Employee Retention Credit - Part 2

If you haven't read Part 1 of our ERC breakdown, be sure to go there first as that handles how many of the calculations are handled.

The CAA broke down the changes to the ERC into two major areas. A change in WHO qualified to claim the credit in 2020 and a change in HOW the credit was calculated in 2021. While the Partially Suspended operations test will allow a large number of businesses to qualify, the 2021 calculation is even more beneficial to struggling business owners.



2021 Changes

Qualifying Wages:

Two big changes are in place starting January 1st. Qualified wages are now set at $10,000 per employee PER QUARTER instead of annually. Additionally, bonuses are now able to be included. In 2020 employees had to meet certain criteria to qualify on bonus payments, but in 2021 this has been removed.

Credit Rate Percentage:

The 2021 credit rate is moved up to 70% from 50%. As a result, when combined with the wage change, a business can now receive up to $7,000 per employee per quarter instead of $5,000 in total for the year per employee.

Gross Receipts Test:

The decline in Gross Receipts to qualify for the credit has been changed from 50% of the comparative quarter to a 20% decline. This is a massive change. Now, if a taxpayer can show their Gross Receipts are 80% of the same quarter in 2019, they qualify for the credit for the entire quarter. There is also an alternative comparison we address below. For those businesses who were not around in 2019 they would use the 2020 calendar year quarter.

Date Extension:

The CARES Act ended the ERC on 12/31/2020, the CAA has extended this to June 30th, 2021. Allowing for fiscal Q1 and Q2 2021 to have the ERC calculation.

Employee Count:

In 2021 the number of FTE's is increased from 100 to 500 for those businesses to claim this credit. Drastically increasing the number of employers who may now qualify to take this credit.

Quarter Comparison:

One of though more confusing parts is how to calculate the Gross Receipts test with how Congress wrote the CAA. In Q1 2021 taxpayers compare Gross Receipts to Q1 2019, not 2020 to see if they meet the decline in GR tests. They may elect to instead compare the previous quarter, this means you can compare Q4 2020 to Q4 2019 and use that decline (if you can show 2020 is 80% or less) and claim the credit in Q1 2021. This is a great planning point as we know today what our Q4 Gross Receipts were. If we know that number is 80% or less, we now the taxpayer qualifies for the credit for Q1 2021.

Advance Claiming of Credit:

The most obvious way to help a business right away with this credit is to withhold the 941 payment. There will be some calculations here to ensure the payment is below the total credit, but for some businesses this could be a considerable cash flow savings. The other change added from the CAA is that taxpayer may elect to receive the credit in advance. The business is limited to 70% of the average quarterly wages paid in 2019, but this is still a useful tool. The advance may be collected using form 7200.

Tax Planning Ideas

With these changes there is an opportunity for taxpayers to actively plan to maximize the credit in Q1 2021. First, as noted, anyone who can pass the Q4 Gross Receipts test will qualify for the credit in Q1 2021. This means for any businesses with employees who may receive a bonus throughout the year it is now in the businesses interest to pay that bonus in Q1, assuming the employee would not normally reach the $10,000 wage and health care mark. Be sure to consider the increase in Unemployment taxes that will go along with this when planning.

As with 2020, any taxpayer who receives a PPP loan distribution in 2021 must identify which wages are being applied to the PPP loan forgiveness and which are being used for the ERC. The same dollars may not be used for both. It is important that you have solid records to support both claims or you risk being denied on both.

Example 1

A small restaurant with 75 FTE's received a PPP loan on May 1, 2020. Due to executive orders from the Governor of Indiana their dining room was closed as of March 1st. Per the CARES Act, the ERC is able to be claimed beginning March 12th. As a result, all wages paid from March 12th through April 30th are eligible to be included in the qualified wages calculation regardless of Gross Receipts as the business was partially or completely suspended. Even if the restaurant had carryout available, or outside dining, they are considered to be partially suspended since their dining room is closed.

As of today, January 28, 2021, Allen County restaurants are still restricted in their dining capacity. As such, they are still partially suspended and qualify for the ERC from March 12th until December 31, 2020. This requires the business to do a summary of wages, by employee, for that period. To specifically identify what wages are for the PPP loan forgiveness and what qualify for the ERC. With restaurants traditionally having low wages per employee, this means most will have non-management workers qualify the entire year. If a restaurant has $100,000 in wages to non-management over that period, after accounting for the PPP loan, they now stand to receive a credit of $50,000 or more, depending on individual wages.

This scenario becomes more complex if the loan forgiveness is already submitted, but the flexibility is something that every business should examine.

A professional services firm with less than 100 FTE's experienced a significant decline in Gross Receipts in Q2 resulting in a 55% drop compared to 2019. This qualifies the firm for Q2 to begin claiming the ERC. In Q3 Gross Receipts increase, but they are still only 70% of Q3 2019. Since they have not reached 80% or more, the wages paid in Q3 qualify as well. In Q4 Gross Receipts hit 81% of the same quarter in 2019. The wages paid in Q4 also qualify as wages qualify to the END of the first quarter in which Gross Receipts reach 80% or more.

Now, using that same scenario, let us instead imagine Q4 2020 Gross Receipts were 78% of 2019. We know that Q4 wages qualify, but we also know that Q1 2021 wages qualify no matter what because the credit stops at the end of the quarter that exceeds 80%, and we also have the ability to look at Q4 to qualify for Q1 2021.

A retail business never had gross receipts fall below 50% in 2020 and was never shut down by government order. We know they do not qualify for the ERC in 2020. In February 2021 the Allen County Health Commissioner closes down all retail shows from February 15th until March 1st to combat a surge in COVID cases. The retail business now qualifies for wages paid from Feb 15th up to March 1st. In an effort to help their employees the retail businesses pays a bonus of $3,000 to each of the 10 employees on February 18th. This is the only payroll issued during the closed period. The business is now entitled to a credit on form 941 for the amount of $21,000.

Using the same scenario, we will add that the business received a second round PPP loan on February 1st for $70,000. Section 206(c) of the CAA states specifically that priority on wages goes to the ERC rather than the PPP unless the taxpayer specifically elects otherwise. As such, assuming they have enough wages during the covered PPP period, the taxpayer may elect to qualify the $30,000 in wages paid on February 18th as ERC wages, and wages after that period as PPP wages. While there is no formal election for this, a written statement and detailed record of wages paid and how they are used will satisfy the requirements and protect the employer.

Conclusion

The ERC was a mostly ignored credit when it first came out due to the 50% decline requirement and elimination for those who took out a PPP loan. With the changes put in place by the CAA there is a real potential for businesses to use this credit to supplement their business during COVID and help ensure their doors stay open. With the uncertainty surrounding COVID and the future it would not be surprising to see Congress extend this yet again through all of 2021, but as of now, the ERC ends with Q2 2021.

There are many scenarios where a business may qualify under the partial suspension ranging from suppliers being suspended while the end user stays open but is impacted. Contact us today and we can discuss how your business may qualify and if we can help you.