In December, Congress passed the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (the “Relief Act”) which was enacted as Division EE of the Consolidated Appropriations Act, 2021 (“CAA”). Among its many beneficial provisions, the Relief Act repealed the restriction in the Coronavirus Aid, Relief, and Economic Security Act (the ‘‘CARES Act”) preventing borrowers under the Paycheck Protection Program (“PPP”) from claiming the Employee Retention Credit (“ERC”).
The one remaining restriction is that the same wages can’t be used for PPP loan forgiveness and claimed for the ERC. Unfortunately, previous IRS guidance on the ERC or SBA guidance on PPP loan forgiveness didn’t discuss this distinction. Neither did the Relief Act itself.
On March 1, the IRS released a notice providing some guidance. It is limited in its application to the ERC as it exists for 2020, meaning it doesn’t apply to the employee retention credit for qualified wages paid after December 31, 2020. They promise to issue guidance about that credit in the future. More importantly, the guidance is limited in that it leaves more questions unanswered than it answers.
Here’s the gist – the notice provides guidance on who is an eligible employer, what constitutes a full or partial shutdown of trade or business operations, how to determine a significant decline in gross receipts, how to claim the credit and how to substantiate the claim. Perhaps most importantly, it discusses what are qualified wages, especially with regard to wages used to determine the amount of PPP loan forgiveness.
|OBSERVATION: If you already applied for PPP loan forgiveness, whatever you put for wages on your application is going to determine what wages remain to be claimed for ERC. If you have not yet applied for forgiveness, there is still time to make sure you maximize both forgiveness and ERC.|
How Do the Partial Shutdown Rules Work?
There’s some interesting guidance here and it turns on whether the part of the business shut down is more than nominal. Solely for purposes of the ERC, nominal is defined as either:
- The gross receipts from that portion of the business operations is not less than 10 percent of the total gross receipts; or,
- The hours of service performed by employees in that portion of the business is not less than 10 percent of the total number of hours of service performed by all employees in the employer’s business.
In each case, the reference is to the amount of gross receipts or hours of service compared to the same calendar quarter in 2019.
Also, a full or partial shutdown may arise if, under the facts and circumstances, the business’s suppliers are unable to make deliveries of critical goods or materials due to a governmental order that causes the supplier to suspend its operations.
However, a governmental order that causes customers to stay home, even if the business is allowed to remain open, is not considered a partial shutdown. Nevertheless, it may result in a reduction in gross receipts sufficient for the business to qualify for the ERC. The Q&A also provide guidance as to how to determine if an employer is able to continue comparable operations even if employees are forced to work remotely.
What is Included in Qualified Wages?
Wages includes all compensation paid including amounts paid by the employer for group health plan benefits, as long as those payments are excluded from employee income. Qualified wages includes the amounts employees contribute as pre-tax salary reduction contributions to a qualified section 401(k) plan. Wages paid to relatives of an owner of the employer are not included in qualified wages.
|Unanswered question: Are wages paid to an owner of more than 50% of a corporation eligible?|
What is included in qualified wages differs for large and small employers. For purposes of the 2020 ERC, a large employer is one who had an average of more than 100 full-time employees (NOT full-time equivalent employees) per month in 2019. Full-time is defined as 30 hours of service per week or 130 hours of service per month.
During the eligible period – either the period of partial or full shutdown or the period where there is a significant decline in gross receipts – small employers may include wages of all employees in their ERC calculation.
For large employers, qualified wages are those wages paid to an employee who is not providing services either because of the full or partial shutdown of the business or due to the significant decline in gross receipts. Moreover, qualified wages paid to an employee may not exceed what the employee would have been paid for working an equivalent duration during the 30 days immediately preceding the commencement of the full or partial suspension of the operation of the trade or business or the first day of the calendar quarter in which the employer experienced a significant decline in gross receipts.
Severance pay is not considered wages for purposes of the ERC. Qualified wages does include health insurance payments made on behalf of an employee even if they aren’t currently being paid wages.
Interaction with Paycheck Protection Program (PPP) Loans
As the Firestone ad used to say, this is where the rubber meets the road. It turns out that the CARES Act originally provided that wages were automatically eligible for the ERC unless an eligible employer elected to use them for PPP loan forgiveness instead. Until now, however, there was no official election mechanism. In this notice, the IRS establishes that “the amount for which the eligible employer is deemed to have made the election is the amount of qualified wages included in the payroll costs reported on the PPP Loan Forgiveness Application up to (but not exceeding) the minimum amount of payroll costs, together with any other eligible expenses reported on the PPP Loan Forgiveness Application, sufficient to support the amount of the PPP loan that is forgiven.” In other words, whatever you put on the Application determines what wages are now no longer qualified wages for the ERC.
The notice contains examples of several different fact patterns to help determine the amount of wages on the Loan Forgiveness Application actually used for loan forgiveness. These examples are helpful not only for those who have already applied for forgiveness but also as a roadmap for those borrowers who have not yet filed their applications.
We hope the IRS will issue further guidance regarding these questions and the 2021 ERC. We expect that such guidance, if issued in time, may affect the approach borrowers take with respect to wages in the PPP Loan Forgiveness Applications. In the In the meantime, please contact your Friedman LLP advisor with any questions.