Is your business eligible for the employee retention tax credit?
UPDATED March 15, 2021 to reflect additional guidance and the ARPA Act of 2021
Under the Consolidated Appropriations Act, 2021, the employee retention credit, a provision of the CARES Act, is available through December 31, 2021 to eligible employers who retained employees during the COVID-19 pandemic. It is meant to help businesses offset the financial disruption caused by the pandemic.
The enactment of the American Rescue Plan Act 2021 (ARPA) and the Consolidated Appropriations Act 2021 (CAA), changed some of the provisions under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, including the employee retention tax credit that has been expanded and extended under the new law. Due to the ongoing impact of the COVID-19 pandemic, eligible employers now have until December 31, 2021 to claim the tax credit on wages paid to employees they retained through the crisis.
Another change under the law is the tax credit is now available to businesses that took a loan under the Paycheck Protection Program (PPP), including borrowers from the initial round of PPP who originally were ineligible to claim the tax credit. Keep in mind, the credit can only be taken on wages that are not forgiven or expected to be forgiven under PPP.
What is the Employee Retention Credit?
Employers who qualify, including borrowers who took a loan under the initial PPP, the credit can be claimed against 50 percent of qualified wages paid, up to $10,000 per employee annually for wages paid between March 13 and Dec. 31, 2020.
For employers who qualify in 2021, including PPP recipients, the new law expands the credit and allows them to claim a credit against 70% of qualified wages paid. Additionally, the amount of wages that qualifies for the credit is now $10,000 per employee per quarter for all of 2021. So, an employer could claim up to $7,000 per quarter per employee or $14,000 for 2021.
What Employers Qualify for the Employee Retention Credit?
Most employers, including tax exempt organizations, can qualify for the credit. Qualification is determined by one of two factors for eligible employers — and one of these factors must apply in the calendar quarter the employer wishes to utilize the credit:
- A trade or business that was fully or partially suspended or had to reduce business hours due to a government order. The credit applies only for the portion of the quarter the business is suspended, not the entire quarter.
Some businesses, based on IRS guidance, generally do not meet this factor test and would not qualify.
- Those considered essential, unless they have supply of critical material/goods disrupted in manner that affects their ability to continue to operate.
- Businesses shuttered but able to continue their operations largely intact through telework.
- However, any of these businesses still may qualify for the credit with the second factor test.
An employer that has a significant decline in gross receipts.
Under the original CARES Act, generally, if gross receipts in a calendar quarter are below 50% of gross receipts when compared to the same calendar quarter in 2019, an employer would qualify. They are no longer eligible in the calendar quarter immediately following the quarter when gross receipts exceed 80% compared to the same calendar quarter in 2019.
Under the new law, beginning in 2021, businesses must be impacted by forced closures or quarantines and have seen more than 20% drop in gross receipts in the quarter compared to the same quarter in 2019.
An employer can amend their Form 941 if they determine later that they qualified for the credit.
If you are a new business, the IRS allows the use of gross receipts for the quarter in which you started business as a reference for any quarter which they do not have 2019 figures because you were not yet in business.
Note: A member of controlled or affiliated service groups are considered a single employer, so they must aggregate their gross receipts to determine when and if they qualify.
What wages qualify when calculating the retention credit?
Wages/compensation, in general, that are subject to FICA taxes, as well as qualified health expenses qualify when calculating the employee retention credit. These must have been paid after March 12, 2020 and qualify for the credit if paid through December 31, 2021. Keep in mind, the thresholds on these wages and the percentage of credit increases on 2021, including allowing the inclusion of Medicare.
When determining the qualified health expenses, the IRS has multiple ways of calculating depending on circumstances. Generally, they include the employer and employee pretax portion and not any after-tax amounts.
When determining the qualified wages that can be included, an employer must first determine the number of full-time employees they had in 2019. Employers with more than 100 full-time employees (based on the employer shared responsibility provision in the Affordable Care Act) use different qualified wages than those with 100 or fewer full-time employees. Under the new law, the employee limit for determining which wages are applicable to the credit increases to 500 in 2021.
What Qualifies as a Full-Time Employee
For the purposes of the employee retention credit, a full-time employee is defined as one that in any calendar month in 2019 worked at least 30 hours per week or 130 hours in a month (this is the monthly equivalent of 30 hours per week) and the definition based on the employer shared responsibility provision in the ACA.
