Employee Retention Tax Credit—A Hidden Business Benefit

When I ask business owners and CFOs I work with if they are aware of the Employee Retention Credit (ERC) as part of the CARES Act, many tell me: “Oh yes, we got all that.” But when I question them further, it often turns out they only applied for and got the Paycheck Protection Program (PPP) loans, and were unaware of the additional ERC available to them.

The ERC and PPP Are Not the Same

Although it is a part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, the ERC is not the same as the PPP. It is a supplemental credit and one companies may be missing out on without realizing it.

The ERC was intended to help businesses retain their workforces and avoid layoffs during the coronavirus pandemic. It provides a per employee credit to eligible businesses based on a percentage of qualified wages and health insurance benefits paid to employees. It often gets overlooked as, when it was first passed, the CARES Act did not allow businesses that received PPP loans to also claim the ERC. Virtually all businesses took the PPP because it was more beneficial.

Still Available to Businesses That Received PPP Loans

With the passage of the Consolidated Appropriations Act in December 2020, the aforementioned restriction was retroactively removed. This opened the way for employers that had applied for or received PPP loans to also apply for the ERC, and for them to apply for it for the first three quarters of 2021. Many businesses that retained employees during 2020 and 2021 can still qualify for and claim this credit, even if they received PPP loans. As the pandemic continues and many small- and medium-sized businesses still struggle with the impact, receiving some additional relief from the ERC makes good business sense.

What Is the ERC and Who Qualifies?

The ERC is a fully refundable payroll tax credit claimed quarterly starting March 12, 2020, running through the end of 2020, and the first three quarters of 2021. This credit can be claimed retroactively and provide reductions to payroll taxes for those time periods, resulting in cash refunds of payroll taxes paid. It is available to both for-profit and not-for-profit employers, but not every business is eligible.

There are two categories of eligible employers—small or large—defined in the ERC. Size is based on the average number of full-time employees in 2019 (pre-COVID-19). Large companies are those with 100 or more employees. The documentation required to claim the credit for a large company is more comprehensive than for a small business.

How Does It Work?

There are two critical tests for eligibility—a partial or total government-ordered shutdown and the applicable decline in gross receipts. A partial or total government-ordered shutdown is one that has been mandated for at least some period of the quarter. The documentation need not be a copy of a government announcement. It can be any documentation showing there was a government-ordered shutdown. The decline in gross receipts test is based on a “significant” decline in gross receipts, and the rules on this are different between 2020 and 2021.

For 2020, if a business had a partial or total government-ordered shutdown and a 50 percent or more decline of gross receipts within a given quarter starting on March 12, 2020, and running through Dec. 31, 2020, compared to the same quarter in 2019, they qualify. The credit for 2020 is based on wages paid of up to 50 percent of qualified wages with a $10,000 maximum per employee, resulting in a $5,000 credit per employee for the year 2020.

For 2021, the partial or total government-ordered shutdown requirement still applies, but otherwise, the rules are significantly more generous. The gross receipts decline needs to be only 20 percent within a given quarter as compared to 2019. The qualifying time periods are Jan. 1, 2021, through Sept. 30, 2021. Instead of 50 percent of qualified wages, it is 70 percent of qualified wages, and the $10,000 maximum per employee is considered for each quarter rather than yearly. Thus, for 2021, the maximum credit is $7,000 per quarter, or up to $21,000 (potentially) per employee for three quarters. This can be a significant incentive for companies to review this potential opportunity.

Further, the statute of limitations on filing amended payroll forms is three years. Thus, if a company qualified in 2020 or any of the first three quarters of 2021, the cash refund associated with this credit can still be claimed.

The Rules

• Qualifying wages include wages paid and any healthcare expenses of the employer.
• The comparison is performed quarterly and compared with the same quarter in 2019.
• If an employer qualifies for any particular quarter, they can claim the credit for that quarter.
• Any PPP funds received during the applicable time period must be backed out.
• The filing is accomplished by amending quarterly 941 payroll tax reports.

There are other rules associated with the ERC, so when considering this, it is best to work with a professional who is conversant with the rules and how to file.

Qualifying Company Examples

Company A qualified for the ERC in 2020. The firm experienced a government-ordered partial shutdown and saw a 60 percent decrease in gross receipts (2019: $200,000; 2020: $80,000). The maximum allowable credit for 2020 is $5,000 per employee. Employee 1 received $10,000 in qualified wages, so the credit is $5,000. Employee 2 received $19,000 in qualified wages, which exceeded the $10,000 maximum; the credit for this employee is also $5,000. Employee 3 received a total of $6,000 in qualified wages, so the credit is $3,000 (Table 1).

Table 1

Company B qualified for Q1 2021. The organization experienced a government-ordered shutdown and saw a 30 percent decrease in gross receipts in Q1 2021 versus Q1 2019. In this example, the maximum allowable credit for 2021 is $7,000 per employee per quarter. Employee 1 had $35,000 in qualified wages, so the credit available is $7,000. Employee 2 had $10,000 in qualified wages, again with an available credit of $7,000. Employee 3 had a total of $7,000 in qualified wages, so the credit available is 70 percent of that, or $4,900 (Table 2).

Table 2

Start-Up Businesses Can Qualify
The ERC was further expanded with the signing of the American Rescue Plan Act into law on March 11, 2021. This law allows newly founded businesses to receive funds as a “Recovery Startup Business” for qualified wages paid during the third and fourth quarter of 2021.

For the purpose of the Employee Retention Credit, a “Recovery Startup Business” is one that:

• 
  Began operations on or after February 15, 2020
• 
  Maintains average annual gross receipts that do not exceed $1 million
• 
  Employs one or more workers (other than 50 percent owners)
• 
  Does not otherwise qualify for the Employee Retention Credit (i.e., its business operations were not fully or partially suspended due to government orders nor did they experience a decline in gross receipts)

This means a business qualified as a Recovery Startup Business is eligible to receive up to $7,000 per employee, per quarter, with a maximum credit of $50,000 per quarter, for the last two quarters of 2021. Unlike other tax credits, these funds are available to be used as a business owner sees fit to help their business grow.

Conclusion
I encourage every business who may potentially qualify to become more familiar with the ERC provisions to determine if they are eligible. The ERC can provide substantial refunds based on the number of employees and how many quarters the business was eligible. In addition, there are nuances to maximize the program, so every business should find out about it and evaluate the opportunities. Eligible businesses can file an amended Form 941 for prior quarters, utilize the program, and recover tax refunds to help sustain and grow the business in these challenging times. 

Chris Lake is president of a professional services consulting company in Kentucky. She has more than 40 years of experience in business management, with a focus on research and development, operations, and financial issues. In addition to having held senior management positions at a number of companies in the technology, insurance, and financial services industries, Lake has owned and been a part-owner in three successful businesses and understands the issues facing small and medium-sized business owners. Lake is passionate about helping businesses understand and take advantage of available R&D tax credits, and, as a result, helping businesses and the American economy stay strong. Chris Lake may be contacted at [email protected].