Understanding Refundable Tax Credits and the ERTC

Key Takeaways:

• • The ERTC is a refundable tax credit that expired in 2021. You can still claim this credit retroactively if you meet eligibility requirements and paid employees qualified wages in 2020 or 2021.

• • Refundable tax credits allow you to get a refund, even if the credit is more than your tax liability. 

• • Nonrefundable tax credits do not give you a refund amount greater than what you owe in taxes.

• • Four examples of refundable tax credits:
    1. 1. Earned income tax credit
    1. 1. Child tax credit
    1. 1. American opportunity tax credit
    1. 1. ERTC

• • Four examples of nonrefundable tax credits:
    1. 1. Adoption tax credit
    1. 1. Child and dependent care credit
    1. 1. Residential energy credit
    1. 1. The saver’s credit

• • Tips for refundable tax credits include staying up on changing legislation, understanding the difference between credits and deductions, and claiming the ERTC retroactively by the deadline.

One of your biggest goals as a business owner is to pay the least amount of tax legally possible each year. You want to minimize what you have to send to the IRS to save money for your business and continue growing. 

Tax credits exist to help businesses and individual taxpayers reduce their tax liability. There are all kinds of credits available, many based on how much money you make, how impacted you are by economic crises that arise, how many employees you have, and other factors. 

The employee retention credit (ERTC) was created in response to the COVID-19 pandemic, and it is the government’s most extensive stimulus program ever. Eligible businesses could potentially qualify for tens of thousands of dollars as a refundable credit across 2020 and 2021. 

How does it work, and what does a refundable versus nonrefundable credit mean? This guide walks you through everything you need to know.

What Is the ERTC?

The ERTC is a refundable credit created during the pandemic, initially by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) in 2020 and then extended by the American Rescue Plan Act of 2021. Most eligible businesses can claim the credit for qualifying wages paid from March 13, 2020, to September 30, 2021.

This tax credit was meant to help businesses keep their employees on the payroll. To qualify, businesses must meet these requirements:

• • They had to suspend operations, at least partially, because of a government order.

• • In 2020, their gross receipts were at least 50% less than their receipts in 2019, and in 2021, at least 20% less.

The ERTC is half of the qualified wages in 2020, and for each worker, the limit is $10,000 for all quarters. The ERTC is 70% for 2021, and the limit per employee is $10,000 per quarter. 

So, the maximum credit per employee per year in 2020 is $5,000, and it’s $21,000 for 2021. Eligible employers can still use Form 941-X to claim the credit for a qualifying quarter and amend the original tax return they filed.

This credit is fully refundable. This means you can receive a cash payment from the IRS for the full credit, even if part of it was used to cover your tax liability. More on that in the next section.

Elements of Refundable Tax Credits

Understanding refundable versus nonrefundable tax credits is key to understanding the ERTC. Both of these credits may lower what you owe the IRS for taxes in a given year.

However, they do have some differences. Here’s a breakdown of these two types of tax credits:

Refundable Tax Credits

These tax credits are fully refundable to the taxpayer. This is true if the taxpayer owes money to the IRS to cover their tax liability as well as if they do not owe anything.

Refundable credits can cover whatever the taxpayer owes, and if there’s anything left, they get that amount back in cash from the IRS. They will receive the full tax credit as a refund if they don’t owe any tax that year. These credits are treated like tax payments, similar to payroll withholding.

Nonrefundable Tax Credits

In contrast, nonrefundable credits are used to offset what the taxpayer owes in taxes. This means that if they owe something to the IRS and the nonrefundable credit covers what they owe, they don’t receive any additional credit. In other words, a taxpayer would not receive what’s left in the credit amount after the tax liability has been covered.

Partially Refundable Tax Credits

The third category includes partially refundable credits. This means that a credit could be refundable up to a certain percentage. The American Opportunity Tax Credit (AOTC), for instance, is refundable at 40%.

All this means that a refundable tax credit can give taxpayers a refund bigger than what they paid in taxes all year. They would then have a negative tax obligation and get the remaining credit in cash. Nonrefundable credits do not pay a taxpayer whatever is left over after the tax liability has been paid.

The ERTC is a refundable credit. So, if the credit covers just some of your tax liability, you can still get the rest of the credit as a cash payment. Talk to an ERTC expert if you’re unsure how much ERTC you’re eligible for.

Four Examples of Refundable Tax Credits

So, which tax credits are refundable? There aren’t as many refundable credits as there are nonrefundable, but you still may qualify for these common refundable tax credits:

1. Earned Income Tax Credit (EITC)

The earned income tax credit (EITC) provides a maximum of $6,935 to taxpayers with relatively low incomes. You must meet certain income, employment, family size, and filing status requirements. You also can’t have over $10,300 in investment income for 2022.

2. Child Tax Credit

The 2022 child tax credit allows eligible taxpayers to get up to $2,000 for each of their children and a partial refund of a limit of $1,500. This credit is now back to the original credit that was in place before the COVID-19 pandemic. 

