Much of the attention throughout 2020 was on the Paycheck Protection Program (PPP), which Congress enhanced just before the holidays with the Consolidated Authorizations Act, 2021 (CAA21). As we discussed in a prior article, the CAA21 supercharged PPP loans, especially for for-profit business borrowers, and helped more borrowers secure full forgiveness. But the CARES Act that brought us the PPP also created the employee retention credit (ERC). The CAA21 has modified the ERC, both retroactively and prospectively, in ways that will provide material benefits to many businesses. The CAA21 not only made the benefits of the ERC easier to obtain, but the CAA21 also made the ERC available to employers that received a PPP loan. Further, employers can now obtain credits for wages paid in the first two quarters of 2021.1
Background of the ERC
The ERC is a refundable payroll tax credit available to taxpayers that, prior to the CAA21, satisfied one of the following two criteria:
- Their business was at least partially suspended by a government rule during at least one quarter of 2020. The IRS significantly limited the scope of when a taxpayer qualified under this test in FAQs 30-38 of its ERC FAQs. The CAA21 does not override these positions.
- They experienced a 50 percent drop in gross receipts in any
quarter of 2020 relative to the same quarter in 2019.
If either criteria were satisfied, the business was entitled to a refundable tax credit (i.e., it would offset tax liability if the business had any; otherwise the government would send you a check for the value of the credit). The amount of the credit depended on the payment of "qualified wages," and that definition was different depending on whether the business had more or fewer than 100 full time employees in 2019. Basically, businesses with an average monthly FTE employee count in 2019 greater than 100 could claim the ERC only for wages paid during an eligible quarter to employees for not working. But businesses that did not hit the 2019 average monthly FTE payroll greater than 100 threshold could claim the ERC for wages paid to employees being paid to work.
The ERC equaled 50 percent of eligible wages paid in that quarter, up to $10,000 per employee, per year. We summarized the basics of computation previously and in an update when the IRS published FAQs for the ERC. For eligible businesses, the computation translated into a maximum credit of $5,000 per employee. Qualified wages for these purposes included health care costs. Two other critical rules for computing credits are worth noting:
- If the employer qualified because of a government shutdown
order, qualified wages only include those paid during the
government imposed shut down.
- If the employer qualified because of a 50+ percent drop in
gross receipts, qualification continued until the fiscal quarter
after business receipts returned to at least 80 percent of what
they were during the same fiscal quarter of 2019.
New and Improved ERC Under the CAA21
The CAA21 expanded the ERC in scope and applicability in several ways.
Retroactive expansion to include PPP borrowers among the businesses that can claim the ERC between March 12, 2020 and December 31, 2020. (CAA21, Section 206)
All those PPP borrowers who, in 2020, thought they would not benefit from, or have to learn the nuances of, the ERC now have an opportunity to do both. And they have to do so without double counting PPP qualified payroll costs when computing ERC qualified wages.
Avoiding double counting will not be computationally easy to do or to prove. For example, assume a business has a PPP loan of $1 million but, in light of the expanded 24 week covered period, the business spent $1 million on qualified payroll costs, $1 million on qualified rent and $1 million on other qualified PPP costs as those qualifying costs were expanded by the CAA21. How much of the PPP forgiveness is attributable to which payroll costs?
Hopefully, the IRS and SBA will provide simple guidance because otherwise qualified payroll costs claimed in connection with a PPP forgiveness application to the SBA could become disqualified if the borrower also claims the ERC when dealing with the IRS. The IRS is also going to need to explain how employers claim the credit retroactively since most will have filed three quarters of Forms 941 by the time they realize they are even entitled to claim the ERC.
Extended the ERC from December 31, 2020 through July 1, 2021, and altered the computation of the credit in extremely favorable ways - but only during 2021. (CAA21, Section 207)
Extending the credit into 2021 is itself an enormous expansion of the ERC, especially now that the ERC is available to an employer that received a PPP loan.
Plus there are a number of significant computational changes:
- The credit percentage increases from 50 percent to 70 percent. Accordingly, employers can receive a credit of $7,000 per employee for paying $10,000 of qualified wages, rather than $5,000.
- Separate $10,000 caps apply in each of the first two quarters of 2021, rather than a single $10,000 cap for the entire year. The maximum ERC for 2020 was $5,000 per employee (50 percent of the first $10,000 of qualified wages). For 2021, the maximum ERC is $14,000 (70 percent of the first $10,000 of qualified wages in the first and second quarters.
- The reduction in quarterly gross receipts compared to the same quarter in 2019 is changed from a 50 percent reduction to only a 20 percent reduction. Accordingly, a business can claim the ERC in 2021 if the business experiences a drop in quarterly receipts (i.e., revenue less allowance for returns) for the first or second quarter of 2021 compared to receipts in the first or second quarter of 2019 of at least 20 percent or more.2
- For purposes of qualifying for the ERC because of a drop in quarterly receipts, a business can elect to use the prior quarter and the corresponding 2019 quarter. For example, if a business experienced a 20 percent or greater drop in the fourth quarter of 2020 compared to the fourth quarter of 2019, but did not for the first quarter of 2021 compared to the first quarter of 2019, the business can elect to qualify for the ERC for the first quarter of 2021. Similarly, it appears that, if the business experienced a 20 percent or greater drop in revenue between for the first quarter of 2021 compared to the first quarter of 2019, the business not only qualifies for the ERC for the first quarter of 2021 but will be able to elect to qualify for the second quarter of 2021, regardless of the revenue the business receives in the second quarter of 2021.
- As noted above, in 2020 the definition of qualifying wages depended on whether the employer had more than 100 FTE employees. For 2021, the 100 FTE threshold increases to 500 FTEs.
- For employees joining or leaving in the middle of a quarter, qualified wages can be increased via additional payments (e.g., hiring bonus or severance) in order to maximize the ERC.
In addition to these computational changes, there is a mechanism for employers with fewer than 500 FTE employees to accelerate receipt of the ERC. In lieu of claiming the credit against payroll tax deposits for the prior period, employers can now claim the credit before the qualified wages are actually paid. The advance credit is capped at 70 percent of the average quarterly qualifying wages paid by the employer in 2019 and must be subsequently reconciled with the actual credit to which the business is entitled. So an employer that anticipates qualifying for the ERC for the first two quarters of 2021 can claim an advance credit of up to 70 percent of the average quarterly wages paid in 2019, subject to the applicable caps.
In sum, the ERC is going to prove an extremely valuable credit for many more businesses, especially so in 2021. In particular, businesses that received PPP loans will be surprised that not only can they now participate, but they can even do so retroactively for 2020. We expect the IRS to provide details on the many confusing aspects of this new and improved ERC by the end of January. We will keep you posted.
1 For those eager to review the actual language of the ERC amendments to the law, you will find it under CAA21 Division EE, Title II, starting on page 2460.
2 If the business did not exist in the comparative quarter of 2019, the business can use its corresponding quarter in 2020.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.