Employee Retention Credit | About this Refundable Tax Credit

August 13, 2026 by Veselina Arangelova, EA

If you own a business, you will agree with the sentiment that it is a challenging endeavor. And, in recent memory, nothing was more challenging than owning a business when the COVID-19 pandemic brought the world to a halt. Like no other major event in the past, it made it impossible for businesses to go about their daily routine and deliver products and services to clients.  

During that time, you may have heard about the Employee Retention Credit or ERC – a government measure introduced to help alleviate the financial pressure on businesses to keep their employees, well, employed. Confusion around this credit is common, especially given how often the rules change and the increased IRS scrutiny of businesses who want to take advantage of this credit. 

 

What is the Employee Retention Credit?

The Employee Retention Credit was a refundable payroll tax credit introduced by Congress in March 2020 as part of the CARES Act to encourage employers to keep their employees on the payroll during the extended period of economic disruption caused by the pandemic. And unlike other emergency funding available to businesses (i.e. loans), the ERC does not have to be repaid, provided it was claimed correctly. The only qualifying years for the credit are 2020 and 2021, and no new claims can be made by business owners. 

Like individual refundable credits, the ERC credit first offsets payroll taxes owed and, if it exceeds the taxes due, the excess amount can be refunded to the employer as cash.

By virtue of being a business tax credit, the ERC was not available to individual taxpayers. It applied only to businesses and certain tax-exempt organizations that had employees. Self-employed individuals could not claim the credit for their own compensation, but they may have been able to claim the credit for wages paid to employees. 

 

Who Qualified for the Employee Retention Credit? 

Eligibility for the ERC was determined on a quarterly basis. An employer needed to meet at least one of the following tests during 2020 or the first three quarters of 2021. 
 

• The business was fully or partially suspended due to COVID-19. 
• The business experienced a significant decline in gross receipts compared to 2019. 
• The business was qualified as a recovery startup business (limited situations). 

Full or Partial Suspension by Government Order 

An employer could qualify if a federal, state, or local government orders limited commerce, travel, or group meetings due to COVID-19 and caused the business to suspend operations fully or partially. Examples include restaurants forced to close indoor dining, retail stores subject to capacity restrictions, or businesses unable to operate normally due to mandatory closures. 

 

Significant Decline in Gross Receipts 

An employer could also qualify based on a drop in gross receipts compared to the same quarter of 2019. The required decline depended on the year and, for 2021, only the first three quarters fell within the scope of the credit. 
 

• In 2020: Gross receipts declined by more than 50% compared to the same quarter of 2019. 
• In 2021: Gross receipts declined by more than 20% compared to the same quarter of 2019. 

Imagine your favorite hairstylist, who owns a studio in town that is usually fully booked. In 2020, for most of the year, the studio was closed due to pandemic restrictions. If they continued to pay their employees but undoubtedly experienced a significant decline in monthly revenue due to the closure, they may be eligible to claim the ERC credit. To demonstrate the significant decline in receipts, they will have to compare the same months in 2020 to the baseline year 2019.  

 

What Wages Counted for the ERC Credit? 

Only qualified wages counted toward the Employee Retention Credit. What qualified depended on the size of the employer. And size was determined based on the number of full-time employees the business had in 2019 prior to the pandemic. 
 

• A small business employer could count wages paid to all employees during eligible quarters. 
• A large business employer could count only wages paid to employees when they were not providing services. 

It is important to note that the rules changed for 2020 and 2021 when it comes to employers' size. It was possible that a business, considered a large employer in 2020, suddenly became a small employer in 2021. That is because the definition of small vs. large employer changed when the full-time employee threshold increased from one year to the next.  

 

How Much Was the Employee Retention Credit Worth? 

The maximum amount of credit depended on the year, and the wages paid by the employer. 
 

• In 2020: Up to $5,000 per employee for the entire year. 
• In 2021: Up to $21,000 per employee for the year, or $7,000 per employee per quarter.  

You may be thinking, “Wow, that is a big change!” And it is. As noted in the previous paragraph, the rules were expanded to cover more employers and provide additional relief to businesses facing the financial strain caused by pandemic-related shutdowns. 

Although the ERC program has ended, it still matters because many claims are being processed, audited, or disputed by the IRS. The IRS has warned about improper claims and continues to review filings, making thorough documentation essential for eligible employers.

For a general explanation of how individual refundable tax credits work, you can revisit our previous article: What is a refundable tax credit? and if you need help with a notice or a letter from the IRS, check out our membership page for more information.