By Dama Hergner, CPA
The Internal Revenue Service (IRS) recently issued guidance with Notice 2021-49 (the Notice) regarding the employee retention credit (ERC). The Notice provides guidance for added categories of Recovery Startup Businesses and financially distressed businesses. Furthermore, the Notice clarifies some questions that apply to the ERC for 2020 and 2021 including tip wages and owner wages.
The ERC was established with the enactment of the Coronavirus Aid, Relief, and Economic Security (CARES) Act in March 2020. Since then, the ERC has been impacted by two other laws. Under the Consolidated Appropriations Act, 2021 (CAA) and the American Rescue Plan Act (ARPA), the ERC was extended and expanded. An employer can claim a refundable payroll tax credit for a portion of wages paid during the coronavirus (COVID-19) crisis. An employer must meet certain eligibility criteria in order to claim the credit which can be claimed through December 31, 2021.
It is important to note the delineation of the law and date as depending on whether you took a Paycheck Protection Program (PPP) loan and when you claim the ERC, there are different requirements.
CARES Act – 2020
For qualifying employers, including borrowers who took a loan under the initial PPP, the ERC can be claimed against 50% of qualified wages paid, up to $10,000 per employee annually for wages paid between March 13, 2020 and December 31, 2020. This provides a refundable tax credit for qualifying employers of up to $5,000 per employee.
CAA – 2021
In December 2020, the CAA extended the ERC through June 2021 and increased the available credit. For qualifying employers, including PPP recipients, the ERC can be claimed against 70% of qualified wages paid. Furthermore, the amount of wages which qualify for the ERC is now $10,000 per employee per quarter for the first two quarters of 2021. If qualifying factors are met, an employer could claim $7,000 per quarter per employee.
ARPA – 2021
In March 2021, the ARPA further extended the ERC through December 2021. The ERC remains at 70% of qualified wages up to $10,000 per employee per employee. This is unchanged from the CAA. Therefore, an employer could claim an ERC per employee up to $28,000 for 2021. Certain startup businesses may now be allowed a credit of up to $50,000 per quarter. These startup businesses are those which started after February 15, 2020, had an average of $1million or less in gross receipts and otherwise would not qualify for the credit.
How to Qualify for the ERC
Following the enactment of the ARPA, most employers can qualify for the credit including colleges, universities, hospitals, and 501(c) organizations. Previously, the CAA expanded the qualifications to include those businesses who took a loan under the PPP including borrowers from the initial round of PPP who were originally ineligible to claim the credit.
There are two factors which determine qualification for eligible employers. One of these factors must apply in the calendar quarter in which the employer utilizes the credit.
- During that calendar quarter, business operations were either fully or partially suspended due to a COVID-10 related government shutdown order. The credit only applies for the portion of the quarter in which business was suspended, not the entire quarter.
Some businesses would not qualify based on this test if their operations are considered essential, unless there was a supply disruption in such a manner that their ability to continue operations was impacted. Additionally, those businesses which were closed but still able to continue operations through remote or telework would not qualify. However, these businesses may still qualify for the ERC with the second test.
- An employer had a significant decline in gross receipts. We will further discuss the definition of significant decline as applicable to the various time periods below.
On August 10, 2021, the IRS released Revenue Procedure 2021-33 which provides a safe harbor under which an employer may exclude the amount of PPP loan forgiveness and the amount of a Shuttered Venue Operators Grant or Restaurant Revitalization Fund grant from the definition of gross receipts SOLELY for the purpose of determining eligibility to claim the ERC. Employers must apply the safe harbor consistently across all entities treated as a single employer under ERC aggregation rules which are discussed in further detail below.
CARES Act – 2020
For 2020 calendar quarter, the employer can qualify if the gross receipts were less than 50% of the gross receipts as compared to the same calendar quarter in 2019. However, the employer is no longer eligible if in the calendar quarter immediately following, their quarter gross receipts exceed 80% as compared to the same calendar quarter in 2019.
CAA – 2021
For 2021 calendar quarter, the employer can qualify if the gross receipts were less than 80% of gross receipts for the same 2019 calendar quarter (or the same 2020 calendar quarter if the employer did not exist as of the beginning of the same 2019 calendar quarter).
ARPA – 2021
In addition to the eligibility requirements under the CAA, a business also has the option of determining eligibility based on gross receipts in the immediately preceding calendar quarter as compared with the corresponding quarter in 2019. This option is a quarter-by-quarter decision which allows the employer to make a different decision each quarter in 2021.
Recovery Startup Business
The Notice established a third category of eligibility which is applicable for the third and fourth quarter of 2021 only. Qualifying entities may be entitled to up to $50,000 per quarter. To qualify as a Recovery Startup Business, a business must:
- Started trade or business after February 15, 2020;
- Have annual gross receipts that do not exceed $1million; and
- Not be eligible for the ERC under the other two categories.
Recovery Startup Businesses may use all qualified employee wages for purposes of the credit, regardless of the number of employees. Determination of whether this category applies is assessed for each quarter.
Another consideration in determining eligibility of the ERC are the aggregation rules. It is important to note that the rules differ between those applied to the PPP eligibility as compared to those for eligibility to claim the ERC. The aggregation rules which apply to the ERC are derived from existing Internal Revenue Code (IRC) provisions under Section 448. From the establishment of the ERC under the CARES Act, aggregation rules require members of a controlled group to calculate the ERC as a single employer.
