Employee Retention Tax Credit (ERC)
Sometimes we all need a little help. And these days, among those most in need of that help are the country’s many small and midsize employers impacted by the COVID-19 economy.
Take Alex Buckingham. He owns a small manufacturing company with 50 employees. The business’ revenue is down by more than 50 percent due to a combination of decreased demand and forced closures. His cash reserves are nearly depleted and he’s struggling to keep his employees on the payroll.
To help Alex and other employers make payroll, Congress created and subsequently expanded the federal employee retention credit.
The employee retention credit has the potential to provide eligible employers with huge and immediate cash infusions. An employer like Alex, with 50 eligible employees, could qualify for a total credit of $1,650,000 — including $250,000 for 2020 and $1,400,000 for all of 2021.
Introduction to the Employee Retention Credit
In broad terms, the employee retention credit is a refundable federal tax credit against employment taxes. Under certain circumstances, employers can even apply for it as an advance credit. It is calculated based on qualified employee wages paid by a business or not-for-profit employer.
The credit was created by the CARES Act to provide relief to smaller employers hard hit by the COVID-19 economy. It was expanded and extended in the Consolidated Appropriations Act to provide additional benefits for the first two quarters of 2021. The updated rules also broadened eligible employers to include larger employers and those previously locked out because they received PPP loans.
The American Rescue Plan Act (ARPA) expanded eligibility and dollar amounts, and extended the credit through December 31, 2021. (Note that the bipartisan infrastructure bill, as passed by the Senate, would end the credit earlier, as of September 30, 2021)
Provisions of the credit are described below, with detailed provisions included in the table that follows.
Eligibility for the Credit
In general, the employee retention credit is available to employers, including for-profit businesses, tribal businesses and 501(c) not-for-profit organizations. Governmental employers do not qualify (with the exception of governmental colleges and universities for 2021), nor do certain entities with no employees or household employers.
More specifically, there are two original eligibility tests, either of which qualify an employer for the credit and determine the periods during which it qualifies. Subsequent legislation created additional eligibility rules.
- Employers that Experience a Full or Partial Lockdown Businesses and not-for-profit organizations are eligible for the credit if they have been negatively impacted by COVID-19 as a result of a full or partial lockdown of their operations by a governmental entity, establishing the time for which a credit can be claimed.
Typically, this applies to nonessential businesses that were more than nominally impacted by a governmental order.
SEE ALSO IRS Notice 2021-20 for examples of more than nominally impacted employers.
- Employers that Experience a Decrease in Gross Receipts Employers are eligible if they can demonstrate that their gross receipts in any quarter of the year are down relative to the same quarter in 2019 — or in 2020 if the employer did not exist in 2019.
The term gross receipts is defined broadly here, and must include that of any affiliates. It’s a complex calculation that includes not only sales/income from the trade or business, but also interest and dividends, annuities, rents and royalties, to name a few. It’s based on the accounting method (cash or accrual) that you use on your federal income tax return.
SEE ALSO IRS Notice 2021-20 for more information on determining gross receipts.
Safe Harbor Employers can exclude the following amounts from their gross receipts to qualify for the credit: Paycheck Protection Program loan forgiveness amount, restaurant revitalization grant amount, shuttered venue operations grant amount. The safe harbor must be applied consistently for determining eligibility for the credit for each calendar quarter in which gross receipts are relevant.
SEE ALSO Revenue Procedure 2021-33 for more on the safe harbor.
For 2020, revenue must be down by at least 50 percent in a calendar quarter compared to the same quarter in 2019 to establish eligibility. Eligibility, once established, continues until the end of the quarter during which revenue equals or exceeds 80 percent of revenue in the same-quarter of 2019.
For a calendar quarter in 2021, gross revenue must be down by at least 20 percent in a calendar quarter compared to the same quarter in 2019. Employers that did not exist in 2019 can demonstrate the 20 percent reduction using the first two quarters of 2020. Alternatively, an employer can elect (on a quarter-by-quarter basis) to compare gross revenue to the previous quarter.
Importantly, employers with Paycheck Protection Program (PPP) loans and somewhat larger employers — including certain state and local entities — are now eligible for the credit.
The extension of the credit to include PPP-borrowers is a retroactive provision in the updated rules for the credit, so 2020 and 2021 PPP borrowers are now eligible for the employee retention credit. However, employers can’t use the same wages in both employee retention credit and PPP forgiveness calculations, and the wage allocation is complex.
