The most popular question we are fielding lately now surrounds the Employee Retention Credit (“ERC”) since the new relief package is allowing it to be utilized even if businesses also obtained Paycheck Protection Program (“PPP”) funding. The Coronavirus Response and Relief Supplemental Appropriations Act of 2021 (“the Act”) not only creates a potential opportunity for the ERC to be obtained in 2020 even if a PPP loan was received, but broadens the possibility for many employers to qualify for the ERC in the first two quarters in 2021 by relaxing the requirements to qualify.
Provided an employer is eligible, the maximum amount of credit per employee in 2020 is $5,000, with the maximum credit significantly increasing in 2021 to $14,000 per employee. As an example, for an eligible employer with 50 employees that meet the salary cap, a $250,000 credit ($5,000 x 50 employees) and $700,000 credit ($14,000 x 50 employees) could potentially be obtained in 2020 and 2021, respectively. These numbers can quickly generate a large cash impact and are nothing to ignore.
Am I Considered an Eligible Employer for the ERC?
The first deviation from PPP stimulus funding is that an employer can have any number of employees and still qualify for the ERC. The ERC is not narrowly directed towards small businesses, but instead available to eligible employers operating a trade or business that meets one of the two following tests:
- The operation of the trade or business is fully or partially suspended during the calendar quarter due to orders from an appropriate government authority limiting commerce, travel, or group meetings due to COVID-19 OR
- The employer experiences a significant decline in gross receipts when comparing quarters between 2019 and 2020 (see detailed discussion below).
Under the original CARES Act, the ERC was not available to employers that were Federal or State governments or agencies. The ERC rules have been modified to allow 501(c)(1) organizations that are exempt from tax under section 501(a), as well as governmental employers if such employer is a College or University or the principal purpose or function is providing medical or hospital care, to qualify for the ERC as of January 1, 2021.
Test 1: Full or Partial Suspension
The first test requires that the employer’s business operations were fully or partially suspended by a government order restricting commerce, travel, or group meetings due to COVID-19. Whether a business is considered fully or partially suspended can be subject to federal and state authority, and therefore the applicability of this test can vary depending on each business’ facts and circumstances. In the case of a government order(s) that limits business operations in some locations but not others, the affected business is considered to have a partial suspension of operations. This is often seen amongst franchises or branches spanning across multiple states. Even if a business only has a full or partial suspension for part of a calendar quarter, the ability for the employee wages to qualify for ERC is in effect for the entire quarter. However, if a business is considered essential or can continue comparable operations through teleworking, it may prove difficult for the business to be fully or partially suspended.
An employer that operates an essential business is not considered to have a full or partial suspension of operations if the governmental order allows the employer's operations to remain open. However, an employer that operates an essential business may be considered to have a partial suspension of operations if, under the facts and circumstances, more than a nominal portion of its business operations are suspended by a governmental order. However, the IRS has not defined “nominal” and it seems to lie with the discretion of the employer.
An employer with an essential business may be considered to have a full or partial suspension of operations if the business' suppliers are unable to make deliveries of critical goods or materials due to a governmental order that causes the supplier to suspend its operations.
Full or Partial Suspension: Teleworking
If an employer's workplace is closed by a governmental order, but the employer is able to continue operations comparable to its operations prior to the closure by requiring its employees to telework, the employer's operations are not considered to have been fully or partially suspended as a consequence of a governmental order.
Test 2: Significant Decline in Gross Receipts
However, the two tests for qualifying for an eligible employer are separate and just because a business may not qualify for a full or partial shutdown, they may still qualify as having a significant decline in gross receipts.
For 2020, a significant decline in gross receipts is met when an employer’s gross receipts in the 2020 calendar quarter are less than 50% of gross receipts for the same calendar quarter in 2019. The ability for that employer to retain eligibility for the employee retention credit will end on the last day of the 2020 calendar quarter in which the gross receipts between the 2020 and 2019 same calendar quarters exceeds 80%.
An example is the best way to review this, as it can get confusing quickly. Let’s assume the following gross receipts:
Based on the above example, this employer would meet the significant decline in gross receipts test in Q2 of 2020 as there was a greater than 50% decline in gross receipts when comparing 2020 to 2019. This employer would remain eligible for the ERC until the end of Q4 in 2020. Even though the employer exceeded 80% in quarter four, the ability to claim the ERC does not stop until the end of the calendar quarter in which the 80% test is met.
Significant changes were made in the Act regarding the percentage that would determine a significant decline in 2021, as well as how businesses can measure the decline. It is important to note that these two changes ONLY affect the gross receipts calculation for the 1st and 2nd quarters in 2021. The changes discussed below do not change the percentage or calculation needed (as reflected above) in order to be deemed to have a significant decline in gross receipts for 2020.
For the 2021 taxable year, a significant decline in gross receipts will be met if there was a 20% decline (as opposed to 50% noted in 2020) in comparative quarters. This most likely will allow far more employers to be able to qualify using the gross receipts test. In addition, the legislation provided different alternatives on how to measure whether there was a 20% decline.
An employer can measure whether a significant decline in gross receipts has been met by comparing the 1st and 2nd calendar quarter of 2021 with the same calendar quarters in 2019.
By measuring the gross receipts test using alternative 1, the employer would only be able to qualify for the ERC in quarter 2. Some taxpayer’s initial reaction was that the 2021 quarters should not be compared to 2019, but instead 2020. However, when trying to prove the business had a decline in gross receipts, the utilization of 2019 gross receipts for comparison will most likely yield a more favorable result. Based on this example, it is worth exploring whether Alternative 2 could provide a better answer.
