Employee Retention Tax Credit: Updates and Impact of 2025 Tax Law

With its signing in July 2025, the tax and spending law — aka H.R. 1 — changes aspects of the Employee Retention Tax Credit (ERTC), including provisions regarding enforcement and the extension of time the Internal Revenue Service (IRS) has to audit previously paid out claims. The biggest change the law makes is closing the program retroactively for certain filers. If a business owner filed a claim for the third and fourth quarters of 2021 that was received after Jan. 31, 2024, these claims will not be paid out.

Impact of Changes to ERTC Under New Law

Businesses that filed ERTC claims might be impacted in several ways:

Missed the New Filing Deadline

The new law could create confusion for businesses that filed claims for quarters three and four of 2021. Some businesses filed prior to the January deadline, had their claim rejected due to error, and then re-filed again after Jan. 31, 2024. It is unclear whether the IRS will use the original filing date or the later filing date to determine whether to process and pay a refund on the claim. The original filing deadline for Tax Year 2021 was April 15, 2025, but changes were introduced by various laws during the past two presidential administrations. Recovery Startup Businesses, which originally were entitled to file claims in the fourth quarter of 2021, also will be impacted by this deadline change.

Extending the Audit Period

The new tax law extends the length of time for the IRS to audit claims that have been paid out. The U.S. tax agency now has six years instead of three to five years from the original filing date to conduct an audit. Businesses that received refunds should plan on saving records for a longer period.

Other Businesses Affected

Unfortunately, businesses that filed legitimate claims after Jan. 31, 2024, deadline will not have their claims processed nor expected refunds paid out. Businesses that do not qualify under the deadline change could be hampered in other ways, including budget shortfalls based on funds anticipated from an ERTC claim. This could force some businesses to shutter operations or result in decreased staffing to offset a lack of funds.

Is the Withdrawal Program Still in Effect?

The Withdrawal Program is no longer in effect. Introduced by the IRS to help businesses pull back their claim if a business believed it wasn’t eligible to make one. Many of these claims resulted from businesses dealing with ERTC mills. Amended returns for 2021 eligible quarters needed to be filed by April 15, 2025, and amended returns for eligible 2020 quarters needed to be filed by April 15, 2024. Claims could be withdrawn if businesses met all the following:

• Made a claim on an adjusted employment tax return (e.g., Forms 941-X, 943-X, 944-X, CT-1X)
• Filed an adjusted return only to claim ERTC without making any other adjustments
• Wanted to withdraw the entire amount of the claim
• Had not received payment on a claim by the IRS or received payment but had not cashed or deposited the check

Is the Voluntary Disclosure Program Still Running?

No, this program, which allowed employers who thought they received ERC funds erroneously to remediate the issue, closed Nov. 22, 2024. It had allowed businesses to repay 85% of the funds received and cooperate with requests for information from the IRS to name the individuals or third parties that prepared the ERTC submission.

Original article

The employee retention tax credit was a refundable credit available to eligible businesses that paid qualified wages after March 12, 2020, through the end of the program to keep their staffs employed during the height of the COVID-19 pandemic.

It was introduced under the Coronavirus Aid, Relief, and Economic Security Act (CARES) in March 2020 and subsequently amended four times by the following laws: the Consolidated Appropriations Act 2021, the American Rescue Plan Act (ARPA), and the Infrastructure Investment and Jobs Act, and H.R. 1 in 2025..

This article delineates by law and date because what a business can claim was determined by the provisions of the law that was in place when a business originally paid the wages to retain their employees. Additional factors such as whether you took a Paycheck Protection Program (PPP) loan impact the credit that could be claimed.

Can You still Apply for the Tax Credit?

No, businesses cannot still apply for the ERTC, and businesses can no longer pay wages to apply for the credit.

For most businesses, the credit could be claimed on wages paid from March 12, 2020, until Sept. 30, 2021, with certain businesses having until Dec. 31, 2021, to have paid qualified wages. The ERC was not a loan. It was a tax credit based on payroll taxes employers previously remitted, so employers did not have to pay back the funds they received.

However, the law signed in 2025 increases enforcement around erroneous funds received and expands auditing deadlines. So, businesses that received funds they were not eligible for could face audits that require them to pay back the money and face penalties.

What is the Employee Retention Credit?

The employee retention credit (ERC) was a refundable credit that businesses could claim on qualified wages, including certain health insurance costs, paid to employees. The following laws — passed between March 2020 and July 4, 2025 — changed requirements, either through expansion or contraction, and other details such as eligibility about the employee retention tax credit.