To maximize the benefits of both, maximize the amount of nonpayroll costs (up to 40 percent) in your PPP forgiveness calculation.
ARPA added another category of eligible employers for the third and fourth quarters of 2021:
- Recovery Startup Businesses Employers that do not qualify under either the first or second category of eligible employers (above) may qualify if they started in business after February 15, 2020. For the three taxable years before the calendar quarter the employer applies for the credit, its annual gross receipts cannot exceed $1 million. For these employers, the credit is limited to $50,000 per quarter, per employer.
Determining Eligible Wages for Small and Large Employers
Eligible wages are determined, in part, based on the employer’s average number of full-time equivalent employees (FTEs) during 2019. It’s important to note that, if the employer is part of an affiliated group, the number of FTEs is determined by adding all of the employees in the affiliated group.
The definition of an affiliated group is based on a complex set of rules, but generally includes brother-sister and parent-subsidiary groups (corporate and partnership), as well as affiliated service groups.
SEE ALSO IRS Notice 2021-20 for more information on affiliated groups and the employee retention credit.
Small employers (maximum of 100 FTEs for 2020, increasing to 500 for 2021) can include the wages paid to both working and nonworking employees.
Large employers (more than 100 FTEs in 2020) can only include wages paid to employees while they are not working.
Severely Financially Distressed Employers experience a more-than-90-percent decrease in gross revenue compared to the same quarter in 2019 (only applicable to third and fourth quarters of 2021). These employers — even those with more than 500 employees — can treat all employee wages paid during the quarter as qualified wages.
In 2020, pay increases such as bonuses and hazard pay are excluded from the wage calculations. For 2021, such pay increases are no longer excluded.
As previously noted, employers cannot include the same wages in determining both the amount of the employee retention credit and the PPP forgiveness amount.
Wages for business owners and spouses may not be eligible for the credit in the third and fourth quarters of 2021. According to IRS Notice 2021-49 otherwise-eligible wages paid to 50 percent or more (majority) owners and their spouses are not eligible for the credit if the majority owner has a living whole or half brother or sister, ancestor or lineal descendent. If the owner has no living relatives, wages paid to the owner and spouse are eligible for the credit, assuming they satisfy all other eligibility requirements.
If the business is an S or C corporation, the 50 percent ownership rule applies to the value of the employer’s stock. For a partnership or other noncorporate entity, the 50 percent rule applies, directly or indirectly, to the capital and profit interests.
Establishing the Amount of the Credit
Employers are eligible for both the 2020 and 2021 versions of the credit.
For 2020, the amount of the credit is generally 50 percent of qualified wages (per employee) paid from March 12 through December 31, plus the cost of the employee’s health benefits. Significantly, if eligibility is based solely on a full or partial lockdown during the quarter, only wages paid during the time of the lockdown are eligible. This may be less than the total wages paid during the quarter.
The 2020 credit is limited to $5,000 (50 percent of $10,000 in qualified wages per year) per qualified employee.
Per ARPA, in 2021 the amount of the credit increases to 70 percent of qualified wages per qualified employee, per quarter — plus employee health benefits. The maximum annual credit increases to $28,000 per employee ($7,000 per quarter).
Claiming the Employee Retention Credit
The credit is a fully refundable federal employment tax credit.
To claim the credit, an eligible employer must report its total qualified wages and related health insurance costs on its quarterly employment tax return, Form 941.
Employers access the funds from the credit by reducing their employment tax deposits, up to the amount of the credit. Through the first two quarters of 2021, the claim is applied to the 6.2 percent employer share of Social Security taxes. Under ARPA, for the final two quarters of 2021, employers claim the credit against the 1.45 percent employer’s share of Medicare taxes.
This is the fastest way to receive funds from the credit. It requires significant coordination with your payroll provider.
If the amount of the reduction is not sufficient to cover the amount of the credit, the employer can request an advance for the difference using Form 7200, Advance of Employer Credits Due To COVID-19.
Further, new in 2021, employers can apply for an advance credit using this form. An employer with no more than 500 employees can, for any quarter, qualify for a payment of up to 70 percent of the average quarterly wages paid for 2019. If the advance exceeds the actual credit due, the excess is added to the employer’s payroll tax due for the calendar quarter.
For credits being claimed retroactively, employers can opt to file amended Forms 941X, as appropriate.
Note that the IRS is currently experiencing a significant delay in processing paper filings. Forms 941X and 7200 are both paper filings, so you may experience a significant wait time in receiving the funds.