The government had allowed for advance monthly payments in part of 2021 because of the American Rescue Plan Act, but those payments have now ended.

3. American Opportunity Tax Credit (AOTC)

The AOTC is a partially refundable credit, as mentioned, at 40%. Taxpayers can get up to $2,500 in total credits in 2022. Your income must be no more than $80,000 for single filers and $160,000 if married filing jointly. The credits then phase out through $90,000 for single filers and $180,000 for joint filers.

4. ERTC

Finally, the ERTC is another example of a refundable tax credit. This credit ended on September 30, 2021, for most businesses, but continued until the end of 2021 for startup recovery businesses. However, you can still claim the ERTC for three years following the date of your original tax return filing.

Knowing which credits are refundable or partially refundable can help you plan for tax time. These credits allow you to get a refund, even if the credit is more than your tax liability. Talk to a tax professional if you have questions about claiming the ERTC.

Four Examples of Nonrefundable Tax Credits

Remember that nonrefundable credits don’t extend beyond your tax liability. There are many more nonrefundable credits than refundable ones. Here are a few examples of nonrefundable tax credits:

1. Adoption Tax Credit

This credit allows taxpayers who adopt a child in 2022 to claim up to $14,890 to help them pay for associated court expenses, travel costs, attorney fees, and other expenses. You have to have a modified adjusted gross income of no more than $223,410 to qualify for the full amount. 

2. Child and Dependent Care Tax Credit (CDCTC)

The child and dependent care tax credit (CDCTC) was created for people who are working while taking care of a child under 13. In 2022, the credit is $3,000 for one dependent and $6,000 for two or more. The credit is meant to credit taxpayers with some of the money they spend paying someone else to take care of their child.

3. Residential Energy Credit

Some home improvements that create energy efficiency may qualify for this credit, including installing solar electricity, water heaters, energy-efficient windows, and roof materials, among others. This credit is 26% of your qualifying expenses.

4. The Saver’s Credit

The saver’s credit is also known as the retirement contribution savings credit. The IRS created it to get people to save for retirement, particularly those with lower incomes. The credit is 10%, 20%, or 50% of the total savings contributions, with a limit of $1,000 for single filers and $2,000 for those who are married filing jointly.

These credits and their terms change from year to year. Make sure you research how the IRS may have altered eligibility requirements, limits, or the refundable/nonrefundable status.

Other Tips for Refundable vs. Nonrefundable Tax Credits

Tax credits can be tricky to understand, especially with so many eligibility requirements to follow and changing laws. These tips will help you break everything down so you’re taking advantage of all tax breaks available to you:

• • Pay close attention to qualification requirements. You can only take advantage of refundable and nonrefundable tax credits if you meet all the requirements surrounding your income level, family size, business type, and others. Ensure you qualify before trying to claim a credit. For instance, you can only claim the ERTC if you paid qualifying wages to employees and meet business eligibility requirements.

• • Watch changing legislation. Tax law unfortunately doesn’t stay consistent from year to year. Rates increase alongside raises to income thresholds. Credits may exist one year and be gone the next. This is especially true during periods like the pandemic or a recession when the government creates stimulus programs to support individual taxpayers, families, and businesses. Keep up on the latest legislation so you know what you can claim and how requirements have changed.

• • Understand how tax credits like the ERTC may benefit you. Tax credits serve multiple purposes for taxpayers, including lowering their tax bill or giving them a big refund. Each situation is different, so you should talk to a tax expert about your tax goals so you know how you’ll be using credits to your advantage.

• • Learn the difference between deductions and credits. Many taxpayers confuse these terms. They’re both types of legal tax breaks, alongside exemptions or exclusions. The difference is that deductions are applied to your taxable income. You can lower what you owe in taxes by reducing your income this way. Credits, on the other hand, either lower your tax liability or give you a higher tax refund.

• • Claim the ERTC retroactively if you qualify. Some credits allow you to claim them retroactively if you didn’t claim them in the applicable year. The ERTC, while over in 2022, might still be available to you for 2020 and 2021. Make sure you meet qualification requirements, but you can likely claim the credit through 2024 for each quarter you paid qualifying wages to employees.

Never leave tax credits to chance. It’s best to discuss your situation with an ERTC professional before moving forward. You want to ensure you file everything correctly to maximize the impact of your tax credits.

Contact an ERTC Expert with Questions 

The success of your business depends on the right approach to your taxes and finances. Preparing for tax time is something you should prioritize all year. The pandemic took its toll on business owners, but tax credits like the ERTC aimed to help businesses stay afloat. 

Make sure you claim the ERTC retroactively while you still have time. Other tax credits may be refundable or nonrefundable, and you need to know the difference to plan for what your tax liability will be each year. 

Talk to the team at ERC Today when you have questions about claiming the ERTC. We help you understand what requirements are in place, if you qualify, and how to start the application process to claim the credit. We can answer any questions you may have about the ERTC. 

Receiving Employee Retention Credits can be a game-changer for your business. Apply now! 

Contact ERC Today for more information about your Employee Retention Credit options.