The Employee Retention Credit (“ERC”), which was originally put into place under the CARES Act, is available to companies that experience a significant decline in gross receipts or are required to fully or partially suspend their business operations due to governmental orders. Recently there have been some key changes made to it by various tax acts. Key among them are as follows:
- The credit is available for qualifying wages until the end of 2021.
- For 2021, the credit increased from 50% of qualifying wages to 70% of qualifying wages with a cap of $10,000 of wages per employee per quarter, so the maximum that can be claimed on any one employee for 2021 is $28,000.
- For 2021, an employer may be eligible for the credit if they experienced a decline of more than 20% of gross receipts (previously more than 50%) in any quarter in 2021 compared to the same quarter in 2019. A taxpayer can elect to determine their decline in gross receipts based on the prior calendar quarter (e.g., comparing Q4 of 2020 to Q4 of 2019 to determine eligibility for Q1 of 2021.)
- The eligibility of wages for the credit depends on whether the taxpayer constitutes a large employer (more than 500 full-time employees -previously 100 employees.) For non-large employers, any wages paid to employees can be eligible for the credit; however, large employers’ qualified wages are only those paid to employees for not working.
- Credit is available to a Recovery Start Up Business (“RSB”) – which is defined as a trade or business that began after 2/15/20, had average annual gross receipts of not more than $1 million, and for a calendar quarter, did not have business operations fully or partially suspended due to a government order due to COVID-19, and did not have gross receipts that were less than 80 percent of those for the same calendar quarter in calendar year 2019. The $1 million gross receipts test looks at a three-taxable-year period ending with the taxable year that precedes the calendar quarter for which the company is applying for the ERC. Prior to the American Rescue Plan (“ARP”), an RSB could not claim a 2021 ERC because it did not satisfy either eligibility requirement. For the third and fourth quarters of 2021, an RSB can now claim an ERC of 70 percent of wages paid in each quarter, capped at $10,000. However, there is a total quarterly cap of $50,000 for an RSB. For example, if an RSB has 10 employees and pays each $10,000 or more in the quarter, the ERC for the RSB would be $50,000, rather than $70,000.
- Retroactive changes (back to 2020) include allowing the ERC for employers that received, or will receive, Payroll Protection Program loans.
Under the CARES Act, an employer could not claim the ERC if they had taken out a PPP. Now an employer can claim the ERC and take out a PPP loan and qualify for loan forgiveness. However, the same wages and health expenses cannot be counted for both calculating the ERC, and loan forgiveness for PPP loans.
Employers that received PPP loans can now file amended returns for 2020 to claim the credit or can claim the credit on their 2021 filings. Employers who had already applied for and received loan forgiveness can see if there are any qualifying wages for the ERC that were not utilized for loan forgiveness.
For employers that are now in the process of taking out second draw PPP loans, and who have not yet applied for loan forgiveness for their first-round draws, they will want to carefully analyze their qualifying wages to determine if those wages are better utilized for PPP or for the ERC, or they can get the best of both worlds. For PPP purposes, a taxpayer would want to maximize to the extent possible non-payroll costs.
If an employer incurs qualifying wages in their forgiveness application, they are deemed to make an election and those costs cannot then be utilized for purposes of the ERC. The amount deemed elected for purposes of loan forgiveness is up to the amount needed for full forgiveness. If the costs included for loan forgiveness are later found to be ineligible for loan forgiveness, then those costs can be utilized for purposes of the ERC if those costs qualify for ERC purposes. An employer can also make an election to not claim qualifying wages for purposes of the ERC by not including them on their employment tax filings.
Below are some simple examples of how these rules work.
Example 1: Employer B received a PPP loan of $200,000. Employer B paid $250,000 of qualified wages that qualifies for the ERC. To receive forgiveness of the entire PPP loan, Employer B reported $200,000 of payroll costs and other eligible expenses (for full forgiveness at least 60% must be payroll costs and 40% can be other eligible expenses (other eligible expenses can be mortgage interest payments, interest payments on other debt instruments, rent payments including equipment rental, utility payments, covered worker protection expenses, covered operating expenses, covered property damage, and covered supplier costs ) and a minimum of $120,000 of payroll costs ($200,000 PPP loan X 60% payroll costs). Employer B submitted $250,000 of qualified wages in support of forgiveness. Employer B received forgiveness of the entire PPP loan amount of $200,000. Since only $200,000 of the $250,000 of wages was needed for full forgiveness. Employer B still has $50,000 of qualified wages remaining ($250,000 reported on the PPP Loan Forgiveness Application, minus $200,000 reported on the PPP Loan Forgiveness Application up to the amount of the loan that is forgiven), and it may treat that amount as qualified wages for purposes of the ERC.
This example shows that only $200,000 out of the $250,000 of qualifying wages were needed for loan forgiveness, and that the employer still has $50,000 of wages leftover to claim the ERC.
Example 2: Employer C received a PPP loan of $200,000. Employer C paid $200,000 of qualified wages that would qualify for the ERC. Employer C also paid other eligible expenses of $70,000. To receive forgiveness of the PPP loan in its entirety, Employer C reported a total of $200,000 of payroll costs (and a minimum of $120,000 of payroll costs) in support of forgiveness of the entire PPP loan, but did not report the other eligible expenses of $70,000. Employer C received forgiveness of the entire PPP loan amount of $200,000.
However, Employer C could have reported $70,000 of eligible expenses (other than payroll costs) and $130,000 ($120,00 minimum) of payroll costs, Employer C reported $200,000 of qualified wages as payroll costs on the PPP Loan Forgiveness Application. As a result, no portion of those qualified wages reported as payroll costs may be treated as qualified wages for purposes of the ERC. Employer C cannot reduce the amount of the other eligible expenses that it could have reported on its PPP Loan Forgiveness Application, because the Forgiveness Application had already been filed, and the entire PPP loan had been forgiven.
In this example the employer did not include $70,000 of eligible non-payroll expenses in their forgiveness application. Had they included those expenses they could have had $70,000 of wages that could have potentially qualified for the ERC. The taxpayer potentially lost out on a $70,000 ERC.
These are just a few simple examples showing that costs need to be carefully analyzed for purposes of PPP loan forgiveness and the ERC. An employer can be potentially losing out on value benefits if they do not carefully analyze PPP loan forgiveness applications and ERC claims.
For more information, please contact Doug Finkle at doug.finkle@sobelcollc.com
