A Guide To California Employee Retention Credit [Full Breakdown]

As a response to the economic challenges brought about by the COVID-19 pandemic, the U.S. government introduced the Employee Retention Credit (ERC) as part of the CARES Act in March 2020. This refundable payroll tax credit has undergone several updates through the Relief Act, the American Rescue Plan, and the Infrastructure and Jobs Act, and has provided much-needed financial relief for businesses since 2020.

An overview of the gross receipts test

This is the most straightforward way to determine your eligibility for the Employee Retention Credit (ERC). The gross receipts test evaluates whether an employer has experienced a significant decline in gross receipts during specific quarters in 2020 and 2021 when compared to the same quarter in 2019.

For 2020, a business is considered an eligible employer for ERC purposes if its gross receipts in any quarter are less than 50% of the corresponding 2019 quarter. For 2021, a business is considered eligible for the ERC if its gross receipts in any quarter have dropped by more than 20% compared to the same quarter in 2019.

In Notice 2021-23, the IRS has outlined the alternative quarter election rule, which allows employers to fulfill the gross receipts test in 2021 by comparing the preceding quarter to the corresponding quarter in 2019. This notice also clarifies that employers who did not exist at the start of the 2019 quarter can use the corresponding 2020 quarter for comparison.

What is the suspended operations test for ERC?

Unlike the gross receipts test, the suspended operations test is very nuanced and requires careful attention to detail to ensure proper interpretation and adherence. To qualify under the suspended operations test, a business must have experienced a full or partial shutdown in 2020 or 2021 due to a government order related to COVID-19.

A shutdown is considered to have occurred when a government order specifically directed a business to restrict access to its location or forced it to reduce its level of operations compared to 2019. If only a portion of the business was closed while another area remained open, the business may qualify for ERC under a partial shutdown. For this to happen, the shutdown must have affected more than a nominal portion of the business.

A nominal portion is defined as either:

1. The gross receipts from that portion of the business being equal to or greater than 10% of the company's total receipts for that quarter (when compared to 2019), or
2. The hours of service performed within that portion of the business comprise 10% or more of the company's total service hours for that quarter (when compared to 2019).

If a business did not experience a shutdown but made modifications in response to a direct government mandate, it could still explore the nominal impact test. A modification is considered to have "more than a nominal impact" on business operations if it results in a 10% or more reduction in the ability to provide goods or services during normal business hours.

Keep in mind that CDC guidelines and OSHA rules are generally not considered valid grounds to claim the ERC, as the suspended operations test requires a government mandate. Additionally, businesses may be eligible for the ERC if they were unable to obtain critical materials from suppliers because the suppliers were required to suspend operations.

It is essential to understand that ERC eligibility is based on the specific circumstances of each business, and it's crucial to consult with a tax professional about the unique facts and circumstances surrounding your operations. Remember to maintain documentation supporting your ERC eligibility, as the IRS may investigate claims in the future.

What about claiming ERC as a Recovery Startup Businesses?

Recovery Startup Businesses (RSBs) are a unique category of businesses that can qualify for the ERC for the third and fourth quarters of 2021.

As described in Notice 2021-49, to be considered an RSB, a business must:

1. Have started carrying on their trade or business after Feb. 15, 2020.
2. Have average annual gross receipts averaging under $1 million for the three tax years preceding 2021.
3. Not be otherwise eligible for the ERC due to suspended operations or a gross receipts decline.

Calculating gross receipts for RSBs that started in 2020 involves dividing the gross receipts by the time in business, multiplying the result by 12 to annualize it, and comparing the result to the $1 million threshold.

RSBs cannot double-claim the ERC using the same wages. They can receive up to $7,000 per employee per quarter, with a maximum of $50,000 per quarter for the third and fourth quarters of 2021.

Business acquisitions, mergers, or spin-offs may be eligible for the ERC as RSBs if the event occurred after Feb. 15, 2020, and all other RSB requirements are met. However, RSB eligibility can vary, and it's essential to consult a tax expert and maintain supporting documentation for validation purposes.

