The CARES Act created the employee retention tax credit (ERTC) for eligible businesses and tax-exempt organizations that pay qualified wages, including certain health plan expenses, to employees after March 12, 2020, and before January 1, 2021. At the same time, the CARES Act also created the Paycheck Protection Program (PPP). Under that legislation, businesses that received a PPP loan were ineligible for the ERTC.
In December 2020, Congress enacted the Consolidated Appropriations Act, 2021 (CAA), which retroactively expanded eligibility for the ERTC to businesses that received a PPP loan, providing businesses an opportunity to review eligibility for the credit for wages paid in 2020. The CAA also extended the credit through June 30, 2021, and modified the rules for 2021. Then, on March 11, 2020, Congress enacted the American Rescue Plan Act (ARPA), further extending the credit though December 31, 2021.
As a refresher, you may recall that, for 2020, the credit was equal to 50% of qualified wages, limited to $10,000 in wages per employee for the year (for a maximum of $5,000 per employee). All wages qualified for the credit for businesses that averaged 100 or fewer full-time employees (FTEs) in 2019. For businesses that averaged more than 100 FTEs in 2019, only wages paid to employees who were not providing services qualified for the credit. An employer was eligible for 2020 if the business was fully or partially suspended or had to reduce business hours due to a government order. Alternatively, an employer was eligible if business gross receipts (as defined in Internal Revenue Code 448(c)) in a calendar quarter were below 50% of gross receipts when compared to the same calendar quarter in 2019.
The CAA did not change these rules for 2020, and businesses are encouraged to review their eligibility.
The CAA changed certain aspects of the rules for 2021. First, businesses who qualify in 2021 are now allowed to claim a credit against 70% of qualified wages. The amount of qualified wages for the credit is now $10,000 per employee per quarter. The maximum credit per employee per quarter is $7,000. Thanks to the ARPA, this means the ERTC maximum credit amount per employee for 2021 is $28,000.
In addition, beginning in 2021, the gross receipts test is changed. For 2021, a business need only show a 20% drop in gross receipts in the quarter compared to the same quarter in 2019. And, under the ARPA, businesses have the option of determining eligibility based on gross receipts in the immediately preceding calendar quarter (compared with the corresponding quarter in 2019). So, for example, for the first quarter of 2021, the business may compare that quarter to the first quarter of 2019, or, instead compare the quarter ended December 2020 with December 2019.
For 2021, businesses with up to 500 FTEs in 2019 can claim the credit without regard to whether the employees for whom the credit is claimed actually perform services. But, except as discussed below, employers with more than 500 FTEs can only claim the ERTC with respect to employees that do not perform services.
Coordination with the PPP Program
As stated above, businesses that received a PPP loan may be able to claim the ERTC. However, wages used for the ERTC cannot be used for purposes of PPP loan forgiveness. On March 1, the IRS issued guidance in Notice 2021-20. There, the IRS reiterates that a business may elect not to take into account certain wages for purposes of the ERTC. The IRS does not require a formal election to do so. The election is made simply by not claiming the credit for those wages on its federal employment tax return.
However, the IRS states that a business that received a PPP loan is deemed to have made the election for wages included in the amount reported as payroll costs on a PPP loan forgiveness application.
Q&A 49 of the Notice then elaborates on this rule. Specifically, the Notice provides that a business will only be deemed to make the election for the minimum amount of wages, together with any other eligible expenses reported on the forgiveness application, sufficient to support the amount of the PPP loan that is forgiven. As such, businesses that reported more payroll costs than necessary to achieve full loan forgiveness will not need to be concerned about the excess payroll costs reported on the application, since the deemed election out of ERTC only applies to the minimum amount of wages needed to achieve full forgiveness.
Of course, if qualified wages are reported as payroll costs and the loan amount is not forgiven, those qualified wages may be taken into account for purposes of the ERTC.
The IRS provides several examples. Here are a few of them.
- Example 1. Suppose Employer A received a PPP loan of $100,000. Employer A paid $100,000 in wages that qualify for the ERTC. In order to receive forgiveness of the PPP loan in its entirety, Employer A needed to report $100,000 of payroll costs and other eligible expenses on its forgiveness application. Employer A actually reported $100,000 of payroll costs on its forgiveness application (and no other costs or expenses). The loan was forgiven. Result: Employer A is deemed to have made an election not to take into account $100,000 of the qualified wages for purposes of the ERTC.
