More Businesses Can Get a Boost to Cash Flow

The Employee Retention Credit (ERC) is one of the more valuable COVID-related tax breaks available to employers, and it’s just been extended until December 31, 2021, through the American Rescue Plan Act. With expanded eligibility, higher maximum amounts and now the ability to claim the credit with Paycheck Protection Program (PPP) loans, more employers can benefit from an almost immediate boost to cash flow – if they understand the new framework.

More People Can Claim the 2020 Employee Retention Credit 

The employee retention credit (ERC) was first introduced in the CARES Act in March 2020. Initially, employers could claim up to 50% of eligible employee’s wages as a tax credit against Social Security taxes. Employers could only claim up to $10,000 of eligible wages per employee for a maximum yearly benefit of $5,000; valuable but limited.

Previous legislation prohibited employers from taking the ERC if they received a PPP loan. Thus, there were several employers affected by COVID-19 that weighed the pros and cons of both PPP and this tax credit and chose to take one or the other.

The Consolidated Appropriations Act, which was passed in December, first extended the timeframe for the ERC. That act also relaxed several provisions of the credit, and the ERC is now available to employers that took out a PPP loan.

2021 Employee Retention Credit Thresholds and PPP Overlap

From January 1, 2021, until December 31, 2021, employers can claim 70% of qualified wages; the $10,000 limit still applies. However, the maximum allowable wages reset in each of the four quarters that ERC is available in 2021. That means that eligible employers can receive up to $28,000 per employee in 2021.

Plus, employers with up to 500 average full-time employees in 2019 can now claim ERC for all employees. This is also an expanded benefit since, in 2020, only employers with fewer than 100 average full-time employees in 2019 could claim ERC for all employees.

The ERC and PPP overlap occurs because both are based on payroll and wages. In 2020, it was common for employers to max out their PPP forgiveness by using all of the loan to support payroll costs. Thus, they used little or none of the loan to support other eligible qualified expenses, especially if there was a risk that an expense would reduce the forgivable portion.

For second-draw PPP loans or first-draw loans that have not yet been submitted for forgiveness, instead of maxing out the payroll costs, employers can spread the reported forgiveness loan application costs across other eligible expenses and payroll, using only the minimum amount of payroll required to achieve forgiveness. Then, claim the ERC on the excess eligible wages.

For example, if an employer received a PPP loan for $100,000 and paid $125,000 of qualified wages, then the excess $25,000 would be eligible for the ERC. Or, if in the same PPP loan, the employer reported $60,000 of wages (the minimum to qualify for forgiveness) and $40,000 in other eligible expenses (like rent or mortgage), then the remaining $65,000 in qualified wages could be deemed part of the ERC.

While employers can amend previously filed Forms 941 for quarterly taxes, they cannot amend a previously submitted application for PPP loan forgiveness. That’s why those who are seeking a PPP loan in 2021 or have not yet filed for forgiveness on a previous loan must carefully weigh their options to receive the maximum benefit available to them.

Clarifying the Full-Time Employee Threshold

One area that creates confusion and could benefit from some clarification is the full-time employee threshold. Within ERC, employers can qualify in one of two ways:

  • If the business was impacted by a government order
  • If gross receipts declined by a significant amount (50% in 2020 or 20% in 2021)

Note that this is an either/or scenario; both conditions need not be met to qualify.

Once one of these scenarios has been realized, employers must adhere to full-time thresholds. Using 2019 employment numbers, the ERC can only be claimed as follows:

  • More than 100 average full-time employees – only for employees who were not actively working due to the shutdown or decline in gross receipts
  • Less than 100 average full-time employees – on any employee’s wages, whether they were actively working during the affected period or not

Businesses that are over the 100 full-time threshold are still eligible for ERC, though the qualified wages only apply to a smaller segment of employees.

And, while some employers may be able to amend previously filed Forms 941 to claim the ERC when they couldn’t before, they must do so under the rules that were in place in 2020. For example, in 2020 the limits were 50% of qualified wages up to $10,000 for the whole year, and at least a 50% decline in gross receipts. They cannot retroactively apply 2021 rules to 2020 amended returns.

The ERC Does Impact the Federal Tax Return

Employers that claim ERC on their quarterly taxes should be aware that there is an effect on the federal income tax return as well, though it’s not widely discussed. IRC Section 280C(a) disallows a deduction for the portion of wages that are paid or incurred for certain credits. What this means for ERC is that an employer’s deduction for qualified wages, including health care expenses, are reduced on the federal income tax return based on the amount of the ERC.

This is something to keep in mind regarding longer-term tax planning.

Know the Documentation Requirements

Employers that claim ERC in either 2020 or 2021 need to maintain appropriate documentation. In some cases, records must be created to demonstrate the process of determining eligibility. For example, employers must be able to show how they determined they were eligible for the credit in the first place.

Support for determination can be found in any governmental order requiring a suspension in business operations. Also, look to gross receipts to show a significant decline there and to payroll records to substantiate which employees received qualified wages and in what amounts.

Other forms of documentation to support ERC eligibility include records that indicate how the employer determined its business operations met the required threshold, or records that substantiate whether a governmental order had more than a nominal effect on business operations.

Large employers can also refer to payroll records that prove eligible wages were paid for an employee that was not working.

Other forms of documentation that may be required include:

  • How the employer determined the amount of allocable qualified health plan expenses
  • If the employer is a member of an aggregated group treated as a single employer, they need proof on how the aggregation affects the amount of the credit they are eligible for if they are claiming the ERC
  • Copies of completed and submitted Forms 7200
  • Copies of completed federal employment tax returns; employers that use third-party payers must provide proof of the information they submitted to the third-party regarding ERC

Employers should keep ERC-related documentation at least four years after the tax becomes due or is paid.

Impact Has to be More than Nominal

When determining eligibility based on partial shutdown due to governmental orders, the impact must be more than a nominal portion of the business. In the IRS’s recent FAQs, this has been defined as either:

  • The gross receipts from that portion of the business operations are not less than 10% of the total gross receipts (both determined using the gross receipts of the same calendar quarter in 2019)
  • The hours of service performed by employees in that portion of the business is not less than 10% of the total number of hours of service performed by all employees in the employer’s business (both determined using the number of hours of service performed by employees in the same calendar quarter in 2019)

Great Benefits Available to Those Who Qualify

Recent changes to the ERC and PPP allow more businesses to reap tax benefits. However, there are detailed rules to follow and different scenarios have to be calculated to weigh a potential boost to cash now with your future tax obligations. Businesses need to get this right to reap the greatest benefits.

Contact Tomika Bullet, CPA for help determining employee retention credit eligibility. She can help with needed calculations for considering how overlapping the credit with PPP forgivable loans can best help.