Are your business owner clients full of questions about the Employee Retention Credit (ERC)? If so, you know the answers are not always straightforward or easy to come by. Below, I’ll break down the basics of the ERC, as well as offer some guidance on how you can provide to clients in more complicated situations to help them claim the credit they deserve.*
What is the Employee Retention Credit?
The ERC is a refundable payroll tax credit that offers financial relief for businesses affected by the pandemic, encouraging them to keep their employees on payroll. It was established in the CARES Act in 2020, and since, has been modified by subsequent legislation.
Determining Employee Retention Credit Eligibility
Congress extended eligibility requirements for the ERC at the end of 2020 and then broadened them further in the American Rescue Plan Act in 2021. This change allowed employers to qualify by simply meeting one of two tests for 2020 and the first two quarters of 2021, or one of three tests for the third quarter of 2021:
- Test 1 — The employer’s business was fully or partially suspended by government order due to COVID-19 during the calendar quarter.
- Test 2 — The employer’s gross receipts were reduced by 50% or more compared to the comparable quarter in 2019 for 2020, or 20% or below for 2021.
- Test 3 — For the third and fourth quarter of 2021, if a business was a recovery startup business (i.e., it began operations after Feb. 15, 2020) and had gross receipts less than $1 million for 2020, it may qualify for a special credit.
The ERC is available to all employers regardless of their size (with limitations), with the exception of state and local government employers and their instrumentalities. Small businesses that received certain business loans or grants are not allowed to claim the credit if the otherwise qualifying wages were paid for using those loans.
Once the employer’s gross receipts go above 80% of a comparable quarter in 2019, it no longer qualifies after the end of that quarter. That said, for 2021, the company may elect to compare against an alternative quarter instead. This means it will not qualify for the credit in the quarter after the quarter in which gross receipts exceeded 80% of the comparable quarter.
The Infrastructure Investment and Jobs Act became law on Nov. 18, 2021, and retroactively ended the ERC as of Oct. 1, 2021. This has reduced the maximum credit available to businesses from $28,000 to $21,000 per employee per year.
To be eligible for the full amount of 2020 credits, a business must have 100 or fewer full-time employees. In 2021, that number was raised to 500 or fewer full-time employees, which greatly expanded the number of businesses labeled as “small.” Employers that have more than those numbers of employees may still claim the credit, but only for those wages paid to employees while they were not working.
- Limited to $5K per employee for all quarters combined
- Must have experienced significant revenue decline or government shutdown (either partial or full)
- Significant revenue decline means at least 50% of gross receipts compared to the calendar quarter in 2019
- Continues until revenue exceeds 80%
- of gross receipts for the corresponding 2019 quarter
- Applies to wages paid from March 13, 2020, through December 31, 2020
- For all quarters, applied against Social Security payroll taxes — 6.2% of wages
- PPP loan recipients are eligible.
- Up to $7K per employee per quarter, limited to $21K per employee per year
- Must have experienced significant revenue decline or a government shutdown or be a qualified recovery startup
- Significant revenue decline means at least 20% of gross receipts compared to the same calendar quarter in 2019 or the alternative quarter
- Continues until revenue exceeds 80% of gross receipts for the corresponding 2019 quarter
- Applies to wages paid from January 1, 2021, through September 30, 2021
- For Q3, applied against hospital payroll taxes — 1.45% of wages
- PPP loan recipients are eligible.
How to Help Clients Avoid Common ERC Pitfalls
Now that we have covered the basics, what about those more specific questions coming your way from clients? Below are the dos and don’ts to help you guide clients in the right direction.
Don’t: Attempt to claim the credit for owner wages. Majority business owners who receive wages are not considered an employee of the company, and their wages are therefore ineligible for the ERC. The IRS considers wages paid to majority shareholders to be unqualified for the ERC. However, those who are both a shareholder owning less than 2% of the company and an employee may qualify as an employee for the credit.
Don’t: Roll wages over to the next quarter. If an employee’s wages exceed $10,000 in a quarter, the business owner might ask if that excess amount can be rolled over to the next quarter. The short answer is no. The ERC is based on payroll expenses per quarter, so wages paid in excess of the qualifying amount aren’t carried forward.
If your clients have made any mistakes with this already, the deadline to amend the ERC is between three to five years, depending on the business type.
Do: Claim the ERC even if you received a PPP loan. Businesses can take advantage of both the employee retention credit and PPP loans. It doesn’t matter if a company received the first or second PPP draw or both—they can still be eligible for the ERC. The only thing to be aware of is that any wages paid for using forgiven PPP loan funds will not be considered “qualified wages” for purposes of claiming the credit.
Let’s look at an example of a business that received a PPP loan and claimed the ERC:
In 2020, Bryan had two employees, experienced a government shutdown and received a PPP loan for $100,000. His employees make $55,000 each. If Bryan uses $50,000 per employee from the PPP loan, he will only have $5,000 of eligible wages per employee for 2020, for a credit amount of $2,5000 per employee. His credit for 2020 will be limited to $5,000.
Originally, PPP loan recipients were not eligible to claim the ERC. The Consolidated Appropriations Act of 2021 expanded eligibility to retroactively allow PPP loan recipients (including first-draw recipients) to claim the credit. But be sure to remind clients that they cannot claim the credit against wages that were paid for using forgiven PPP funds. They can separate out the eligible wages and the wages paid from a forgiven PPP loan.
Do: Determine if the business was impacted by a government shutdown. Some business owners are still questioning how exactly to determine whether they’ve experienced a government shutdown for the purposes of the ERC. Does the word “shutdown” mean the customers of the business were affected? No, because the shutdown only relates to how mandatory closures impacted the business. However, if customers were affected and didn’t shop, the business’s sales would likely have declined and, therefore it could qualify for the ERC due to loss of revenue.
However, the word “shutdown” has caused confusion among employers because it can be interpreted in different ways. An easy way to think about it is to consider what the state did. Since many shutdowns were state-mandated, a good rule of thumb is that if a governmental order from the state changed the way a company could do business, then that qualifies for the ERC.
But what if the business has more than one location, and only one location experienced a shutdown? Will the wages in the shutdown location still count? If the business implemented certain measures across multiple jurisdictions, the business is considered to have suffered a partial shutdown. This partial shutdown makes it an eligible employer in all jurisdictions.
A business is considered to have suffered a partial shutdown if it was able to continue some but not all of its typical business operations due to COVID restrictions. An example of a partial shutdown would be a restaurant that was able to remain open but could only offer take-out or delivery food options due to a governmental order.
Sometimes what constitutes a partial shutdown can get a little murky. For example, a grocery store that is fully open but could no longer offer a self-serve food bar to customers would not qualify as a partial shutdown because a food bar is only considered an ancillary part of the business in a large grocery store.
Do: Take the credit if you qualify. Be sure to encourage your qualified clients to take advantage of the ERC if they can. Let them know they can file an amended return if necessary and go back through quarterly information through 2019 so they can potentially claim for both years. They should keep detailed records and analyze which credits will provide the biggest benefits.
*Some of this information could become outdated upon the release of updated guidance from the US Treasury, SBA or IRS.
Sarah E. Adkisson, Esq., is a senior tax law analyst at Corvee, a software and solutions company serving tax and accounting firms. At Corvee, Adkisson works as part of the team that develops and maintains the Corvee Tax Planning software.