GAAP and Accounting Best Practices for the Employee Retention Credit

A calculator sitting on documents with graphs and charts, representing GAAP accounting for Employee Retention Credit information
Table of Contents

Key Takeaways:

  • You can still claim the Employee Retention Credit (ERC), if you qualify, for three years from when you submitted your original tax return
  • GAAP is a set of principles that govern how businesses approach accounting in the United States, though it doesn’t have specific guidelines for the ERC
  • The 10 GAAP principles are:
    • Principle of Regularity
    • Principle of Consistency
    • Principle of Sincerity
    • Principle of Permanence of Methods
    • Principle of Non-compensation
    • Principle of Prudence
    • Principle of Continuity
    • Principle of Periodicity
    • Principle of Materiality
    • Principle of Utmost Good Faith
  • Nine ways to approach ERC accounting:
    1. Recognize that the ERC is a payroll tax credit
    2. Learn the difference between the ERC and a loan
    3. Know when to recognize the revenue
    4. Consider subtopic 958-605
    5. Understand IAS 20
    6. Be consistent with your PPP loan reporting
    7. Use the GAAP loss recovery model for retroactive ERC
    8. Meet all disclosure requirements
    9. Pay attention to future guidance
  • Laws and guidelines can get complicated fast when you’re reporting the ERC, so make sure you talk through your options with an ERC expert

Companies are still navigating the COVID-19 pandemic and its accompanying economic crisis. One of the key tools at their disposal is the Employee Retention Credit (ERC). This tax credit is designed to help employers support their workforce and keep people on the payroll. One component businesses may miss about the ERC, however, is how to report it properly.

A set of generally accepted accounting principles, called GAAP for short, is the standard method businesses use for accounting in the United States. The basic principle behind GAAP accounting is that expenses are incurred when the benefits are received, not necessarily when cash is paid out. This means that if an employer receives income, they must recognize it on their financial statements even if they haven’t received the cash.

Employers should continue to follow GAAP principles and follow certain guidelines when recording expenses, such as accurately tracking ERC eligibility (including employee wages and health insurance costs), allocating administrative costs related to the program, separating taxable from nontaxable amounts, and distinguishing between regular payroll versus bonus payments.

There are no specific guidelines about the ERC from GAAP. This guide, however, walks through the basics of the ERC and GAAP and best practices to follow for your accounting approach.

How to Claim the ERC

You first need to determine whether you qualify for the ERC. There are two ways you can qualify:

  • Your business had to close, fully or partially, because of a government order in 2020 or 2021, or
  • You lost at least 50% in gross receipts in 2020, or 20% in 2021, when compared to the same quarter in 2019

The ERC for 2020 is 50% of qualified wages, which can be up to $10,000 per employee per year. The ERC for 2021 is 70% of qualified wages, up to $10,000, per employee per quarter. This means that for 2020, the maximum ERC you can receive is $5,000 per employee per year, and for 2021, the maximum is $21,000 per employee per year (or $7,000 per quarter).

The ERC ended on Sept. 30, 2021, for most businesses, though you can still claim it retroactively. You may be eligible for the first three quarters of 2021, but not the fourth. However, recovery startup businesses can claim that last quarter. These businesses started after Feb. 15, 2020, and make less than $1 million in gross receipts.

You could have originally claimed the ERC on your tax return, Form 941, but claiming it retroactively requires using Form 941-X to amend your payroll tax return. You have three years from when you filed your initial tax return to submit the amendment and receive the ERC. Don’t forget to talk to an ERC or tax professional who can help you understand these requirements further.

What Is GAAP?

GAAP is the standard system of rules used to record and report financial information. The Financial Accounting Standards Board (FASB) issues GAAP. This set of principles is essential for companies to accurately track their expenses, assets, and liabilities. Companies within the United States must follow these principles when generating financial statements.

GAAP also allows for a common language to be used when discussing finances with investors, creditors, and managers, helping to ensure all stakeholders have a clear understanding of the company’s financials. GAAP accounting helps businesses remain compliant while providing a reliable basis on which investors can make decisions.

Using a set of accounting principles for the ERC helps businesses ensure their compliance and accuracy with the rules set by the IRS. Businesses can be sure they qualify for the credit and are meeting all IRS guidelines. Being diligent ensures they track expenses, liability, and income from tax credits so they can take full advantage of the program and maximize their savings.

GAAP doesn’t provide specific guidelines for how for-profit companies should report ERCs, however, so they may have to use another accounting standard for this and other forms of government relief that came about during the pandemic. These options are discussed more below.

