Employee Retention Tax Credit (ERTC): What It Means for Employers

What it means in practice

What the credit was. The IRS describes the ERC, which it says is sometimes called the Employee Retention Tax Credit or ERTC, as a refundable tax credit for certain eligible businesses and tax-exempt organizations that had employees and were affected during the COVID-19 pandemic. Any credit above the employer's share of payroll taxes was refundable as an overpayment. It was created by section 2301 of the CARES Act in March 2020 and amended three times, with the American Rescue Plan Act of 2021 moving the rules for the second half of 2021 into section 3134 of the Internal Revenue Code. Public Law 119-21 added enforcement rules in 2025. Only wages paid from March 13, 2020, through December 31, 2021, can qualify. This page does not decide whether any employer qualified.

Which payroll tax it offset. Under CARES Act section 2301(c)(1), the credit for 2020 and the first half of 2021 was applied against the employer share of Social Security tax under section 3111(a); see Social Security tax. For the third and fourth quarters of 2021, section 3134(c)(1) applied it against the employer share of Medicare tax under section 3111(b); see Medicare wages and tips. Employees' withheld taxes were never reduced by the credit.

Who could be an eligible employer. The IRS comparison chart says any employer operating a trade or business or a tax-exempt organization could be eligible, but not governments, their agencies and instrumentalities. For 2021 quarters, certain governmental employers were added: organizations described in section 501(c)(1), and colleges, universities and entities whose principal purpose is providing medical or hospital care. The IRS FAQs say employees, retirees, self-employed people with no employees, household employers and employers that paid no wages in the qualifying periods are not eligible.

The three ways to qualify. According to the IRS, an employer had to meet one of these tests for a given quarter. (1) Its operations were fully or partially suspended by an order from an appropriate governmental authority limiting commerce, travel or group meetings due to COVID-19, during 2020 or the first three quarters of 2021. (2) It had the required decline in gross receipts in the same periods. (3) It was a recovery startup business in the third or fourth quarter of 2021. The FAQs say recommendations are not orders, voluntary closures do not count, and a supply chain problem alone does not qualify. The IRS treats a partial suspension as "more than nominal" when at least 10% of the business, by gross receipts or employee hours, was suspended, or when an order caused at least a 10% reduction in the ability to provide goods or services. Masking or one-way aisles do not meet that standard. An employer suspended for part of a quarter is eligible for the whole quarter, but may count only wages paid during the suspension.

The gross receipts test. For 2020, section 2301(c)(2)(B) and the IRS FAQs say eligibility began in the first quarter in which gross receipts were less than 50% of the same quarter in 2019 and ended after the quarter in which they were more than 80% of the same 2019 quarter. For 2021, section 3134(c)(2) required gross receipts below 80% of the same 2019 quarter, an employer may elect to compare the immediately preceding quarter instead, and an employer not in existence in 2019 may compare with 2020.

Recovery startup businesses. Section 3134(c)(5) defines a recovery startup business as an employer that began carrying on a trade or business after February 15, 2020, with average annual gross receipts of no more than $1,000,000 for the prior three taxable years. The IRS FAQs say such a business can claim only for the third and fourth quarters of 2021, up to $50,000 per quarter. Notice 2021-65 explains that after the November 15, 2021 amendments, employers other than recovery startup businesses are not entitled to the credit for wages paid on or after October 1, 2021.

What counted as qualified wages. The IRS says qualified wages must be wages subject to Social Security and Medicare taxes and reportable on Form W-2, so payments to independent contractors on Form 1099-NEC never count. Qualified wages can include allocable employer-paid group health plan costs. Large employers had a narrower rule: for 2020, an employer averaging more than 100 full-time employees in 2019, and for 2021, one averaging more than 500, could count only wages paid to employees who were not providing services. Notice 2021-20 uses the section 4980H definition of full-time: at least 30 hours of service per week or 130 hours in a month. For the third quarter of 2021, section 3134(c)(3)(C) let a "severely financially distressed employer," one with gross receipts below 10% of the same 2019 quarter, treat all wages as qualified.

Wages that are excluded. The IRS FAQs say wages paid to related individuals of a majority owner, including children, siblings, parents, in-laws and household members, are not qualified wages, and Notice 2021-49 explains when a majority owner and spouse are also treated as related. Payroll costs reported to obtain Paycheck Protection Program loan forgiveness cannot also be used for the ERC, up to the amount forgiven, and wages reported as payroll costs for a shuttered venue operators grant or restaurant revitalization grant are excluded.

How the credit was claimed. The IRS says the only way to claim the ERC is on a federal employment tax return: the original Form 941 or, for an earlier quarter, Form 941-X (Form 943-X, 944-X or CT-1X for other filers). See prior period adjustment for how Form 941-X works. The IRS will not process a claim if no original return was filed, or if Forms W-2 were due and never filed.