Statute of Limitations
Because of the inherent complexity around the evolving rules for the credit — including the issue of compatibility with PPP calculations — the statute of limitations for the IRS to review credit claims was extended from three years to five years.
The five-year period begins with the original filing date of the annual tax return that includes the calendar quarter for which the credit is claimed. Alternatively, if later, it begins with April 15 of the following calendar year.
To support your credit claims in the event of an IRS inquiry, you should save the following for at least five years:
- support for eligibility and affiliate group determinations
- relevant health care expenses
- federal employment tax records, including any Forms 941X and 7200
- wage allocations between the credit and PPP loan forgiveness amounts
- payroll reports
Employee Retention Credit
CCA and ARPA
|Eligible business and not-for-profit organizations||Operations fully or partially suspended by COVID-19 lockdown order|
(or) Gross receipts in any quarter of 2020 is less than 50% of same quarter in 2019
|Operations fully or partially suspended by COVID-19 lockdown order|
(or) Gross receipts in any quarter of 2021 are less than 20% of same quarter in 2019
(or) Doesn’t qualify per above, started business after February 15, 2020 and annual gross income of $1 million or less (a recovery startup business, for Q3 and Q4 2021 only)
(or) Gross receipts in any quarter of 2021 are less than 20% of same quarter in 2019)
|Eligibility ends||End of quarter during which gross receipts are at least 80% of same quarter 2019|
(or) End of lockdown order
|End of quarter during which gross receipts are at least 80% of same quarter 2019 or the previous calendar quarter|
(or) End of lockdown order
|Small Employer||Maximum of 100 FTEs||Maximum of 500 FTEs|
|Large Employer||More than 100 FTEs|
|PPP borrowers eligible?||No. Includes affiliated companies||Yes, unless wages paid with proceeds of forgiven PPP loan|
Retroactive to March 12, 2020
|Federal, state and local governmental entities eligible?||No||Available to certain state and local entities, including organizations chartered by Congress and those providing higher education and medical care|
|Qualified Period||March 12, 2020 – December 31, 2020||January 1, 2021 – December 31, 2021|
|Pay increases eligible?||No. Prohibited||Prohibition is repealed, including for bonuses and hazard pay increases|
|Wages for working employees included?||If 100 or fewer employees, wages for working and non working employees are eligible|
If more than 100 employees, no credit for wages earned while employee was working, even at a lesser capacity
Includes those of affiliated companies
|If 500 or fewer employees, working employees are eligible|
Includes wages of affiliated companies
|Credit calculation||50% of qualified wages, plus cost of qualified employee health benefits||70% of qualified wages, plus cost of qualified employee health benefits|
|Maximum credit||$5,000 per employee for 2020 (50% of $10,000)||$28,000 per employee, in addition to any 2020 credit|
Calculated as $7,000 per quarter of 2021 (70% of $10,000)
For recovery startup businesses, the credit is limited to $50,000 per quarter, per employer.
|Safe Harbor||Gross receipts exclude the following amounts: PPP loan forgiveness, restaurant revitalization grant, shuttered operations venue grant||Gross receipts exclude the following amounts: PPP loan forgiveness, restaurant revitalization grant, shuttered operations venue grant|
|Advance credit allowed?||No. Credit not allowed before wages are paid||Yes for employer with no more than 500 employees|
For any quarter, credit is limited to 70% of average quarterly wages paid in 2019
|Statute of limitations||Three years||Five years|
The employee retention credit is a complex and evolving section of the federal tax code for businesses and not-for-profit organizations. Much more complex than can be described here. It is especially complicated for those claiming both the employee retention credit and a PPP loan. Seek professional guidance.
There are many events that occur during the year that can affect your tax situation. Preparation of your tax return involves summarizing transactions and events that occurred during the prior year. In most situations, treatment is firmly established at the time the transaction occurs. However, negative tax effects can be avoided by proper planning. Please contact us in advance if you have questions about the tax effects of a transaction or event, including the following:
- Pension or IRA distributions
- Significant change in income or deductions.
- Notice from IRS or other revenue department.
- Job change.
- Divorce or separation.
- Attainment of age 59½ or 72.
- Charitable contributions of property in excess of $5,000
- Sale or purchase of a business.
- Sale or purchase of a residence or other real estate.
This blog post contains general information for taxpayers and should not be relied upon as the only source of authority.
Please seek professional tax advice (like reaching out to us) for more information concerning your specific scenario.
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