Today I am going to walk you through two parts of the tax law passed this year to a) increase the number of qualifying jobs in the state where the work is performed and b) increase the size of the EWC tax credit. I will explain what you need to know about these changes and give you a bunch of free tax planning advice on how you can take advantage of the changes in the new law. If you missed the first part of this series where I discussed the details of the new tax law, you can read that here.
But first, let’s review what the new law did. The gist of the new tax law is this:
The new law raises the employer’s taxable income so that it is no longer limited to 35% of the lesser of their total wages or W-2 wages. It then replaces the “adjusted basis” of a business with a “net investment basis.” It also changes the maximum credit, and, for the first time, the EWC refund.
What is the Employee Retention Tax Credit?
It is an income tax credit created in 2011 as part of the COVID Relief Act, which among other things extended tax benefits for Illinois workers. The idea was to incentivize employers to provide living wages and benefits, which would in turn keep those employees, including older retirees, working in the state.
Currently the maximum EWC credit is $2,000 per employee per year. Previously the maximum EWC credit was $1,600 per employee per year. When the new tax law was passed it changed that limit to $2,000 per employee per year for qualified employees who are age 21 and older.
This effectively raised the maximum EWC credit to $2,400, which should mean that if you pay more than $2,400 in qualified wages, you get the full $2,400 credit. I have included this information above for your reference.
Who Is Eligible?
What makes an employee eligible for the ERC is determined by several factors.
- First, the work must be performed in the state where the employer is located. For example, a worker who performs part of the work in California, some of the work in Illinois, and some of the work in Florida is a California resident for the purposes of the ERC.
- Second, the employee must be considered an employee for the purpose of the law. For example, if you pay a worker $500 a week, you will not be eligible to take advantage of this credit. A California resident receiving $500 per week would be eligible.
- Third, the employee must be hired and paid by the employer. Employers who do not employ any workers on a regular basis are not eligible. The same applies to contractors, or even employees who have only a contract with a labor firm.
- Next, the employee must be offered a performance-based compensation arrangement. This means that the employee must be considered a free agent in the contract. The ERC will not be available to employees who are only consultants, or who are subject to mandatory “cadillac” or guaranteed plan requirements.
- Last, the employer must pay the qualified wages. Any payments above the minimum wage, or above the overtime rate, will be excluded from the ERC.
When Can I Get The ERC?
The ERC is one of the better-known credits in the tax law, and it is one that almost every tax expert recommends that you consider taking advantage of. But there are two key qualifiers.
- First, the ERC can only be claimed for the year in which the qualified wages were earned. So if you earn more than $2,400 in qualified wages in 2016, you can’t get the ERC in 2017. For 2016 it will be an annual credit, but in 2017 it will be a lump-sum payment.
- Second, you cannot take the ERC in lieu of paying income taxes, so if you pay a worker $1,500 in wages but do not owe income taxes you cannot claim the ERC.
So if you are eligible and you aren’t claiming it, it is probably a mistake. You may want to check with your local accountant or tax preparer, since they may have a better idea of how to go about applying. But you can learn more about the ERC here.
How the credit is used
The old tax law used the modified Adjusted Gross Income (MAGI) basis, ERC (W-2 wage income), Modified Adjusted Gross Income (W-2 wage income) and Modified Adjusted Gross Income (W-2 wage income) basis, the net investment basis, or net investment income tax basis.
The net investment income tax basis requires a minimum net investment income level of $25,000 per year. For each state’s EWC which is “revenue neutral,” state business taxes are paid on a state’s income tax return. The result is a different tax liability from a “normal” business because the state’s “normal” tax is based on MAGI or MAGI plus the “comprehensive state tax” or CCGT tax rate.
If you earned your income from the state (as in selling your services or goods), it’s one thing, but if you sell your services and earn income in another state, for example, where you live most of the year, you will have to report your income as long-term investment income which is taxed at ordinary income rates (which is taxed at your personal rate) rather than the long-term capital gains tax rate.
Employee Retention Tax Credit (ERTC)
So, in a nutshell, what happened is that the old rules basically allowed taxpayers to deduct up to $4,000 of employee wages or wages paid to independent contractors as long as they had earned enough to be eligible for the EWC. And so, they received a 50% EWC tax credit for each $1,000 of wages up to a limit of $4,000.
The new law changes that. To qualify for an EWC, the taxpayer must have earned income in excess of $325,000 for an individual or $400,000 for a married couple for the tax year. In other words, if the taxpayer qualifies for an ERC in 2021, they do not qualify for the ERC in 2022.