Alternative 2: Employer Election
Only for purposes of determining whether a significant decline in gross receipts has been met for 2021, an employer may make an election to calculate the gross receipts based on the prior quarter. This would mean that for quarter 1 of 2021, the employer could compare the fourth quarter of 2020 and the fourth quarter of 2019, to see if there was a significant decline in gross receipts.
By the employer making the election to determine gross receipts on a prior quarter, the first quarter of 2021 would qualify. Whether the election would be binding for the 2nd quarter of 2021, or alternative 1 could be used, remains unclear and further guidance needs to be provided.
How do I Measure Gross Receipts?
Gross receipts for employers other than a tax-exempt organization generally include total sales (net of returns and allowances) and all amounts received for services. In addition, gross receipts include any income from investments, and from incidental or outside sources. For tax-exempt organizations, gross receipts are determined in reference to IRC Section 6033 and the Treasury Regulations thereunder (the provisions that set forth return filing requirements for tax-exempt organizations).
In addition, there are aggregation rules that must be followed when determining whether a significant decline of gross receipts has occurred. The aggregation rules of IRC Sections 52(a), 52(b), 414(m), and 414(o) apply, which are all too familiar to tax professionals as they were referenced through the last major federal tax reform bill. Seriously, we had nightmares regarding these rules. Based on IRS guidance, if the aggregated group does not experience a significant decline in gross receipts, then no member of the group may claim the Employee Retention Credit on that basis.
What are the Qualified Wages for Purposes of Calculating the ERC?
Provided a business is an eligible employer, the next step is to determine which wages are allowed to be counted towards the credit. Qualifying wages can only be counted for each calendar quarter in which the employer qualifies. Therefore, in our previous 2020 example where the employer qualified for Q2, Q3, and Q4, the wages of Q1 must be ignored.
Qualified wages not only include wages and compensation, but also an allocable portion of qualified health plan expenses paid by an eligible employer. It is important to note that employers must ensure that the wages utilized for PPP debt forgiveness are not the same wages utilized for the ERC. Furthermore, wages that are taken into account to determine payroll tax credits for qualified sick leave or qualified family leave under the Families First Coronavirus Response Act are not qualifying wages.
In addition, the amount of wages a business can include is based on the number of employees that were employed during 2019.
- Small Employers: For an eligible employer that averaged 100 or fewer full-time employees in 2019, qualified wages are the wages paid to any employee during the eligibility period, whether providing services or not.
- Large Employers: For an eligible employer that averaged more than 100 full-time employees in 2019, qualified wages are the wages paid to an employee for time that the employee is not providing services during the eligibility period.
The definition of a full-time employee (“FTE”) means an employee who, with respect to any calendar month in 2019, had an average of at least 30 hours of service per week or 130 hours of service in the month. In addition, the aggregation rules referenced for the gross receipts test also apply for purposes of determining the number of FTE’s.
For the 2020 taxable year, the maximum amount of qualified wages per employee for all quarters is capped at $10,000. The ERC is limited to 50% of those qualified wages, creating a maximum credit of $5,000 per employee in 2020.
For the identification of 2021 qualified wages for eligible employers, the definition surrounding a large employer was increased to 500. Therefore, for employers with 500 or fewer employees in 2019, they are now allowed to look at all wages paid to employees, regardless of level of service. The limitation that eligible wages only include wages paid to employees not performing services will only apply to employers with more than 500 FTE’s in 2019.
In addition, the Act allows eligible wages to include $10,000 per quarter and is no longer limited to the entire year. Lastly, the percentage that can be applied to eligible wages has increased from 50% to 70%, allowing a maximum credit per employee of $7,000 per quarter, for up to a total of $14,000 per employee in 2021.
Find a quick reference chart below to highlight the significant differences between the ERC rules for 2020 versus 2021.
How Does a Business Claim an ERC?
Eligible Employers will report their total qualified wages for purposes of the Employee Retention Credit for each calendar quarter on their federal employment tax returns, usually Form 941, Employer's Quarterly Federal Tax Return. An eligible employer may reduce its federal employment tax deposit by the qualified wages that it has paid without incurring a failure to deposit penalty. In addition, if a Form 941 has already been filed and it is now determined that an ERC is available, an amended Form 941 can be filed. Furthermore, there is, at the employer’s election, an ability to claim the ERC on “applicable amounts” paid prior to Q4 2020, as if the appliable amounts were paid in Q4 of 2020. Such appliable amounts relate to (i) certain health plan expenses which are treated as qualifying wages for purposes of the ERC and (ii) wages which the employer originally elected to not treat as qualifying wages in anticipation that such wages were to be used in determining the business’ PPP loan forgiveness, but for which loan forgiveness does not occur.
Does your Head Hurt yet?
While the Act is beneficial to taxpayers, it does make the utilization of and prioritization of expenses in order to maximize government stimulus more complicated. The need to rely on advisors and better understand how the new laws intertwine seems increasingly necessary. Please reach out to your Bonadio advisor or our CARES Consulting Team to navigate these recent law changes.
The information and advice we are providing for this matter relates to COVID-19 legislative relief measures. Because legislative efforts are still ongoing, we expect that there may be additional guidance and clarification from regulators that could modify some of the advice and information provided to you, after the conclusion of our engagement. We, therefore, make no warranties, expressed or implied, on the services provided hereunder.