The following summarizes some of the changes of each law and its impact on the employee retention credit.

CARES Act of 2020 and ERC

Eligible employers included those operating a trade, business, or tax-exempt organization.

• The credit was taken against the employer’s portion of Social Security tax
• The credit could be claimed against 50% of qualified wages paid, up to $10,000 per employee annually
• Wages must have been paid between March 13 and Dec. 31, 2020

Consolidated Appropriations Act of 2021 and ERC

Definition of qualified employer, including PPP recipients, expands to colleges/universities whose main purpose is to provide medical care, as well as 501(c)(1) organizations.

• Could claim a credit against 70% of qualified wages paid
• Amount of wages that qualified for the credit increased to $10,000 per employee per quarter

American Rescue Plan Act of 2021 and ERC

• Credit remained at 70% of qualified wages up to a $10,000 limit per quarter

The 2025 law changed any deadline extensions and additional qualifications originally provided under the Infrastructure Investment and Jobs Act.

How Did the Employee Retention Credit Work?

The ERC is a refundable tax credit based on payroll taxes your business paid. New laws passed during the pandemic made some changes, but these changes did not change the amount of the credit itself.

The American Rescue Plan Act stipulated that the nonrefundable pieces of the employee retention tax credit could be claimed against Medicare taxes instead of against Social Security taxes as they were in 2020.

• This change will only apply to wages paid after June 30, 2021, and did not change the total credit amount.

If the credit exceeded the employer’s total liability of the portion of Social Security or Medicare, depending on whether before June 30, 2021, or after in any calendar quarter, the excess is refunded to the employer.

ERC Eligibility: Who Could Claim?

The qualifications changed under several laws to expand eligibility.

ERC Qualifications for Employers

Qualification was determined by one of two factors for eligible employers — and one of these factors must apply in the calendar quarter the employer wishes to utilize the credit:

1. A trade or business that was fully or partially suspended or had to reduce business hours due to a government order.

• The credit applied only for the portion of the quarter the business is suspended, not the entire quarter.

2. An employer that has a significant decline in gross receipts.

The IRS provided a safe harbor to allow employers to exclude certain forgiveness amounts (e.g., PPP loan, Shuttered Venue Operators Grant, Restaurant Revitalization Fund grant) from gross receipts solely to determine eligibility to claim the ERTC.

The following summarizes some of the changes of each law and its impact on the employee retention credit.

• CARES Act – 2020
  • Generally, if gross receipts in a calendar quarter were below 50% of gross receipts when compared to the same calendar quarter in 2019, an employer would qualify. They are no longer eligible if in the calendar quarter immediately following the quarter their gross receipts exceeded 80% compared to the same calendar quarter in 2019.
• Consolidated Appropriations Act, 2021
  • Beginning in 2021, businesses must have been impacted by forced closures or quarantines or have seen more than 20% drop in gross receipts in the quarter compared to the same quarter in 2019.
  • If you were a new business, the IRS allowed the use of gross receipts for the quarter in which you started business as a reference for any quarter which they do not have 2019 figures because you were not yet in business.
• American Rescue Plan Act – 2021
  • In addition to eligibility requirements under the Consolidated Appropriations Act, 2021, business also had the option of determining eligibility based on gross receipts in the immediately preceding calendar quarter (compared with the corresponding quarter in 2019).

3. Recovery Startup Business

• American Rescue Plan Act – 2021
  • 3^rd and 4^th quarters of 2021 only — a third category was added. Those entities that qualify may be entitled to up to $50,000 per quarter

Under H.R. 1, if claims for the 3rd and 4th quarters were not received by Jan. 31, 2024, they will not be processed.

To qualify as a Recovery Startup Business, one must:

• Had begun carrying on trade or business after Feb. 15, 2020
• Had annual gross receipts that do not exceed $1 million
• Not be eligible for the ERTC under the other two categories, partial/full suspension of operations or decline in gross receipts

The IRS notice 2021-49 clarified that Recovery Startups may use all qualified employee wages for purposes of the credit, regardless of the number of employees.

Form 941-X had to be used to file retroactively for the applicable quarter(s) in which the qualified wages were paid.

Under the Infrastructure Investment and Jobs Act of 2021, eligibility for Recovery startups changed, essentially making all RSBs eligible in the fourth quarter. Again, no funds will be received if the claim was not filed by Jan. 31, 2024, under H.R. 1.

What Wages Qualified When Calculating ERC?

