Employee Retention Tax Credit – Existing Rules and New Changes

The Employee Retention Tax Credit is another tax credit opportunity under recently passed Coronavirus-related relief legislation. As a business owner, you should review these rules to determine if you can receive credit dollars from the Employee Retention Tax Credit.

Background:

The Coronavirus Aid, Relief, and Economic Security (“CARES”) Act was signed into law on March 27, 2020 and provides qualifying employers new opportunities with the Employee Retention Tax Credit (“ERTC” or “ERC”).

For 2020:

The ERC permits qualifying employers to claim a payroll tax credit of 50% of qualifying wages (up to $10k wages) per employee. The total credit amount is limited to $5k per employee for the entire year of 2020. But you must meet certain qualifiers.

Under the CARES Act, a small employer with significant decline in gross receipts may qualify for the ERC. An employer qualifies for a significant decline in gross receipts for the period beginning with the first calendar quarter in 2020 for which its gross receipts are less than 50 percent of gross receipts from the same calendar quarter in 2019. The original credit ended the earlier of:

  • January 1, 2021 (the calendar year); or
  • the first calendar quarter after the quarter for which gross receipts are greater than 80 percent of gross receipts for the same calendar quarter in 2019.

Thus, generally you get at least two quarters if you qualify for one.

An employer is considered small if it had an average of 100 or fewer employees in 2019. There are two other possibilities to get this credit:

  • First, if you a required shutdown of your business because of Covid; or
  • Secondly, for those businesses that don’t meet the definition of small, these larger businesses can also get a credit for wages paid where the worker is technically not working because of the stoppage.

The details and rules for the stoppage circumstances can be complex. Also, see below where the 2021 definition of small is now set at 500 employees.

Like most labor-based tax credits, the ERC is subject to rules outlined in Code Sec. 280C(a), which disallow a deduction for the portion of wages equal to the credit. Accordingly, if the ERC is computed to be $100k for 2020, then total wage expense must be reduced by $100k on the company’s annual 2020 income tax return. So, although you may receive $100k as a credit against your payroll taxes, the effective savings is the residual of your marginal tax rate. If you pay income tax at 30% on, for example, passthrough income, then the $100k is really a tax savings of $70k.

For 2021:

The Consolidated Appropriations Act (“CAA”) was signed into law on December 27, 2020 and increased the value of the ERC and liberalized the availability of the credit.

The CAA increases the maximum credit to $7k per employee for each of the first two quarters of 2021 (70% of qualifying wages up to $10k in wages). The total credit amount is limited to $7k per quarter, for a total of $14k per employee for 2021.

Three major changes for 2021:

  • The CAA modified the test for small employers to determine eligibility for the ERC by reducing the threshold of decline in gross receipts to 20% (much less than the 2020 threshold of 50%) from a quarter in 2021 to the same quarter in 2019. In addition, the CAA gives employers the option to apply the 20% test to the fourth quarter of 2020 (comparing it to the fourth quarter of 2019). If either test shows a more than 20% decline, the employer qualifies for ERC in the first quarter of 2021. i
  • An employer is now considered small if it had on average 500 or fewer employees throughout 2019.
  • The CAA also retroactively uncoupled the Paycheck Protection Program (“PPP”) and ERC for 2020.

The uncoupling of PPP and ERC is significant. Taxpayers who were precluded from claiming the ERC because they had received a PPP loan are now permitted to go back and claim the ERC for 2020 by amending payroll tax filings.

However, the same wages cannot be used for both PPP and ERC. So, you still need to meet the PPP 60% requirement whereby you must use 60% of the PPP loan proceeds for payroll. Therefore, when the two (ERC & PPP) coincide during the same time period, you need to effectively plan where the payroll dollars will be best utilized.

Form 7200 (Advanced Payment of Employer Credits Due to COVID-19) can be filed to receive your 2021 ERC in advance. Employers will need to ensure that their ERC estimates are fairly accurate. Any excess credit paid to employers will need to be paid back once the employer files their quarterly Form 941 and reconciles advanced funds versus the actual amounts for each quarter in 2021.

Key Point: If you qualified for PPP 2nd draw by meeting the 25% PPP revenue reduction in the 4th quarter of 2020 (vs 2019), then you also very likely qualify for the ERC. And you would likely be entitled to the ERC during at least the first quarter of 2021. If this applies to your circumstances, call us to discuss this ASAP.

Disclaimer: The information contained herein is a summary of complex tax matters. Do not implement any tax strategies suggested herein without first contacting your advisor or Shavell & Company, P.A.

i Amended Subparagraph (B) of section 2301(e)(2) of the CARES Act of 2020.