There are three categories of aggregated companies which fall under the special controlled group classification:
- Parent-Subsidiary Controlled Groups: One entity owns 50% or more of all entities
- Brother-Sister Controlled Groups: 5 or fewer people own at least 80% of each entity in the group with at least 50% voting power
- Combined Groups of Corporations: A combination of brother-sister and parent-subsidiary companies
Entities which exist within any of the above categories are subject to the aggregation rules. Therefore, all group members will be treated as a single employer when applying the ERC qualifiers of eligibility and qualified wages. Aggregation does not require that the businesses be related to one another; if ownership is controlled, all businesses are combined for purposes of the ERC determination. Employers who meet the criteria for the ERC under the aggregation rules will allocate the ERC among the members of the group in proportion to each member’s share of qualified wages. Additionally, if one member of the controlled group qualifies for the ERC, all members will qualify as the qualifiers are determined as a single employer.
How to Calculate Qualifying Wages
Wages and compensation which are subject to FICA taxes, as well as qualified health expenses, generally will qualify as wages when calculating the ERC. These amounts must have been paid after March 12, 2020 to qualify for the credit which extends to those amounts paid through December 31, 2021.
NOTE: The ERC can only be calculated on wages which were not funded with PPP monies that were forgiven or expected to be forgiven.
While the IRS has information dedicated to the various specific circumstances which can modify determination of qualified health expenses, in general, qualified health expenses include the employer and employee pretax portion and do not include any after-tax amounts.
In order to determine the qualified wages to be included in the ERC, an employer must first determine the number of full-time employees. For the purposes of the ERC, a full-time employee is defined as one that in any calendar month in 2019 worked at least 30 hours per week or 130 hours in a month as determined in accordance with Section 4980H of the Internal Revenue Code.
- Employers who were in business for the entire calendar year of 2019 or 2020 would take the sum of the number of FTEs in each calendar month and divide by 12.
- Employers who started a business in 2019 or 2020 determine the number of FTEs by taking the sum of the number of FTEs in each full calendar month in 2019 or 2020 in which the business operated and divide by that number of months.
- Employers who started a business in 2021 determine the number of FTEs by taking the sum of the number of FTEs in each full calendar month in 2021 in which the business operated and divide by that number of months.
NOTE: The calculation of FTEs used for the PPP forgiveness report is NOT calculated the same way as FTEs are calculated for the ERC.
CARES Act – 2020
Employers who have more than 100 FTEs can only use the qualified wages of employees not providing services because of suspension or decline in business. Any wages paid for vacation, sick, or other days off based on the employer’s current policy cannot be included in qualified wages. Essentially, employers can only use the ERC for employees who are not working.
Employers with 100 or fewer FTEs can use all employee wage; those working as well as any time paid not being at work with the exception of paid leave provided under the Families First Coronavirus Response Act.
It is important to note that aggregation rules of entities with common ownership apply to the determination of the 100 FTE threshold. The employees of all affiliated companies which share more than 50% common ownership are aggregated.
CAA – 2021
The CAA increased the employee limit to 500 for determining which wages are applicable for the ERC. Therefore, for the first two quarters of 2021, an employer that had 500 or fewer employees in 2019 would be eligible for the ERC even if the employees were working.
The same aggregation rules which require that employees of related companies which share more than 50% common ownership be included in the determination of the threshold.
ARPA – 2021
Under the ARPA, severely financially distressed employers can claim the ERC against all employee’s qualified wages instead of those who are not providing services. A severely financially distressed business is defined as employers whose gross receipts in the quarter are less than 10% of what they were as compared to the same quarter in 2019 or 2020. This only applies to the third and fourth quarters of 2021.
The Notice clarifies that tips would be included in qualified wages if such wages were subject to FICA. Generally, tips which are over $20 in a calendar month for an employee would be included as qualified wages for ERC. This is because tips which are less than $20 in a month for an employee are not subject to FICA wages and therefore would not qualify for the ERC.
Previous IRS guidance had stated that those individuals related to a majority owner were not allowed to be included in qualified wages. The Notice states that wages paid to a majority (more than 50%) owner of a corporation, or a majority owner’s spouse are not qualified wages unless the majority owner does not have any living parents, children, or siblings.
How does the Credit Work
Remember, the ERC can only be claimed on wages not used for other credits such as paid family medical leave or the work opportunity tax credit nor can the wages be funded by a grant program such as the restaurant revitalization fund. We will again state that the ERC can only be calculated on wages which were not funded with PPP monies that were forgiven or expected to be forgiven.
The Notice affirms that the ERC is extended for the third and fourth quarters of 2021 and that the credit now applies against Medicare taxes rather than Social Security taxes. The credit is still refundable, and this change does not limit the credit. The maximum credit is $7,000 per employee per quarter for the third and fourth quarters of 2021. The Notice also extends the statute of limitations for the credit claimed for the third and fourth quarters of 2021 to a period of 5 years.
The ERC is reconciled and claimed as a credit on the employer’s Form 941. If an employer is retroactively claiming the ERC, they must file Form 941-X for the applicable quarter(s) in which the qualified wages were paid.
Taxpayers claiming 2020 ERC must reduce the wage deduction on the 2020 income tax return which may require filing an amended return or administrative adjustment request for those taxpayers that filed the 2020 federal income tax return prior to calculating the 2020 ERC.
Longevity of the ERC
The infrastructure bill released on August 1, 2021 includes a provision which would limit qualified wages to those paid on or before September 30, 2021 except for employers that are not a recovery startup business. Therefore, the ERC may no longer apply in fourth quarter of 2021 if the bill passes as presently drafted.
Disclaimer: The rules and applicability of the rules surrounding the ERC are complex and unique to your situation. It is imperative that any calculation of a potential credit is first regulated by determining eligibility factors applicable to the employer.