Ten Principles of GAAP Accounting

Part of the reason GAAP exists is to ensure companies act honestly and accurately in their accounting practices, and that there is consistency in how they do things. These are the primary 10 principles included in GAAP:

  1. Principle of Regularity: This principle ensures a company’s accounting approach follows GAAP standards
  2. Principle of Consistency: Practices need to be both consistent and comparable so each reporting period has similar information
  3. Principle of Sincerity: All accounting components need to accurately reflect the company’s financial information
  4. Principle of Permanence of Methods: Accounting practices and procedures are the same throughout all tracked periods
  5. Principle of Non-Compensation: Companies must report all financial performance information, both good and bad, with complete transparency, and there should be no assumption of debt compensation
  6. Principle of Prudence: Financial information needs to be based on facts, realistic, and up to date, without bringing in assumptions or speculation 
  7. Principle of Continuity: Financial data is provided based on the expectation that the business will continue to run moving forward
  8. Principle of Periodicity: Accounting entries should be made so accounting periods are consistent and routine, and the information is appropriate for each period
  9. Principle of Materiality: Complete, truthful financial information must be provided in reports, including valuing assets at cost
  10. Principle of Utmost Good Faith: All involved parties are honest in accounting reports and processes

GAAP helps accountants and companies ensure their reporting methods are accurate, clear, and helpful. The only downside is that GAAP doesn’t always issue guidelines for every relief program or credit that comes up, like the ERC. You do, however, have other options for reporting related to this credit, discussed next.

Nine Ways to Approach Accounting for the ERC

GAAP, as mentioned above, doesn’t provide specific guidelines for ERC reporting. Businesses, both for-profit and not-for-profit, however, can follow other guidelines for reporting. Here are several ways to approach ERC accounting, along with a few tips:

1. Recognize the ERC Is a Payroll Tax Credit

It’s first important to know that the ERC is a payroll credit, not an income credit. The FASB standards don’t have the same guidance for these types of credits as they do for income taxes.

2. Learn the Difference Between the ERC and a Loan

The ERC also isn’t a government loan, like the Paycheck Protection Program (PPP). It is a refundable credit, even when a business gets a credit advance. This means the ERC isn’t reported as debt under ASC Topic 470.

3. Know When to Recognize the Revenue

Businesses should record the ERC in their financial statements when they figure out they are eligible for the ERC and will probably receive it. They should record the revenue for their amount of ERC that applies to the given period at hand.

4. Consider Subtopic 958-605

Subtopic 958-605 within GAAP provides a revenue recognition approach that allows credits to be treated as conditional contributions to the organization. This is typically for not-for-profit organizations to use, but for-profit organizations can use this method as a guideline to report the ERC as a state grant. Businesses can recognize contributions when certain conditions are met, like being adversely impacted by COVID-19 or sustaining payroll costs to retain employees.

5. Understand IAS 20

Not-for-profit organizations can’t use the IAS 20 model, which is the International Accounting Standard 20, but for-profit businesses can, again reporting the ERC as a state grant. They don’t recognize the credit until they meet a “reasonable assurance” threshold for getting the credit and meeting certain ERC conditions.

6. Consistency With PPP Loan Reporting

A PPP loan and the ERC are different forms of income, but if you used either Subtopic 958-605 or IAS 20 to report the PPP loan, you should use the same method for reporting your ERC.

7. Use the GAAP Loss Recovery Model for Retroactive ERC

One issue that comes up with reporting ERC credits is that a business may not have known they qualify in a former year, so they’re unsure how to report the credit for those past accounting periods. Businesses can use GAAP’s loss recovery model for retroactively applying the ERC credits.

8. Meet Disclosure Requirements

Subtopic 958-605 comes with certain disclosure requirements that need to be followed closely. All details about the ERC program, amounts received, accounting method you used, and how you’ve included the credit within your financial statements need to be disclosed.

9. Pay Attention to Future Guidance

The FASB still may provide guidance to businesses relating to the ERC and other pandemic-introduced relief programs. Pay close attention to any coming updates that may arise in the near future relating to the ERC.

Remember to closely follow the guidelines and principles of the method you decide to use to report ERC income. You never want any information you provide or report to be misleading, inaccurate, or not based on facts. Contact an ERC expert who can help you understand the best way to move forward with ERC accounting.

Contact ERC Today With Questions About Accounting and the ERC

All these moving parts can seem complex, but there are plenty of resources available online for businesses looking for guidance on how best to manage the ERC in accordance with GAAP and beyond. The IRS website has a lot of helpful information about the ERC and payroll credits, while other organizations like the American Institute of Certified Public Accountants can provide more specific ERC advice.

Reporting the ERC correctly ultimately requires knowledge of both business law and GAAP accounting principles. Doing your research and consulting with professionals allows you to take advantage of this valuable tax credit while complying with government regulations and avoiding endangering your company’s reputation and finances.

Don’t forget to claim the ERC within the allowed time frame, which is three years from the date you initially filed your tax return, or two years from when you paid the tax, whichever is later. You have the potential to receive up to $26,000 per employee across 2020 and 2021 if you qualify for each quarter.

Claiming the ERC doesn’t have to be a headache. Work with ERC Today to receive expert guidance on eligibility requirements, the filing process, and receiving your fully refundable credit from the IRS.

Learn more about the ERC process by reaching out to ERC Today or completing our easy online application.

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