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 available to business owners who meet certain criteria as laid out in the Consolidated Appropriations Act, 2021.
ERC 2021
Eligibility Requirements and Credit Calculations
The ERC2021 program is available from January 1, 2021 to June 30, 2021 (first and second quarters of 2021 only).
The business must demonstrate a significant reduction in gross receipts in the first or second quarters of 2021 compared to the same quarter in 2019.
Let’s walk through the requirements and calculations step by step….
Step 1: Is your business eligible?
Experience a significant decline in gross receipts during the calendar quarter.
Eligibility is achieved if gross receipts of any quarter in the first half of 2021 is less than 80% of the same quarter in 2019. If the business did not exist at the beginning of the same quarter of 2019, the business can substitute the same quarter in 2020 instead.
The Act also gives businesses the option to test eligibility by using the “immediately preceding” calendar quarter. A comparison would be done between that quarter and the same quarter in 2019. It seems that a business that does not qualify based on the first quarter 2021, could use quarter four of 2020 and compare those gross receipts to quarter four of 2019 to determine eligibility. This option should help speed up the eligibility determination process.
It is not clear based on current guidance if a business has to formally qualify in each quarter of 2021 to be eligible for the credit in that quarter. Our assumption at this point is a business will have to formally qualify for this credit by doing calculations for each quarter of 2021 independently.
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 in the relevant quarter. 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 500 average monthly FTEs in 2019: Wages paid to an employee to not provide services are eligible for the credit.
Less than 500 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 500 employees.
Our sample business will qualify for the ERC2021 program in both quarter one and quarter two based on gross receipts for each in 2021 being less than 80% compared to the same quarter in 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 ERC2021 is 70% of qualified wages, capped at $10,000 in qualified wages per quarter (simply put, the maximum credit is $7,000 per employee, per quarter or $14,000 total). The credit in our example is $25,900. No employees were capped in this example, which differs from the ERC 2020 example we ran through on the previous blog post.
Other Considerations
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. ERC2021 is driven 100% by payroll costs. The Act disallows using the same payroll costs for PPP forgiveness and the ERC2021 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 ERC2021 program versus PPP forgiveness. It is extremely likely that the period of time you are eligible for the ERC2021 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.
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?
Get Strategic Now! We know enough about both programs to start planning for how best to take advantage of both programs. Consider the following thoughts and questions.
1. Do you think you will be eligible for the ERC2021 program based on the current requirements?
2. We know that your only chance for ERC2021 eligibility is the first and second quarters of 2021. We know that the credit is driven by payroll costs. Given these facts, you will want to maximize the dollar value of payroll costs you can put toward the ERC2021 program.
3.You should determine what you expect your payroll costs to be over the next six to nine months. Why do I use six to nine months?
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If you get your PPP loan funded on January 31, you will have until mid-July to spend the funds if you take advantage of the 24-week covered period
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If you get your PPP loan funded on March 31 (this date is when the PPP program closes), you will have until mid-September to spend the funds if you take advantage of the 24-week covered period
4. Remember, PPP forgiveness rules require you to spend 60% of your loan on payroll costs (assuming you are attempting 100% forgiveness). How many payrolls will it take to achieve 60%? The more payrolls you run in the third quarter that can be applied to your PPP forgiveness calculation the better because it will allow you to maximize the payroll costs you can apply to the ERC program.
Stay tuned for updates as the SBA issues further guidance related to these programs.
