Through Covid-19 and the transition of the White House, many things are changing rapidly in regard to not only the tax code, but also interpretations and changes in the different Covid-19 acts and executive orders. A big area of help that is now available to business owners and wage payers is the Employee Retention Credit (ERC), and we wanted to make our clients aware of the opportunities available to them.
The recently enacted Consolidated Appropriations Act, 2021 (CAA) has given new life to the Employee Retention Credit (ERC) initially made available by the Coronavirus Aid, Relief, and Economic Stimulus (CARES) Act. The ERC is a refundable payroll tax credit designed to help employers adversely affected by the coronavirus pandemic who maintain employee payroll during qualifying periods in 2020 and 2021.
Many employers did not previously utilize the ERC due to the fact it was unable to be taken in conjunction with a Paycheck Protection Program (PPP) loan. But the CAA has retroactively removed the mutual exclusivity between the two incentives, making the ERC newly available for 2020 periods to millions of small businesses. In addition, the CAA extended the ERC into the first two quarters of 2021 and brought other favorable changes for those periods as well.
Qualifying for the Credit
Businesses qualify for the ERC in both 2020 and 2021 by passing at least one of two tests in a calendar quarter:
1) The business fully or partially suspends operations due to a COVID-19-related government order during a calendar quarter between March 12, 2020 and June 30, 2021, or
2) Experiences a large drop in year-over-year gross receipts.
To qualify for the first scenario, for any quarter, the operation of the employer’s trade or business must have been “fully or partially suspended” during the quarter due to “orders from an appropriate governmental authority limiting commerce, travel, or group meetings (for commercial social, religious, or other purposes), due to COVID-19.” Once this occurs, the quarter is an “eligible quarter,” but a business will only get a credit on wages paid during the part of the quarter the business was shut down, unless the business otherwise satisfies the gross receipts test described in the second scenario.
The IRS FAQs on the matter stress that a business must actually be limited by mandates, not just subject to them. A partial suspension may be where a business is still allowed to be open, but it may not be able to continue all of its typical operations due to the imposed restrictions.
Qualifying for the second test depends on the year. For any quarter in 2020, the gross receipts from the trade or business of the employer must be less than 50% of what they were for the same quarter in 2019. Once this happens, every subsequent quarter is an “eligible quarter” until the end of the quarter in which the business’s receipts have returned to at least 80% of what they were for the same quarter in 2019.
For example, if receipts in Q1, Q2, Q3 and Q4 of 2019 were $100,000, $120,000, $100,000 and $150,000, and for the same quarters in 2020 receipts were $40,000, $70,000, $85,000 and $125,000, the “eligible quarters” for 2020 are Q1 (the first quarter in which receipts are less than 50% of 2019), Q2 (still less than 80% of 2019) and Q3 (the end of the first quarter in which receipts have returned to at least 80% of the same quarter of 2019).
For 2021, the decline in receipts test is satisfied for any quarter of the first half of 2021 in which gross receipts is less than 80% (rather than 50%) of the same quarter in 2019. Thus, in the first quarter of 2021, a business would compare its receipts in that quarter to the first quarter of 2019, not the first quarter of 2020. This is meant to be taxpayer friendly in establishing a qualifying quarter, considering many businesses will have higher receipts in 2019 than in 2020.
Calculating the Credit
Once eligible quarters are established, the credit calculations can begin. For 2020, the credit equals 50% of up to $10,000 of qualified wages paid in all 2020 quarters per employee after March 12, 2020 through December 31, 2020. Therefore, in all of 2020 the maximum credit available per employee is $5,000.
For 2021, the credit equals 70% of up to $10,000 of qualified wages paid in any quarter during January 1, 2021 through June 30, 2021. This means that for 2021 only, the credit is equal to a maximum of $7,000 per eligible quarter, per employee – a significant increase in potential credit over 2020.
An important full-time employee (FTE) threshold exists in calculating eligible wages paid. For a 2020 credit, if a business averaged more than 100 FTEs for 2019 only wages paid to an employee during an eligible quarter to not provide services are eligible for the credit. In other words, a business must be paying an employee to not work, either because business has been shut down or receipts have dropped significantly. If a business averaged 100 or fewer FTEs for 2019, then all wages paid to an employee during an eligible quarter can give rise to a credit, even if the employee is currently at work. For a credit taken related to 2021 wages paid, this threshold is increased from 100 to 500 FTEs.
Qualified wages include compensation plus the allocable portion of qualifying health care expenses paid with respect to an employee during the period. If an employer has more than 100 FTEs in 2019 (for claiming the 2020 ERC) or 500 FTEs in 2019 (for claiming the 2021 ERC), the employer may not treat as qualified wages amounts paid to employees for paid time off for vacations, holidays, sick days and other days off as these would represent benefits accrued during a prior period. However if FTE count is below the required threshold, all wages paid qualify even if under a pre-existing vacation, sick and other leave policy.
Unless elected otherwise, wages used in calculating the ERC cannot be used in obtaining PPP loan forgiveness. Careful consideration is necessary to ensure that wages are not duplicated – i.e., both eligible for the ERC and forgiven as part of the PPP process – and that the tax benefits from both programs are maximized.
Claiming the Credit
The credit is generally claimed on an original Form 941 or Form 7200 when credits exceed a quarter’s regular payroll tax filing. However, given the CAA’s retroactive change to allow PPP borrowers to now take the ERC as well, an amended Form 941-X may be used to make corrections to prior quarters. Aside from amended filings, the CAA did provide for a potential fourth-quarter true-up to capture previous quarter information – however, a potential drafting error or perhaps purposeful limitation make this option other than ideal until further guidance is released.
For a credit in 2021, if an employer has fewer than 500 FTEs, it may elect for any calendar quarter to receive an advance payment of the credit for that quarter in an amount not to exceed 70% of the average quarterly payroll for the same quarter in 2019. The advance credit would then need to be reconciled against the actual credit. If the advance payments end up exceeding the actual credit due, the employer’s payroll tax is increased for the calendar quarter by the excess.
Revisions to the ERC create substantial opportunity for employers, particularly for qualifying businesses who previously obtained a PPP loan in lieu of the ERC. Many more businesses have the potential to qualify in 2021 as well and may be able to take advantage of the substantially increased incentive.
A lot of this information is still being interpreted by the IRS, and is rapidly changing. Please keep this in mind as you start working through this information.
Please contact us with questions or assistance.