Employee Retention Credit - Part 1

When the CARES Act was passed in early 2020 there were 3 major vehicles used to get money to businesses. The Paycheck Protection Program (PPP) and Economic Injury Disaster Loan (EIDL) received the most attention and provided almost instant cash flow to businesses. The third was the Employee Retention Credit (ERC), designed to help employers keep employees on staff and reduce or eliminate the payroll tax payments due.

The ERC was simple in theory, if an employer had a significant drop (50% or more) in Gross Receipts or was completely or partially shut down due to Government order, they could receive a credit of 50% of wages paid to employees with a max wage of $10,000 per employee for the year. In other words, if your business was hit by COVID, you could qualify for the government to give you up to $5,000 per employee to keep them on your payroll. If you took a PPP loan however, you did not qualify.

With the passing of the Consolidated Appropriations Act in December 2020, this credit had some significant changes put in place, but it was broken down into changes for 2020 and changes for 2021. Rather than explain the differences, let's take a look at what the rules are now for the ERC.

PPP Loan Proceeds, how does this impact the ERC:

If you took out a PPP loan you may now also qualify for the ERC. The caveat is that you can not use the same wages for both. For example, a business took out a PPP Loan for $15,000 and had 3 employees that were each paid $6,000 in gross wages for the year. If they were each paid evenly, the first $5,000 per employee would go towards the PPP loan forgiveness, and the remaining $1,000 per employee would be eligible for the ERC. That's a simplified example, but gets us on the right foot to start.

Qualified Wages are wages paid from March 12 through December 31, 2020. Let's look at a scenario where an employer received a PPP loan on April 30th. This could lead to an employer having qualified wages in Q1 for March 1 through March 31, then Q2 for April 1 through April 29th. The wages for April 30th until the PPP loan was paid off may then be applied to the PPP loan, and if the employer still qualifies, the credit could resume again after the PPP loan is fully satisfied. This of course leads to many more questions, but shows how many options are out there and how quickly this credit can become complicated.

Employee Count - Full Time Employees (FTE):

If a business had more than 100 FTE's in 2019 the only wages that qualify for the ERC in 2020 are wages paid to an employee to NOT provide services. Meaning, the business paid an employee to stay home and not work. If the business had 100 or less FTE's in 2019 then all wages paid in 2020 qualify, up to the $10,000 maximum.

Qualifying for the Credit:

A business must meet 1 of 2 tests to qualify for the credit:

1. Gross Receipts from the Trade or Business declined by 50% for the quarter compared to the same quarter in 2019. To test this simply prepare a Profit and Loss on your tax basis of accounting and compare all 4 quarters. If you see a 50% drop from Q2 2019 to Q2 2020, you qualify starting Q2, and continue to qualify until the end of the first quarter in which Gross Receipts exceed 80% of the comparative quarter.
2. That last bit tricks up some people. Let's take a business who had $100K in Gross Receipts in Q2 2019 and $45K in Q2 2020. That $55K drop is greater than 50%, so Q2 has them qualified under the Gross Receipts Test. If Q3 2019 Gross Receipts were $100K and Q3 2020 Gross Receipts were $70K, they are now at 70%, and thus, qualify in Q3 because they have not exceeded 80%. For Q4 2019 they had $100K in Gross Receipts and $81K in Q4 2020. They once again qualify in Q4, but that would signal the end of their qualified wage period, unless Q1 2021 dropped back down. We will get into this in Part 2. Since Q4 is now above 80% of 2019 Gross Receipts, the qualified wages can be used until the end of Q4.
3. The business must have been Fully or Partially suspended due to Government authority limiting their business operations. This can not be voluntary, it must be government ordered, but the range for partial suspension is quite liberal with the new changes.
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Qualified Wages:

This is a little complicated, but we can walk through the the process to determine what qualifies. First, you need to determine if test 1 or 2 is met and if they had 100 or less FTE's. Assuming they are under and met one of the tests, you then look at the quarter in which it was met and what are the wages paid.

Once you have those figures in hand, you are then limited to taking $10,000 in wages per employee for the entire year. One important note is that the CAA does not state it is the first $10,000 in wages, rather it is simply $10,000 in wages (and qualified Health Care costs). This is important for anyone who has a PPP loan and needs to identify what wages are applied to the PPP loan and what wages are for the Retention Credit. If a business had an employee laid off, but they were still paying their health care costs, those health care costs are considered Qualified Wages for the credit as well.

Complete or Partial Shutdown due to Government Order:

Simply put, the government had to close your business, or partially suspend it. An example of this would be a restaurant who had to close, or reduce their inside seating capacity due to government order. In Allen County Indiana we are still under this restriction, so even if you offer carryout and delivery, and ignoring Gross Receipts completely, since your dining room is partially suspended, you qualify. By contrast, if you elect to reduce occupancy on your own you do not qualify. For example, a CPA firm may restrict their offices to 2 clients at a time, while this is a restriction, it is an elective restriction unless it is so ordered by a government authority.

If a business meets this criteria, they must identify the specific dates in which they qualify. Those wages paid during that period are then qualified wages. As a result it is possible you could have qualified wages for a portion of a quarter, but not the entire quarter. By comparison, the Gross Receipts test is for the entire quarter.

Qualified Health Care Costs:

If an employer pays health care coverage for an employee, those payments are also considered Qualified Wages for purposes of the ERC. As mentioned earlier, if an employer laid off employees for wages but continued to pay their health care costs, those costs are now eligible for the ERC.

