The CARES Act passed last March contained a number of important stimulus provisions. Among these were the Paycheck Protection Program (“PPP”) loans and the Employee Retention Credit (“ERC”). At that time, employers were limited to one or the other. For most, the PPP loans were more beneficial and, as a result, few paid attention to the mechanics of the ERC.
The Taxpayer Certainty and Disaster Tax Relief Act of 2020 (the “Act”) (part of the Consolidated Appropriations Act of 2021, passed in late December) not only made some significant changes to the ERC, it also retroactively repealed the restriction on having a PPP loan and claiming the ERC. As is often the case, the Act has some drafting errors and does not explain how to apply many of its provisions, especially those that are retroactive. We will do our best to relate what we know and hope that the IRS will issue guidance to fill-in remaining knowledge gaps.
So, to catch up on the ERC, here are a few facts:
- The purpose of the ERC, much like the PPP, is to help businesses retain employees – even those not providing services
- It is a credit against the employer portion of the Social Security tax
--It is fully refundable
--Employers may be eligible for an advance payment (which will be reconciled later on their payroll tax returns)
- Initially set to expire December 31, 2020, the ERC is now available for wages paid through June 30, 2021
- You can’t use the same wages for both the PPP and the ERC (more on this later)
- Wages of those related to owners aren’t eligible for the credit
- Aggregation rules apply in determining whether your business was fully or partially suspended, whether you suffered a significant decline in revenue, and how many full-time employees you have
--The rules are the same as those used to determine eligibility for certain other income tax provisions such as eligibility to use the cash method of accounting
--They are NOT the same as the affiliation rules used to determine eligibility for PPP loans
How do I know if I’m eligible for the ERC? Well, the criteria are slightly different depending on whether we are talking about 2020 or 2021. For either year, if your business was either fully or partially suspended by governmental order due to COVID-19 during a quarter, or if supply chain interruptions resulting from governmental orders prevented you from operating at normal capacity during a quarter, you are an Eligible Employer. It is important to note, however, that you will only be able to get a credit for the portion of the quarter that your business was actually shut down.
You may also be eligible if you suffered a significant decline in gross receipts – but the test of significance is different for 2020 and 2021:
- For 2020, the gross receipts must be less than 50% of what they were for the corresponding quarter in 2019
- For 2021, the test is much more liberal – gross receipts must be less than 80% of what they were for the corresponding quarter in 2019
--For example, if the gross receipts for the first quarter of 2021 are less than 80% of the gross receipts of the first quarter 2019, you qualify
--There is also an alternate test for 2021 – an employer will qualify for the first quarter of 2021 if the gross receipts for the fourth quarter of 2020 are less than 80% of gross receipts for the fourth quarter of 2019
NOTE à In either year, once you qualify for a quarter, you qualify for every quarter until your gross receipts exceed 80% of the gross receipts for the corresponding quarter in 2019
--If you use the alternative test to qualify for the first quarter of 2021, it’s not clear if you will automatically qualify for the second quarter – additional IRS interpretation is needed to answer this question
• There are special rules for employers who weren’t in business for all or part of 2019
According to Miles’ law, where you stand depends on where you sit. And, while the principle of bureaucratic politics may seem out of context, you’ll see that your circumstances will determine how you may benefit from changes to the ERC.
Which employee wages are eligible for the credit is different in 2020 and 2021 depending on the monthly average number of Full Time Employees (“FTE”) in 2019 – not to be confused with Full-Time Equivalent employees which often uses the same acronym. For ERC purposes, an FTE is any employee who works 30 hours or more per week or 130 hours or more per month. And, not to be any more confusing, this count determines only which eligibility bucket you fall in, not which employee wages are used to compute the credit.
- What wages are eligible?
--If you have 100 or fewer FTE, all employee wages are eligible for the credit
--If you have more than 100 FTE, qualified wages include only those employees not providing services because operations were fully or partially suspended due to a shutdown order or because gross receipts declined by 50% quarter over quarter
- For 2021:
--The cutoff is 500 or fewer FTE
- How is the credit computed?
--For both years
--Once you determine you are eligible, you include all employees in your computation – both full- and part-time
--If you are credit eligible because of a complete or partial shutdown, you are entitled to a credit for only the portion of the quarter that your business was actually shut down
-- You can include bonuses paid to essential workers
-- Allocable health care costs are considered qualified wages even if no other wages are paid
- For 2020:
--The credit is 50% of qualified wages up to a maximum of $10,000 per employee per year – in other words, a maximum of $5,000
--The original CARES Act limited the credit, in certain circumstances, to the amount the employee was paid during the 30 days immediately preceding the period for which they are not providing services – the Act repealed that restriction
- For 2021
--The credit is 70% of qualified wages up to $10,000 per quarter
--So, up to $7,000 per quarter, per employee
Mechanics for claiming the ERC
- Advanced Payment:
--File Form 7200
--For 2020 it is due by February 1, 2021
--For 2021 it is due by the earlier of April 30, 2021 or the date of filing of Form 941 for the first quarter of 2021
--The form and instructions have not yet been updated for 2021 credit
- Claim on Form 941
--ERC for all of 2020 may be claimed on the fourth quarter 2020 Form 941
--ERC for 2021 may be claimed on Form 941 for either the first or second quarter, as appropriate
- File an amended return
--You can file Form 941-X to claim a refund based on the ERC
--Form 941-X is generally due within 3 years of the date Form 941 was filed or 2 years from the date you paid the tax reported on Form 941 (in this case the employer’s portion of the Social Security tax) – whichever is later
Coordination with PPP
Under the CARES Act, PPP loan borrowers were not permitted to take the ERC. The Act allows employers to take the ERC with respect to any wages NOT paid for with PPP loan proceeds. Technically, the way the law works is that wages used to claim an ERC are not eligible to be included in the PPP forgiveness application. Even more technically, the ERC is actually the default provision. So, the law now allows taxpayers to elect not to include certain wages in the ERC computation, saving those to compute PPP loan forgiveness.
NOTE--> Given the lack of guidance as to how to determine which wages are deemed to be paid with PPP Loan proceeds and which aren’t, borrowers who are considering claiming the ERC for quarters which include the Covered Period of their PPP Loan may wish to defer applying for forgiveness or the 2020 ERC until there is greater clarity.
Coordination with other Provisions
In addition to not allowing double dipping with PPP loans, wages used to determine the ERC may not be taken into account as wages for:
- Research and Development credit
- Family and Medical Leave credit
- Work Opportunity credit
- Empowerment Zone Employment credit
Again, we await guidance on how to apply the statutory limitations and allocate wages among these various programs.
As with everything else that has transpired in the last year, there is still a lot we don’t know about the mechanics of the ERC, it’s interaction with PPP, etc. We will continue to update you as new guidance is released. In the meantime, please contact your Friedman LLP advisor with any questions or to arrange a meeting with Friedman’s dedicated ERC Team.