- Assume you had other eligible expenses of $40,000 and just chose not to report them on your PPP forgiveness application. Can you after the fact make a case that such costs would have counted for PPP forgiveness and thus preserve $60,000 of wages for the ERTC? Sadly, you cannot.
- Example 2. Employer B received a PPP loan of $200,000. Employer B paid $250,000 of wages that qualify for the ERTC during the second and third quarters of 2020. In order to receive forgiveness of the PPP loan in its entirety, Employer B needed to report $200,000 of payroll costs and other eligible expenses on its forgiveness application. Employer B actually reported $250,000 of payroll costs on its forgiveness application (and no other costs or expenses). The loan was forgiven. Result: Employer B is deemed to have made an election not to take into account $200,000 of the qualified wages for purposes of the ERTC. The remaining $50,000 of wages may be used for purposes of the credit.
- Example 3. Employer C received a PPP loan of $200,000. Employer C paid $200,000 of wages and had $70,000 of other expenses that qualify for forgiveness. Employer C reported all of these on its forgiveness application. Result: Employer C is deemed to have made an election not to take into account $130,000 of qualified wages for purposes of the ERTC, which is the amount included in the reported payroll costs up to (but not exceeding) the minimum amount of payroll costs, together with other eligible expenses, sufficient to support the amount of the loan forgiven. As you can see in this example, other expenses are considered used “first” (subject to their 40% cap) against loan forgiveness, which is beneficial.
- Example 4. Suppose the same facts as Example 3, except that Employer C paid and reported $90,000 of other eligible expenses. Result: Employer C is deemed to have made an election not to take into account $120,000 of qualified wages for purposes of the credit. $80,000 of the qualified wages reported as payroll costs may be treated as qualified wages for ERTC purposes. This example shows the impact of limiting the other expenses to 40% of $200,000 or $80,000. As such, $120,000 of wages are taken into account for PPP forgiveness leaving the $80,000 ERTC eligible.
The examples above assume that all wages used for the PPP forgiveness application are qualified wages for the ERTC. The calculation gets a little more involved when wages used for PPP forgiveness include both qualified and non-qualified. We can help you sort through that.
Other Aspects of Notice 2021-20
Business Fully or Partially Suspended. The notice provides numerous scenarios of when a business is considered to be fully or partially suspended. One item of note is that a business where its employees are teleworking (i.e. working from home) is generally not considered to be fully or partially suspended.
Business Income Tax Return. Q&A 60 provides that, on the business’ income tax return, the deduction for qualified wages, including qualified health plan expenses, is reduced by the amount of the 2020 ERTC. This is true for both cash and accrual basis taxpayers.
Claiming the Employee Retention Credit. Q&A 50 provides that the ERTC is claimed by reporting qualified wages and the amount of the credit on the designated lines of the federal employment tax return(s). For most employers, that will be Form 941 (or Form 941-X if amending a return already filed). In anticipation of receiving the credit, eligible employers can (1) reduce their deposits of federal employment taxes, including withheld taxes, that would otherwise be required up to the amount of the anticipated credit, and (2) request an advance of the amount of the anticipated credit.
Substantiation Requirements. In Q&As 70 and 71, the IRS indicates that a business must keep adequate documentation for at least 4 years after the date taxes become due or are paid, whichever comes later. Here are examples:
- Documentation as to how the employer determined it was eligible for the credit (governmental order, gross receipts, etc.).
- Documentation as to how the employer determined the amount of allocable qualified health plan expenses.
- Application of the aggregation rules, if there are related entities.
- Copies of any completed Forms 7200 that the employer submitted to the IRS.
- Copies of the completed federal employment tax returns.
Actions to Consider:
- 2020 tax year
- Assess whether you qualify for each quarter.
- If yes, determine qualified wages that are eligible for the ERTC if a PPP loan was applied for and forgiven.
- If your PPP loan forgiveness application has not been submitted (or approved) and you expect to qualify for the ERTC, ensure that you are reporting all possible non payroll costs in order to maximize your credit potential.
- File amended payroll tax filings either through your third party provider, on your own or with our assistance.
- 2021 tax year
- Assess whether you qualify for each quarter.
- If yes, determine the impact, if any, of any PPP loan considerations where 2021 payroll costs will be used to seek forgiveness.
- If yes, incorporate this into your quarterly payroll tax filings with the intent of not needing to later amend them.
At Sisterson, we stand ready to advise and to help you through any or all steps of the process.