Wages/compensation, in general, that are subject to FICA taxes, as well as qualified health expenses qualify when calculating the employee retention tax credit. Remember, the credit can only be taken on wages that are not forgiven or expected to be forgiven under PPP.

Generally, qualified health expenses included the employer and employee pretax portion and not any after-tax amounts.

The ERTC was based on the number of full-time employees, which for this credit was defined as one that in any calendar month in 2019 worked at least 30 hours per week or 130 hours in a month. The definition also is based on the employer shared responsibility provision in the ACA.

Note: The employee calculation of full-time equivalent (FTE) used for the PPP forgiveness report is not calculated the same way as a full-time employee for the employee retention credit.

The following laws impacted eligibility requirements for the employee retention tax credit.

CARES Act – 2020

Businesses with more than 100 full-time employees could only use the qualified wages of employees not providing services because of suspension or decline in business. Basically, employers can only use this credit on employees who are not working.

Employers with 100 or fewer full-time employees can use all employee wages.

Consolidated Appropriations Act – 2021

This law increased the employee limit to 500 for determining which wages are applicable for the credit.

American Rescue Plan Act – 2021

This law allowed certain hardest-hit businesses — severely financially distressed employers — to claim the credit against all employees’ qualified wages instead of just those who are not providing services.

• “Hardest hit businesses” defined as employers whose gross receipts in the quarter are less than 10% of what they were in a comparable quarter in 2019 or 2020. This only applies to the third quarter of 2021 for businesses that aren't Recovery Startup Businesses.
• Under H.R. 1 in 2025, the IRS will only process claims for the third quarter if such a claim was filed by Jan. 31, 2024.

Are Tipped Wages Included in Qualified Wages?

IRS notice 2021-49 clarified that tips would be included in qualified wages if these wages were subject to FICA. In general, this mean if tips are over $20 in a calendar month for an employee, then all tips (including the first $20) would be included in qualified wages for the purpose of the retention credit.

Are Owner/Spouse Wages Included in Qualified Wages?

Previous IRS guidance made it clear that related individuals (e.g., child, grandchild, siblings, step relations, nieces, nephews, aunts, uncles, in-laws) to a majority owner were not included in qualified wages(see IRS FAQ #59 for specifics). However, the owner and spouse wages were unclear.

Notice 2021-49 clarified that if you were considered a majority owner, then those wages are not qualified wages for ERTC.

These rules the IRS clarified apply to all quarters for ERTC.

What Is the Interaction with Other Credits and Funding Sources?

• There is no double-dipping for credits. Employers who took the employee retention credit could not take credit on those same qualified wages for paid family medical leave.
• If an employee was included for the Work Opportunity Tax Credit, they may not be included for the employee retention credit.

Remember, the credit can only be taken on wages that are not forgiven or expected to be forgiven under Paycheck Protection Program.

American Rescue Plan Act — 2021

Shuttered Venue Operators Grant (SVOG) or Restaurant Revitalization Fund (RRF) recipients could not treat any payroll costs that they take into account in connection with either program to justify use of the grant as qualified wages for the employer retention tax credit in the third quarter 2021 (Recovery Startups still have the fourth quarter).

Employers who received these grants must retain records justifying where the funds were used. The funds must have been used for eligible uses no later than March 11, 2023 for RRF while the SVOG dates varied (June 30, 2022 is the latest).

What Businesses Should Know about ERTC Retroactive Termination Guidance?

Notice 2021-65 lists conditions that must be met to avoid a failure to deposit penalty.

Employers (not Recovery Startup Business) who requested and received an advanced payment of the ERTC for wages paid in the fourth quarter of 2021 will be required to repay the advances by the due date for the applicable employment tax return that includes the fourth quarter of 2021..

For PEO/CPEO customers who had employment tax deposits reduced, as well as received advance payments by filing Form 7200, they will need to repay these under their PEO/CPEO accounts.

How Does a PEO Client Employer Reconcile?

Employers utilizing a Professional Employer Organization (PEO) or Certified Professional Employer Organization (CPEO) did not have an individual 941 filed on their behalf, so it’s important for them to understand how they would reconcile this information and receive the credit. The IRS posted guidance to clarify how it would work.

If an eligible employer uses a PEO or CPEO, the retention credit is reported on the PEO/CPEO aggregate Form 941 and Schedule R.

What's Next?

There is much to consider, but at the present time Paychex continues to wait for guidance from the IRS to address how the agency will handle returns already submitted and those returned due to issues and then refiled.

If employers who filed an ERTC claim still have questions or need more information, they should consult their accountant or a payroll processing specialist.