ERC Eligibility & Claims — Maximizing Your Employee Retention Credit

What Is the Employee Retention Credit?

The Employee Retention Credit (ERC) is a refundable payroll tax credit originally established under the CARES Act in March 2020 and subsequently expanded by the Consolidated Appropriations Act (CAA) in December 2020 and the American Rescue Plan Act (ARPA) in March 2021. The credit was designed to incentivize employers to keep employees on payroll during periods of economic disruption caused by COVID-19 government orders and revenue declines.

For 2020, eligible employers could claim up to $5,000 per employee for the full year. For the first three quarters of 2021, the credit increased to up to $7,000 per employee per quarter — a potential $21,000 per employee. Recovery startup businesses could claim the credit for Q3 and Q4 of 2021, even without meeting the suspension or gross receipts tests.

Despite the program's expiration for wage payments, employers can still claim the ERC retroactively by filing amended payroll tax returns (Form 941-X). However, the IRS has dramatically increased scrutiny of ERC claims, placing a moratorium on processing new claims in September 2023 and launching a dedicated enforcement initiative targeting improper filings. The result is a landscape where legitimate claims are delayed alongside fraudulent ones — and employers need legal counsel to ensure their claims are properly documented and defensible.

ERC Eligibility Criteria

Full or Partial Suspension Test

An employer qualifies under the suspension test if a governmental order related to COVID-19 caused a full or partial suspension of business operations during any calendar quarter. A full suspension means the business was ordered to shut down entirely. A partial suspension means the business could continue operating but a more-than-nominal portion of operations was suspended due to the government order.

The partial suspension analysis is where most eligibility disputes arise. The IRS requires employers to identify the specific government order, demonstrate that it applied to their operations, and show that the suspended portion of operations was more than nominal — generally meaning more than 10% of revenue or hours of service. Supply chain disruptions qualify if a supplier was subject to a government order that prevented them from delivering critical goods or materials, and the employer could not readily obtain those supplies from an alternative source.

Gross Receipts Test

An employer qualifies under the gross receipts test if it experienced a significant decline in gross receipts compared to the same calendar quarter in 2019. For 2020, the threshold was a decline of more than 50%. The CAA reduced this threshold to more than 20% for quarters in 2021, substantially expanding the pool of eligible employers.

Gross receipts are determined using the employer's normal accounting method and include all receipts from operations — not just taxable income. The comparison period is the same quarter in 2019 (or 2020 for certain 2021 quarters if the employer did not exist in 2019). Employers should document their gross receipts calculation thoroughly, as the IRS compares claimed figures against filed returns during examination.

Large vs. Small Employer Distinction

The distinction between large and small employers directly affects which wages qualify for the credit. For 2020, a small employer had 100 or fewer average full-time employees in 2019. For 2021, this threshold increased to 500 or fewer. Small employers can claim the credit on all employee wages — whether the employee was working or not. Large employers can only claim the credit on wages paid to employees who were not providing services due to the suspension or revenue decline.

This distinction is critical. A business with 600 employees in 2019 that experienced a partial suspension can only claim the credit on wages paid to employees during periods they were not working. Misclassifying employer size is one of the most common errors in ERC claims, and the IRS specifically targets this issue during audits.

Recovery Startup Businesses

The ARPA created a special category for recovery startup businesses — employers that began operations after February 15, 2020, and have average annual gross receipts of $1 million or less. These businesses can claim the ERC for Q3 and Q4 of 2021 without meeting the suspension or gross receipts test, with a maximum credit of $50,000 per quarter. This provision was designed to support new businesses that launched during the pandemic and never had a pre-COVID baseline for comparison.

Interaction with PPP

Originally, employers who received a Paycheck Protection Program (PPP) loan were disqualified from claiming the ERC. The CAA retroactively changed this rule, allowing employers to claim both — but not on the same wages. This means employers must carefully allocate wages between PPP forgiveness and ERC claims to avoid double-dipping, which the IRS treats as an improper claim.

The wage allocation analysis is technical and requires coordinating the PPP covered period, forgiveness application, and ERC qualifying periods. Many early ERC claims filed by payroll companies and ERC mills failed to properly account for PPP overlap, creating liability for employers who relied on those filings.

Common Eligibility Errors

The IRS has identified patterns of improper claims that drive their enforcement priorities. The most common errors include: claiming the credit without a qualifying government order (general economic hardship does not qualify); incorrectly calculating gross receipts (using net income instead of gross receipts, or comparing wrong quarters); failing to account for PPP wage overlap; misclassifying employer size; and claiming credits on wages paid to owner-employees or related individuals, which are subject to special attribution rules under IRC §267.

If your claim was prepared by an ERC promoter or mill, an independent legal review is essential — not because every mill-prepared claim is wrong, but because the documentation supporting those claims is often insufficient to survive an IRS examination.

The Amended Return Process (Form 941-X)

ERC claims are filed by submitting Form 941-X (Adjusted Employer's Quarterly Federal Tax Return) for each qualifying quarter. The form must be filed on paper — there is no electronic filing option. Each quarter requires a separate 941-X, and the form must include a detailed explanation of the eligibility basis and wage calculation.

The IRS moratorium on processing new ERC claims means current processing times are measured in months, not weeks. Claims filed before the moratorium are being processed, but the IRS is applying heightened scrutiny and requesting supporting documentation before issuing refunds. Having an attorney prepare or review your 941-X filing — with proper legal memoranda supporting each eligibility test — significantly reduces the risk of denial or audit adjustment.

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