On top of that, the net investment income tax basis changes have an even greater impact. The new law makes it possible to use the investment basis for the taxpayer’s new or existing business, and the “normal” basis for the entire “business” for the current year, whichever is greater.
However, the investment basis has a lot of restrictions, and some of the key restrictions are these:
- The new investment income doesn’t get included on a prior year return, it gets included on a current year return. So, what gets included on a prior year return can’t be included on a current year return.
- A taxpayer’s current tax deduction doesn’t get “rolled” over. In other words, it can’t get deducted twice.
- You have to use the net investment income to establish the investment basis and you can’t use the “normal” business investment income. So, any business investments would be considered “standard” and non-deductible.
And, finally, you don’t get to keep any investment income. All of it gets included in your business’s net investment income and “amounts owed for tax purposes” (as reported on a Form 1040) is based on the investment income at the end of the year. So, at the end of the year, you’ll need to figure your liability based on all of your business’s net investment income and all of that is reported on the company’s Form 1040.
Interest on Debt
There are also a few changes to interest paid on debt.
- First, you can no longer deduct interest on home mortgages. Note, however, that mortgage interest is still deductible on a note related to a rental property, so you may still be able to deduct the interest on the loan, even if the home you’re buying is a rental property.
- Second, while you can still deduct interest on student loan interest payments, if you’re a sole proprietor, you can no longer deduct any interest payments on any individual debt, including personal loans and credit cards.
Consult your tax advisor to see whether your circumstances have changed, and if so, to make sure that you have enough time to meet all your annual tax reporting deadlines.
Special Congressional Supplement
Since many taxpayers take the standard deduction on their federal tax return and are not subject to a personal exemptions, they might need some extra money for various other items, ERC s included. The Special Congressional Standard Supplement allows taxpayers to file for an additional exemption on Form 1040, line 21.
If you want to claim the additional exemption and you’re a single filer, you will have to file Form 1040, Line 23. If you’re married filing jointly, you’ll need to file Form 1040, Line 24. And, if you have qualifying children (or children who are otherwise treated as qualified dependents for tax purposes), you’ll need to file Form 8332.
Changes in ERTC s and Guidelines
Congress made some changes to the ERC rules. The new rules are as follows:
- First, it became possible for a taxpayer to qualify for a new ERC in the same tax year as they qualify for the standard ERC. The new ERCs would not be reflected on a prior year’s return.
- Second, a $1,000 exemption has been removed from all ERCs.
The Form 8332 has also changed. Before, you needed to file an ERC. Now, you can file a Standard Schedule 1, line 21 EPC. You don’t have to file an ERC. The Form 8332 will provide additional information that would be helpful to a tax preparer when determining your ERC (such as sources of ERC income).
Useful, but Not Easy
Making your federal tax return more efficient is good for your bottom line, but it’s also a lot of work. Efficient tax preparation doesn’t mean that you’ll get perfect results every time. But you should always understand your options and try to make your tax return as simple as possible, so that you don’t have to do too much of your own tax work. A CPA can also help you to ensure that your taxes are accurate and complete, and that you know how to avoid any mistakes that could result in a penalty, an audit, or even an audit and tax bill.
Why ERC Changes in Part 2 Are Important
Making the right decision about whether to itemize your deductions or to take the standard deduction can be critical for taxpayers to be able to take advantage of the tax benefits offered by the tax law. For instance, even though you might not be subject to the limitations for the Alternative Minimum Tax (AMT), you still may have to pay some tax, especially if you aren’t subject to the AMT. If you did not claim the AMT in 2017, you won’t owe any tax in 2018. But if you didn’t claim the AMT in 2017, you might be subject to the AMT in 2018.
You’ll need to decide whether you’re eligible for a small business deduction and whether you should take the standard deduction. Another thing to consider is whether you need to pay an estimated tax payment for 2018 (and in some cases, 2016). Your credit-card statements might show that you’ve already paid, and if you didn’t pay, you might have to pay some interest and penalties.
Learn more about choosing the right line item, and make sure you understand all the implications of the new tax law. You can get an ETC update, find your estimated tax payment, and use the ERC to itemize for 2022 on IRS official site.
Bottom line
The Employee Retention Tax Credit (also known as the COVID Relief Act) is a worthwhile credit. You can use it to offset income taxes, and it can be a big boost to your tax bill if you meet the requirements.
Once you do qualify for the credit, it can be a big boost to your pocketbook, but that is not to say it is easy to get it. There are two main conditions to qualifying:
1) the qualifying wages must be earned in the state where you work and
2) you must be a full-time employee.
Hope you like the article and, if so, please share it on social media!