Calculating qualified wages for the ERC

Qualified wages, in the context of Employee Retention Credit (ERC) eligibility, refer to the wages and compensation paid to employees that can be used to claim the ERC. The qualified wages differ based on the size of the employer:

1. For employers with 100 or fewer full-time employees in 2019 (500 or fewer in 2021): Qualified wages include wages and compensation paid to all employees, regardless of whether they were working or not, during the period of eligibility (i.e., when the business experienced a significant decline in gross receipts or had suspended operations due to a government order).
2. For employers with more than 100 full-time employees in 2019 (more than 500 in 2021): Qualified wages only include wages and compensation paid to employees who were not working during the period of eligibility (i.e., they were furloughed or had their work hours reduced due to the business experiencing a significant decline in gross receipts or having suspended operations due to a government order).

To calculate qualified wages for ERC eligibility, follow these steps:

1. Determine the number of full-time employees in 2019 (or 2021, depending on the applicable period) to understand which category your business falls into.
2. Identify the period of eligibility when your business experienced a significant decline in gross receipts or had suspended operations due to a government order.
3. Calculate the total wages and compensation paid to all employees during the period of eligibility.
   
4. Keep in mind the maximum credit limits for each employee: up to $5,000 per employee in 2020 and up to $7,000 per employee per quarter in 2021.

By calculating qualified wages, you can determine the amount of ERC you're eligible to claim during the relevant periods. Ensure that you maintain proper documentation to support your ERC claim and consult the ERC team at MBS Accountancy for guidance tailored to your specific circumstances.

Has the ERC expired?

The IRS generally gives you three years from the date you filed your original return or two years from the date you paid the tax to file an amended federal employment tax return. However, the 2021 American Rescue Plan Act extended this limitation for ERC claimed for the third and fourth quarters of 2021. As we’ve explained in our blog post on the ERC’s expiration date, this means that the expiry date for the ERC is April 15, 2024 for qualifying 2020 quarters and April 15, 2025 for qualifying 2021 quarters.

How to retroactively claim the ERC

The Employee Retention Credit (ERC) presents a valuable opportunity for California business owners seeking financial relief amidst challenging economic conditions. 

This lucrative tax incentive, designed to mitigate the impact of COVID-19 on employers, offers up to $5,000 per employee in 2020 and up to $7,000 per employee per quarter in 2021. With such substantial potential savings, the ERC has become one of the most attractive tax relief measures available. 

For California businesses navigating the ongoing effects of the pandemic, the ERC is a much-needed financial lifeline that can help you ensure business continuity and provide a short-term financial boost.

Here are the steps you can take to retroactively claim the ERC for your California business:

1. Confirm eligibility for the ERC, either through the gross receipts test, the suspended operations test, or as a Recovery Startup Business.
2. Calculate your qualified wages, based on the size of your company in 2019 or 2020.
3. Gather documentation: Collect relevant payroll records, financial statements, and any documentation related to government orders that led to suspended operations. This information will be necessary to support your claim.
4. File an amended return: To retroactively claim the ERC, you'll need to file an amended payroll tax return. This typically involves filing IRS Form 941-X, "Adjusted Employer's Quarterly Federal Tax Return or Claim for Refund." Complete this form with the necessary information and adjustments to claim the ERC.
5. Keep records: Retain all documentation related to your ERC claim, including payroll records, financial statements, and any correspondence with the IRS. This will be important if your claim is reviewed or audited by the IRS.

Do you need help with the ERC? Contact MBS Accountancy!

Because navigating the ERC can be complex, we recommend that you consult with one of our tax professionals to ensure you accurately navigate the process. This ERC can be a highly lucrative opportunity but you must maintain compliance with the relevant regulations. Here are some examples of ERC amounts we’ve helped clients claim:

• A hotel management company claimed $35, 391 when they qualified for the last three quarters of 2020.
• A sports shop received $58, 255 for the first two quarters of 2021.
• A farmer received $81, 055 for the last three quarters of 2020 and the first quarter of 2021.

Contact us today to learn more about our ERC services!