ERC May Not Be All Free Money
The federal government established the Employee Retention Credit (ERC) to provide a refundable employment tax credit to help businesses with the cost of keeping staff employed.
Eligible businesses that experienced a decline in gross receipts or were closed due to government orders and didn't claim the credit when they filed their original return, can take advantage by filing adjusted employment tax returns.
- For example, businesses that file quarterly employment tax returns can file Form 941-X, Adjusted Employer's Quarterly Federal Tax Return to claim the credit for prior 2020 and 2021 quarters.
So, what’s the ERC catch?
First: ERC is not at all like PPP which was super easy to apply for and get 100% forgiveness.
Second: Figuring out ERC is complicated and requires an accountant to determine the correct payroll credit amount and to complete the Form 941-X Adjusted Employer's Quarterly Federal Tax Return.
Third … and here’s the catch: If you filed Form 941-X to claim the Employee Retention Credit, you must reduce your deduction for wages by the amount of the credit, and you may need to amend your income tax return (e.g., Forms 1040, 1065, 1120, etc.) to reflect that reduced deduction.
Here’s what that third point means: The amount that ERC reduces your wages, for 2020 and 2021, drops right to the bottom line as taxable income.
- If your salon/spa was profitable in 2020 and/or 2021, ERC will make it more profitable because wages were reduced. You will have to pay income tax on the profit created by ERC.
- If your salon/spa had a loss for 2020 and/or 2021, ERC can turn that loss into a profit. You will have to pay income tax on the profit.
- If your salon/spa has enough loss carry forward from previous unprofitable years, hopefully, it’s enough to offset the ERC and eliminate potential income tax.
Be prepared to pay income tax on profit created by ERC before you receive the actual funds.
Before you get too excited about the ERC money coming back to you, remember that you will likely have to pay the income tax on the ERC before the actual credit funds hit your account.
Why? Because IRS is terribly backed up processing your ERC Form 941-X Adjusted Employer's Quarterly Federal Tax Returns.
We have one coaching client that filed for ERC in July 2021 and just received her 2020 ERC funds. That’s an eight-month lag time from filing 941-X to receipt of funds. She’s still waiting for 2021 ERC funds.
Here’s the good news about ERC
Unlike PPP where you received tax-free funds, it is still extremely worthwhile to apply for ERC. Why? Because after taxes, it’s still found money that can help your company cover expenses and fund growth.
Here’s my challenge to you: Managing cash flow and building cash reserves is a discipline every owner must learn and practice.
The challenge ERC creates is having the funds in cash reserve to pay the increased income tax it creates while waiting for the funds to hit your bank account. And that wait can be a while.
If you file for ERC and don’t have the cash to pay the income tax the reduced payroll creates for the 2020 and/or 2021 tax years, ERC can put you in a cash bind until the funds arrive.
According to the latest information from the IRS, amended Forms 941 that have already been filed should expect to see a refund somewhere between 6-10 months from the filing date.