The Employee Retention Credit (“ERC”) has been the most asked about topic coming out of the Consolidated Appropriations Act, 2021 (“The Act”) per my inbox. The Act opened up the ERC program to PPP borrowers for the first time and also extended the program through July 1, 2021.
The Act effectively split the ERC into two distinct programs. One program ends on December 31, 2020 and the other begins on January 1, 2021. For simplicity sake, I will refer to the program ending on December 31, 2020 as “ERC2020” and the program beginning on January 1, 2021 as “ERC2021”.
I’ll warn you; this is going to be a meaty blog post. I’ll keep it as simple as possible, but the program is complex. We need to walk through eligibility, credit calculations, and how this program works alongside the PPP program.
What is the Employee Retention Credit?
The ERC is a refundable payroll tax credit that is only available to business owners who meet certain criteria as initially laid out in the CARES Act and now updated via the Consolidated Appropriations Act, 2021.
Eligibility Requirements and Credit Calculations
The business must have been fully or partially suspended during at least one quarter in 2020 or can demonstrate a significant reduction in gross receipts for a quarter in 2020 compared to the same quarter in 2019.
Let’s walk through the requirements and calculations step by step….
Step 1: Is your business eligible?
Option 1: Were business operations fully or partially suspended during any calendar quarter in 2020 due to orders from an appropriate governmental authority?
What does this mean?
The operation of a trade or business is partially suspended if an appropriate governmental authority imposes restrictions on the employer’s operations by limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to COVID-19 such that the employer can still continue some, but not all of its typical operations.
There are many circumstances to be considered as it relates to partial suspension. One example from the IRS website that hits home for many businesses and Ceterus customers is as follows:
Employer F, a restaurant business, must close its restaurant to on-site dining due to a governmental order closing all restaurants, bars, and similar establishments for sit-down service. Employer F is allowed to continue food or beverage sales to the public on a carry-out, drive-through, or delivery basis. Employer F’s business operations are considered to be partially suspended because a portion of its business operations – its indoor and outdoor dining service – is closed due to the governmental order.
If Option 1 is utilized, it is important to point out that the business is only eligible for the credit during the period of the time the business was shut down by government order.
Option 2: Experience a significant decline in gross receipts during the calendar quarter.
A significant decline in gross receipts begins with the first calendar quarter in 2020 in which an employer’s gross receipts are less than 50 percent of its gross receipts for the same calendar quarter in 2019. The business remains eligible through the end of the quarter in which the business’s gross receipts are greater than 80 percent of its gross receipts for the same calendar quarter in 2019.
Step 2: You Qualified, How Do You Calculate the Credit?
Before we get into the credit calculation, we need to understand the inputs. The most significant is qualified wages. Qualified wages are generally those wages that are included in the employee’s gross pay after March 12, 2020 and before January 1, 2021. Qualified wages include the Employer’s qualified health plan expenses that are properly allocable to the wages.
Simple right? It really is, but we need to work through one significant nuance. The rules are different depending on how many employees you have.
More than 100 average monthly FTEs in 2019: Wages paid to an employee to not provide services are eligible for the credit.
Less than 100 average monthly FTEs in 2019: All wages paid to an employee qualify, regardless of whether the employee is working or not.
Let’s take a look at an example. We will assume the business has less than 100 employees.
Our sample business will qualify for the ERC2020 in Q2 based on the 66.7% reduction in gross receipts in 2020. The business’s eligibility will end at the conclusion of Q3 based on the business achieving 93.3% of gross receipts in 2020 compared to 2019.
Now let’s calculate our credit. The table below shows the wages paid during the business’s eligible period by employee.
Ok, so what is my credit?
The credit for ERC2020 is 50% of qualified wages, capped at $10,000 in qualified wages (simply put, the maximum credit is $5,000 per employee). The credit in our example is $14,000. Employees 2 and 3 have their credit capped at $5,000 because their wages for the eligible period were greater than $10,000.
Legislators opening up the ERC program to PPP borrowers is a major win for small businesses, however there is quite a bit to think about.
What do we know today?
We know both programs rely heavily on payroll. PPP forgiveness has a requirement that you spend 60% of PPP loan proceeds on payroll costs in an attempt to achieve 100% forgiveness. ERC2020 is driven 100% by payroll costs. The Act disallows using the same payroll costs for PPP forgiveness and the ERC2020 program.
What do we not know today?
The main item we need guidance on is how those participating in both programs can make selections related to which wages will apply to the ERC2020 program versus PPP forgiveness. It is extremely likely that the period of time you are eligible for the ERC2020 program will overlap with your PPP covered period. There must be a way to document which wages you are applying to each program, but that remains to be seen.
There are questions around PPP borrowers that have already applied for forgiveness? It is very likely those borrowers included all wages in their forgiveness application because they were not eligible for the ERC2020 program at the time of applying for forgiveness. Are they out of luck or will there be a way to still take advantage of both programs?
We expect guidance on these questions and more to come out in the coming days and weeks.
What should I do while I wait for further guidance?
Determine if you qualify for the ERC2020 program
If you qualify, start collecting your payroll data for the quarters you are eligible
Do the same for PPP, collect payroll data for the covered period you have chosen
Be strategic! Determine how best to apply your payroll costs to take advantage of both programs
It’s time to take a breath. We will be back with ERC2021…