1st, 2021, and September 30th, 2021
• Qualified wages for 2021 may extend through December 31, 2021, for recovery startup businesses

Wages Paid By A Business Experiencing A Significant Decline In Gross Receipts

Businesses that experienced a significant decline in gross receipts from 2019 to 2020 or 2021 are eligible to claim the ERC. The IRS defines a significant decline in gross receipts differently for 2020 and 2021.

In 2020, the IRS defined a significant decline in gross receipts as a calendar quarter that is 50% less than the same calendar quarter in 2019. Once your gross receipts are greater than 80% compared to the corresponding 2019 calendar quarter, the period of significant decline ends in the NEXT calendar quarter. For example, if your business meets the 8o% threshold in February, the period of significant decline ends in April.

In the Relief Act of 2021, the IRS defined a significant decline in gross receipts as a quarter where gross receipts are less than 80% of the same quarter in 2019. If your business didn’t exist in 2019, the IRS allows you to determine a significant decline in gross receipts by comparing the calendar quarter in 2021 to its gross receipts in the same calendar quarter in 2020.

In the American Rescue Plan Act of 2021, the IRS amended the credit to make it available in the third and fourth calendar quarters of 2021 to “recovery startup businesses” who otherwise did not meet the previously stated eligibility criteria.

In the Infrastructure Investment and Jobs Act (IIJA), the IRS created limited availability for the fourth calendar quarter of 2021 to recovery startup businesses.

Wages Subject To FICA Taxes

Only wages that are subjected to the Federal Insurance Contributions Act U.S. Federal Payroll Tax (FICA) are considered qualified wages.

Wages that are subject to FICA taxes include:

• Cash wages (salaries, hourly wages)
• Tips earned in a calendar month that total to more than $20
• Vacation pay
• Certain health insurance expenses

Health Expenses That Count As Qualified Wages

Certain health expenses are also considered qualified wages. The definition of these qualified health plan expenses is vast and technical and you can read the IRS FAQ document about tax credits for paid leave prior to April 1, 2021.

Qualified health plan expenses are defined as amounts paid or incurred by the employer to provide and maintain a group health plan. However, these expenses are limited to amounts excluded from the gross income of employees.

What Wages Don’t Qualify For The Employee Retention Credit?

The majority of regular wages are considered qualified wages when applying for the ERC. However, there are a few exceptions.

Wages Exempt From Social Security & Medicare Taxes

Wages that are exempt from Social Security & Medicare Taxes are not considered qualified wages and cannot be applied toward the ERC.

Wages Paid To Former Employees

If you paid wages to former employees that are no longer employed by you during the specified timeframe, those are not considered qualified wages and cannot be applied to the ERC.

Wages Paid To Relatives

Wages that you paid to relatives do not count as qualified wages and cannot be applied toward the ERC. If you are a small business owner or co-own with a family member, you might run into issues with this category of wages.

The IRS defines a relative as:

• A child or grandchild
• A sibling or stepsibling
• Parent or grandparent
• Stepparent
• A niece or nephew
• An aunt or uncle
• In-laws

Wages Used For Other Tax Credits

Wages that are used towards other tax credits do not count as qualified wages and cannot be applied toward the ERC. This includes paid family leave medical credit, the Work Opportunity Tax Credit, and qualified sick and/or family leave credits.

If you have wages that were covered or that you expect to be covered by a Paycheck Protection Program (PPP) loan, those wages are also not considered qualified wages and cannot be applied towards the ERC.

What Is Full-Time Equivalent When Claiming The ERC?

The IRS defines a full-time employee as an employee who works at least 30 hours per week or 130 hours per month. Knowing how many employees you have is critical to calculating your ERC refund.

Calculating FTE For The Employee Retention Tax Credit

In 2020, 50% of qualified wages up to $10,000 per employee are eligible for the ERC. The maximum credit per employee is $5,000 for the entire year. The number of FTE impacts what wages are considered qualified wages:

• For businesses with 100 or fewer average FTE
  • Wages paid to employees providing services AND wages paid to employees not providing services are counted as qualified wages.
• For businesses with more than 100 average FTE
  • ONLY wages paid to employees not providing services are counted as qualified wages.

In 2021, the rules changed to allow employers to count up to 70% of qualified wages up to $10,000 per employee per quarter for the ERC. The maximum credit per employee is $7,000 per quarter (or $21,000 for the year). As previously mentioned, recovery startup businesses may also be eligible to claim the credit for Q4 2021.

Again, the number of FTE impacts what wages are counted as qualified wages:

• For businesses with 500 or fewer average FTE
  • Wages paid to employees providing services AND wages paid to employees not providing services are counted as qualified wages.
• For businesses with more than 500 average FTE
  • ONLY wages paid to employees not providing services are counted as qualified wages.

The Bottom Line On Determining Qualified Wages For The Employee Retention Credit

This post should give you a better understanding of how to determine qualified wages for calculating your ERC refund.

If you paid qualifying wages in 2020 and/or 2021, the next step is to file your amended return and claim your ERC. If you don’t think you can handle the task alone, you have options. Talk to your accountant or a tax professional if you have any questions about whether your business qualifies, how to calculate the credit, or how to file form 941-X.

FAQs About Determining Qualified Wages For The ERC