PPP Loan Forgiveness Wages and the ERC together:

The major change from the CAA was that businesses who took out a PPP loan may now qualify for the ERC. Congress made sure however to put in place criteria that eliminate a business from being able to claim the credit and forgive the loan on the same dollars paid in wages. So, what's the order, and how do you qualify?

Section 2301(g)(1) of the CARES Act states that a taxpayer (business) can elect to NOT include certain wages and allocable health care costs in the computation of the ERC. This means the business can elect what wages are applied to the PPP loan forgiveness and what wages go to the ERC. Further more, section 206(c) of the Taxpayer Certainty and Disaster Relief Act states payroll costs can not be claimed for both, and the priority goes to the ERC over the PPP loan forgiveness.

In English, that means wages would go to the ERC first, unless the business wants to apply the wages towards the PPP loan forgiveness first. Why does this matter? For many businesses in Indiana they were partially or fully suspended from March 12th through May 3rd. If a business received a PPP loan on April 12th, for example, they would have to identify if those wages paid from April 12th to May 3rd are to be used for the ERC over the PPP Loan Forgiveness or vice versa to eliminate any confusion. The reason being, if they do not meet the Gross Receipts test, it is possible they will not qualify for the partial suspension when Indiana reached Stage 2. This is a very important step that can not be overlooked. Unfortunately, most taxpayers have already submitted their PPP Loan Forgiveness and must not decide if they want to wait for the IRS and Congress to determine how to handle that forgiveness, or if they want to justify their own argument and hope to win in the event of an Audit.

Calculating the actual Credit:

Once you determine the eligible wages for 2020, the business may receive a credit of 50% of wages paid up to $10,000 in wages/health care costs.

Here is an example: Credit Calculation

As you can see, there is a requirement to track total wages per employee for 2020 and keep the running total. Once that employee reaches $10,000 in wages or health care costs, they no longer qualify for the ERC. In the same wage scenario, if the employer was using the partial suspension only the wages paid during the days in which the government order was in place would qualify for the credit. Another scenario to consider is if Q3 was not qualified and Q2 and Q4 were qualified. That would then eliminate the Q3 credit for Joe and Jane, but allow for the full $4,500 paid to Jane to qualify in Q4 for the credit, Joe's Q4 would remain the same as he is still under the $10,000 in total wages.



It is very important to note that if the business received a PPP loan they MUST identify what wages are being used for loan forgiveness and what wages are being used for the ERC. They may not use the same dollar for both. Using our example above, let us assume the business received a $4,000 PPP Loan, and they were partially suspended for all of Q2, reopened Q3 and Q4, then received the loan on April 1. The only qualifying quarter would be Q2, the same quarter the PPP Loan was received. If the taxpayer elected the 24 week payroll period, the could specifically identify the Q2 wages for the ERC and receive a $4,000 credit. Then, starting in Q3 they could identify the first $4,000 in wages paid to apply to the PPP loan forgiveness. Or, better yet, they could identify $2,400 in wages (60% of the 4,000) and use Rent, Utilities and other qualified expenses for the loan forgiveness, in the event they had another partial or complete shut down ordered by the government in Q3. As you can see, the calculations here begin to become complex and varied rather quickly.

How to take the credit if a business already applied to have their PPP Loan forgiven:

Unfortunately this is where we are in a bit of a grey area (Charcoal, to quote Irwin M Fletcher for you 80's movie buffs). There is no official guidance as of today on this. From our experience we are finding that almost every business used payroll only to apply for forgiveness, and had more than enough wages to satisfy the loan. For example, if a company received a $500,000 PPP loan and then had $1,000,000 in wages over the 28 week period, many simply sent in their wages to show the loan satisfied in full and did not remit any other expenses. To take a conservative approach on this, that would mean $500,000 in wages were used for the PPP loan because no rent, utilities, or other expense as included in the paperwork. However, that also means there is $500,000 left to apply potentially to the ERC. A more aggressive approach would be to say that since only 60% was required for the loan forgiveness, $300,000 in wages ($500,000 loan x 60%) were used and the remaining $200,000 was forgiven by Qualified Expenses (assuming they exist), leaving $700,000 in wages available for the ERC.

This is where documentation on the taxpayers part will identify what exact dollar wage was applied to which. We are of the opinion that if you already submitted your loan forgiveness, you have to follow what you sent in. If you have not yet submitted the form, we highly encourage you to use the 60% of wages and substantiate the rest of the forgiveness with qualified expenses so you can eliminate any questions. This is a discussion between you and your CPA and will vary by individual.

How to Apply for the Credit:

Since this credit is taken on form 941 (or 944), it ideally would have been calculated each quarter. Since the CAA amended this act in December that means the business owner can either file amended form 941X and wait for a check, or they can election to catchup in the quarter in which the credit became law (i.e. Q4). The CAA allows for businesses to file their Q4 941 form with the full 2020 qualified wages all in Q4 rather than amending each quarter. There are some issues with this approach as Congress worded the bill to potentially not allow it, but yet also allow it. Since we are dealing with elected officials who don't understand tax law it is no surprise that they once again managed to cross their i's and dot their T's rather than the other way around. It is our stance that you can file a Q4 941 with the full credit for 2020, but that of course means you had to wait until the last minute to file your Q4 941 form, and need to go through all the steps above.

What happens in 2021?

There are some huge opportunities for 2021 with the changes that were put in place. Check out our next post for how this credit significantly changes January 1, 2021 and how to plan for it.