Why the deadlines are April 15. The Form 941-X instructions say overreported tax can generally be corrected within 3 years of the date Form 941 was filed or 2 years from payment, whichever is later, and that Forms 941 for a calendar year are treated as filed on April 15 of the next year. That is why the instructions say the period generally expired for ERC corrections on April 15, 2024, for 2020 wages and April 15, 2025, for 2021 wages, and why the current Form 941-X no longer explains the ERC lines.

What the July 2025 law changed. Section 70605 of Public Law 119-21, signed July 4, 2025, made four changes that the IRS and the statute describe. (1) Under section 70605(d), no credit under section 3134, the third and fourth quarters of 2021, can be allowed or refunded after enactment unless the claim was filed on or before January 31, 2024. IRS Fact Sheet 2025-07 says this applies even if the employer otherwise met eligibility requirements, does not affect claims refunded or credited before July 4, 2025, and does not block an amended return withdrawing an ERC. A claim counts as filed on time if it was postmarked and properly mailed or submitted by January 31, 2024. A disallowance comes on Letter 105-C and can be appealed. (2) The assessment period for third and fourth quarter 2021 credits now runs at least 6 years after the latest of the original return's filing date, its deemed filing date, or the date the claim was made, replacing an earlier 5-year rule. (3) A "COVID-ERTC promoter," defined largely by refund-based fees and the share of its gross receipts from ERC work, faces a $1,000 penalty for each failure to meet due diligence requirements; certified PEOs are excluded. (4) The 20% penalty under section 6676 for an excessive refund claim now covers employment tax as well as income tax, for claims made after enactment.

Processing pause and current status. On September 14, 2023, the IRS announced an immediate moratorium on processing new ERC claims through at least the end of 2023, and said the processing goal for existing claims would move from 90 to 180 days. In August 2024 the FAQs said the IRS would start processing claims filed between September 14, 2023, and January 31, 2024. As of the week ending October 3, 2026, the IRS reports about 13,000 remaining claims: 750 under review, 2,300 pending payment or disallowance, 3,000 under audit, 5,400 awaiting review of disallowance responses and 1,500 with Appeals.

Withdrawal and voluntary disclosure. The IRS withdrawal process lets an employer ask the IRS not to process an adjusted return filed only to claim the ERC, if it withdraws the whole claim and the claim has not been paid or the refund check has not been cashed. The IRS says withdrawn claims are treated as never filed and no penalties or interest are imposed. It does not cover credits claimed on an original Form 941 or partial reductions. Two ERC Voluntary Disclosure Programs have closed. The first ended March 22, 2024, and let participants keep 20% of the claimed credit (Announcement 2024-3). The second ended November 22, 2024, was limited to 2021 claims credited or refunded before August 15, 2024, and required repaying 85% (Announcement 2024-30).

Income tax effect. Notice 2021-20, Question 60, says the employer's deduction for qualified wages is reduced by the credit, while Question 61 says the credit itself is not included in gross income. The IRS FAQs give two examples. Business A claimed a $700 credit on $1,000 of 2021 wages, did not reduce its 2021 deduction, and was paid in 2024: it can include $700 in gross income on its 2024 return instead of amending 2021. Business B reduced its 2021 deduction but the claim was disallowed in 2024 and it did not contest: it can increase its 2024 wage expense by the amount it reduced. IR-2022-89 notes possible reasonable-cause penalty relief when the extra income tax came due before the refund arrived.

Example 1 (illustration): 2020 cap. An eligible small employer paid one employee $12,000 of qualified wages across the 2020 quarters in which it qualified. Only $10,000 counts for the year, so the credit for that employee is 50% x $10,000 = $5,000.

Example 2 (illustration): 2021 quarters. The same employee is paid $12,000 of qualified wages in the first quarter of 2021 and $8,000 in the second. The first quarter counts $10,000, a $7,000 credit; the second counts $8,000, a $5,600 credit; the total is $12,600, under the $14,000 maximum Notice 2021-23 gives for those two quarters.

Promoter warning signs. The IRS lists unsolicited ads, eligibility checks "in minutes," large upfront fees, fees based on a percentage of the refund, preparers who refuse to sign the return, and claims that "every business qualifies." Suspected abusive promoters can be reported on Form 14242.

Disallowance letters. The IRS says Letter 105-C is its legal notice disallowing an ERC claim. An employer that disagrees can request review by the Independent Office of Appeals or file suit in a U.S. District Court or the Court of Federal Claims, generally within two years of the letter; an appeal does not extend that period, but Form 907 can.

Recordkeeping. The IRS FAQs list the records relied on, including the specific government order, gross receipts figures, which employees received qualified wages and how much, and PPP forgiveness documents. The Form 941-X instructions say employment tax records are generally kept at least 4 years, but records for ERC wages paid after June 30, 2021, and before January 1, 2022, should be kept at least 7 years because of the longer assessment period.

Federal only. The ERC is a federal credit with the same rules in every state. Qualifying government orders could come from local, state or federal authorities, but the credit was claimed only on federal employment tax returns.

Question: Does withdrawing a claim end criminal exposure? No. The IRS says withdrawing a willfully fraudulent claim does not exempt anyone from potential criminal investigation and prosecution.

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