The COVID-19 pandemic and associated lockdowns have harmed a significant number of American businesses. Recognizing this reality, Congress created a variety of tax breaks to assist small businesses, including the recovery startup credit.
In particular, the Employee Retention Credit has provided a windfall of much-needed cash to many employers. And, with the passage of the American Rescue Plan, Congress expanded this benefit to include eligible startup businesses.
As such, we’ll use this article to discuss claiming the Recovery Startup Credit.
Specifically, we’ll cover the following topics:
- What is the Recovery Startup Tax Credit?
- Recovery Startup Credit vs Employee Retention Tax Credit
- What are the Benefits of the Recovery Startup Tax Credit?
- How to Qualify for the Recovery Startup Tax Credit
- How to Claim the Recovery Startup Tax Credit
- Final Thoughts
What is the Recovery Startup Tax Credit?
This tax credit is actually a subset of the Employee Retention Credit (ERC). In simple terms, this latter tax credit incentivizes small businesses to keep employees on their payroll during COVID-19 lockdowns. More specifically, the ERC provides eligible small businesses with a refundable tax credit based on qualified employee wages. Employers can retain funds set aside for payroll-related taxes to immediately access this cash. Or, if their allowable tax credit exceeds retained payroll funds, businesses can request a refund directly from the IRS.
When initially passed, the ERC only applied to existing businesses. However, Congress has subsequently recognized that small businesses founded during the COVID-19 pandemic have also struggled. As a result, Congress decided to expand the eligibility criteria for the ERC. By creating the recovery startup designation in the American Rescue Plan of 2021, eligible startup businesses can now qualify for a tax credit.
More precisely, the Recovery Startup Credit allows eligible businesses to qualify for up to $100,000 in total ERC funds. This total credit must apply to the ERC for Q3 and Q4 of 2021, and the credit for each quarter cannot exceed $50,000.
Recovery Startup Credit vs Employee Retention Credit
The Employee Retention Credit serves as an overarching tax credit program. Within this program, eligible employers can qualify for a refundable tax credit based on payroll tax withholdings. Congress had two primary goals in creating this tax credit. First, the credit immediately provides cash to businesses that have been hurt by the COVID-19 pandemic. Second – and related – this tax credit incentivizes these businesses to keep employees on their payroll.
The Recovery Startup Credit is not a separate tax credit program. Rather, the American Rescue Plan of 2021 used this to add an additional qualification category to the ERC: startup businesses. If your business began operations after February 15th, 2020, and meets other IRS criteria, it can qualify for the ERC via the Recovery Startup Credit.
How Does It Help?
The Recovery Startup Tax Credit allows eligible businesses to receive up to $100,000 in cash. These funds can come from payroll withholding accounts or, if necessary, directly from the IRS.
In the best of times, starting a new business comes with tremendous challenges. And, when you combine these challenges with a global pandemic and associated shutdowns, startups face major obstacles. An extra $100,000 in cash won’t guarantee startup success, but it’ll certainly help.
Best of all, startups don’t lose anything by applying for this credit. However, if you qualify, the cash you receive could make the difference between success and failure for your new business.
How to Qualify for the Recovery Startup Credit
The IRS has outlined the following three criteria for businesses to qualify for this credit:
- Began carrying on a trade or business after February 15, 2020;
- Had average annual gross receipts of $1 million or less for the 3 tax years ending with the tax year before the calendar quarter in which the employee retention credit is claimed; and
- Isn’t otherwise eligible for the third or the fourth quarter, as applicable, for the employee retention credit.
And, it’s important to note, to qualify for the ERC via the Recovery Startup Credit your business must actually have employees. As with the broader ERC, the startup-specific eligibility hinges upon businesses paying qualified wages to employees.
How to Claim It
Due to ERC-related changes between 2020 and 2021, calculating the total credit can be a complicated process. We highly recommend working with a tax professional to figure out your unique situation. Professional assistance will maximize your potential credit and ensure you don’t make any filing mistakes. With that said, here’s a high-level review of how to claim your Recovery Startup Tax Credit.
According to the IRS: Eligible employers who […] pay qualified wages eligible for the employee retention credit […] should retain an amount of the employment taxes equal to their anticipated credit for […] the employee retention credit […] rather than depositing these amounts with the IRS. As with a lot of IRS guidance, this may appear confusing to small business owners, so we’ll attempt to put it in more understandable terms.
Every pay period, employers withhold payroll-related taxes from employee pay. Typically, employers hold these funds in a designated account, paying the IRS on a quarterly basis in conjunction with Form 941, Employer’s Quarterly Federal Tax Return. Rather than make these quarterly payments, the above IRS guidance tells employers to simply withdraw the ERC funds from their payroll tax accounts.
However, not all employers will have enough cash on hand to cover their full credit. The IRS states that: If there aren’t sufficient employment taxes to retain to cover your anticipated credits, employers can file Form 7200 to request an advance payment from the IRS. As such, Form 7200, Advance Payment of Employer Credits Due to COVID-19, lets employers access tax credit cash when they don’t have enough payroll-related funds on hand.
The COVID-19 pandemic has significantly disrupted the American economy. To assist small businesses, Congress has passed a variety of tax credits. And, with the Recovery Startup Tax Credit, eligible startups can now receive much-needed cash via the broader ERC program.
While COVID-related tax credits can seem complicated, tax planning shouldn’t be a daunting task. If you’re a startup business, we can help. At Tax Hack, we live and breathe taxes for small businesses, so contact us to set up a tax savings strategy session!