- Employers who were in business the entire calendar year in 2019 would take the sum of the number of full-time employees in each calendar month and divide by 12.
- An employer who started a business during 2019 determines the number of full-time employees by taking the sum of the number of full-time employees in each full calendar month in 2019 in which the business operated and divide by that number of months.
- An employer who started a business in 2020 determines the number of full-time employees by taking the sum of the number of full-time employees in each full calendar month in 2020 that the business operated and divides by that number of months.
Once full-time employees are determined, employers will know which qualified wages to use.
Those who have more than 100 full-time employees (this threshold increases to 500 beginning in 2021) can only use the qualified wages of employees not providing services because of suspension or decline in business. Furthermore, any wages paid for vacation, sick or other days off based on the employer’s current policy cannot be included in qualified wages for the larger employers. Basically, employers can only use this credit on employees who are not working.
All Other Employers
Employers with 100 or fewer full-time employees (this threshold increases to 500 beginning in 2021) can use all employee wages — those working, as well as any time paid not being at work with the exception of paid leave provided under the Families First Coronavirus Response Act.
The IRS does have guardrails in place to prevent wage increases that would count toward the credit once the employer is eligible for the employee retention credit.
- There is no double-dipping for credits. Employers who take the employee retention credit cannot take credit on those same qualified wages for paid family medical leave.
- If an employee is included for the Work Opportunity Tax Credit, they may not be included for the employee retention credit.
So, employer’s considering which credits to take should evaluate which one is better financially to their business.
How do the credits work?
The employee retention credit is allowed against the employer’s share of Social Security and Medicare taxes. However, the credit is fully refundable. So, if the credit exceeds the employer’s total liability of the portion of Social Security in any calendar quarter, the excess is refunded to the employer.
At the end of the quarter, the amounts of these credits will be reconciled on the employer’s Form 941.
How does a PEO client employer reconcile?
Employers utilizing a Professional Employer Organization (PEO) or Certified Professional Employer Organization (CPEO) do not have an individual 941 filed on their behalf, so it’s important for them to understand how they would reconcile this information and receive the credit. The IRS posted guidance to clarify how it would work.
If an eligible employer uses a PEO or CPEO, the retention credit is reported on the PEO/CPEO aggregate Form 941 and Schedule R.
PPP Loan Forgiveness and ERC
The IRS released notice 2021-20 which outlines the interplay of PPP loan forgiveness and the Employee Retention Credit (ERC).
In brief, wages are disallowed for ERC based on how you reported wages on the PPP loan forgiveness application. If only reported wages were provided to get forgiveness, then you cannot utilize the wages (up to the loan amount) for ERC. If other qualifying costs plus the wages were reported, then more wages will be allowed for ERC.
Three examples will show you how this will likely work in most situations. In each example the PPP loan amount is $200,000. Payroll costs are only wages and health insurance costs since those qualify for both the PPP and ERC. Other qualifying costs may be different amounts. NOTE: W&D encouraged clients to report all forgivable payroll and nonpayroll expenses when filing for forgiveness. If payroll costs reported are greater than the amount needed to meet maximum loan forgiveness and/or the minimum 60% eligible payroll cost requirement, the balance may be used for the ERC (if client meets requirements.)
Example # 1 – You report $200,000 of qualifying payroll costs and no other qualifying costs (even though you had $70,000 of other costs). $200,000 of payroll costs are not allowed for the ERC. You could have reported the $70,000 of other costs but chose not to bother with listing them on the forgiveness application. This prevents $70,000 of payroll costs qualifying for the ERC.
Example #2 – Same facts as Example #1, but you report the full $200,000 of payroll costs plus the $70,000 of other costs. Instead of $200,000 of payroll costs not being allowed for ERC, it drops to $130,000, the minimum amount of payroll costs needed to get full forgiveness in combination with other costs.
Example # 3 – Same as Example #2, however other costs are now $90,000 which was reported on the application. In this case, the minimum payroll needed to get full forgiveness is $120,000 (60% of $200,000), therefore $80,000 of payroll costs will be allowed for the ERC.
Contact your Warady & Davis advisor or our PPP team at 847-267-9600; firstname.lastname@example.org. You can also visit the Warady & Davis LLP COVID-19 Resource Center for a wealth of information on stimulus assistance, new legislation and much more. This information is updated regularly.
Source: IRS, US Treasury, Paychex