Updated for Provisions in the Consolidated Appropriations Act 2021
On March 27, the House of Representatives passed the Coronavirus Aid, Relief and Economic Security (“CARES”) Act. This legislation included many provisions intended to improve cash flow for taxpayers impacted by the COVID-19 pandemic. One such provision is the Employee Retention Credit.
The Employee Retention Credit was modified in the Taxpayer Certainty and Disaster Relief Act of 2020 which was passed as part of the Consolidated Appropriations Act 2021 on December 27, 2020. Several taxpayer favorable changes were included in this Act including extending the period the credit is available through June 30, 2021, allowing PPP loan recipients to claim the credit, and increasing the amount of credit available for 2021.
Note that the IRS has not yet updated its regulations and frequently asked questions regarding the Employee Retention Credit for this new legislation as of this update, so clarifications to some of the new provisions discussed below may be released in the forthcoming weeks.
Key Provisions Include:
- Eligible employers may claim a refundable credit against the employer portion of social security payroll tax of up to $5,000 per employee in 2020, or up to $14,000 per employee for the first two quarters of 2021.
- Applies to employers whose business was fully or partially suspended as a result of governmental orders due to the Coronavirus, or whose gross receipts for the quarter are less than 50 percent of gross receipts in the comparable quarter in 2019, or for credits claimed in 2021, less than 80 percent of gross receipts in the comparable quarter in 2019.
- Large employers, those with more than 100 employees in 2019 for businesses claiming the credit in 2020, or more than 500 employees for businesses claiming the credit in 2021, may only claim the credit for wages paid to employees who were furloughed (not working).
- The credit is available as an advance against expected payroll tax deposits.
An eligible employer must have been carrying on business in 2020 and must meet one of two criteria, tested quarterly, indicating their business was impacted by the virus:
- The employer must have been ordered by a governmental authority to suspend or reduce business operations due to COVID-19, including restrictions on commerce, travel or group meetings during the quarter; or
- The employer must have suffered a decline in gross receipts in the calendar quarter as compared to the same quarter in 2019.
- For 2020 this must be over a 50 percent decline. Eligibility under this criterion continues in subsequent quarters until gross receipts for a quarter are 80 percent or more than the gross receipts from the same calendar quarter in 2019. The entity is ineligible in the quarter after the 80 percent threshold is reached.
- For 2021 this threshold was reduced to a more than 20 percent decline. Note that the comparison is still to the comparable quarter in 2019. Additionally, in 2021 a business may elect to determine eligibility for a quarter based on comparing sales in the immediately preceding quarter to the corresponding quarter in 2019.
- Special rules apply to businesses that were not operating during all of 2019.
Household employers, for example taxpayers that employ a nanny, are not eligible. Governmental employers, other than tribal governments, are also not eligible.
Orders, proclamations, or decrees from the Federal government, or any State or local government are considered “orders from an appropriate governmental authority” if they limit commerce, travel, or group meetings due to COVID-19 in a manner that affects an employer’s operation of its trade or business, including orders that limit hours of operation. If they are from a State or local government, they must be from a State or local government that has jurisdiction over the employer’s operations. Statements from officials, such as recommending that people practice social distancing, that are not authoritative, are not considered “government orders.”
The government order must not only limit commerce, travel, or group meetings, it must also affect an employer’s operation of its trade or business. Government orders that only impact non-essential businesses do not qualify essential businesses to claim the credit.
For purposes of the gross receipts test, receipts include total sales, less returns and allowances, income from services, and income from incidental or outside sources. Income from investments, such as interest (including tax exempt interest) and dividends, rents, royalties, and net gains on sales of capital assets are also considered receipts.
For tax-exempt employers, receipts include amounts received by the organization for sales (net or returns and allowances) and for services, whether or not those sales or services are substantially related to the organization’s exempt purpose or function. Gross receipts also include the organization’s investment income, including from dividends, rents, and royalties, as well as the gross amount received as contributions, gifts, and grants, and the gross amount received as dues or assessments from members and affiliated organizations.
Interaction with the Payroll Protection Loan Program
Originally, under the CARES Act, taxpayers who received a “PPP” loan were ineligible to receive the employee retention credit. The COVID relief provisions in the Consolidated Appropriations Act removed this restriction. There is now a limitation which disallows the same wages that were used to claim forgiveness of the PPP loan to be claimed for the Employee Retention Credit. Priority for where the wages are claimed goes to the Employee Retention Credit, however an employer may elect not to claim certain wages and allocable health care costs for the ERC.
Calculation of the Credit
The credit for 2020 is calculated as 50 percent of qualified wages. For the 2021 credit this has been increased to 70 percent of qualified wages.
- For 2020 the credit applies to wages paid after March 12, 2020, and before January 1, 2021, and qualified wages are limited to $10,000 per employee for the year.For 2021 the credit applies to wages paid after December 31, 2020 and before July 1, 2021. Qualified wages are now limited to $10,000 per quarter per employee, which allows up to $20,000 of qualified wages for the first six months of 2021 per employee.
- Employers who are eligible on the basis of governmental orders which fully or partially suspended their business, are only eligible employers in the quarters in which the orders were in effect. If the orders were lifted during the quarter, only the wages paid during the period the order was in force may be claimed.
- Employers who are considered “large employers” under the rules for the Employer Retention Credit may only claim wages paid to an employee during the time the employee wasn’t working due to a full or partial suspension of the employer’s business by a governmental order or a significant decline in gross receipts. In other words, the employer must have been paying the employee to stay home and NOT work. For 2020, the threshold to be considered a “large employer” was more than 100 full-time employees. For 2021 the threshold was increased to more than 500 full-time employees.For the 2020 credit, qualified wages for an employee of a “large employer” are limited to the wages the employee would have received for the same amount of work in the 30 days prior to when the employer met the government order test or the reduced gross receipts test. This limitation was removed for 2021.
- “Full-time” employees are those who, for any calendar month in 2019, averaged at least 30 hours of service per week or 130 hours for the month. The number of full-time employees is then determined by dividing the sum of the full-time employees for each month by the number of months.
- Qualified wages include qualified health plan expenses paid to a group health plan properly allocable to the employee during the period. Qualified health plan expenses are only included to the extent they are excluded from the gross income of the employee by reason of Code section 106. Discriminatory health benefits that are taxable to highly compensated employees or key employees are not qualified.
- Qualified wages do not include wages for qualified paid sick leave or qualified paid family leave eligible for the credit under the recently enacted Families First Coronavirus Response Act, wages used in determining credits under the existing Employer Credit for Paid Family or Medical Leave, or wages for which the Work Opportunity Credit was claimed. Severance pay and other payments to former employees are also not qualified. For “large employers,” holiday pay, sick pay, vacation and paid time off are not qualified.
- Wages paid to a related individual, as determined in IRC § 51(i)(1), are not eligible. Related individuals include individuals owning, directly or indirectly, more than 50 percent of the entity. Relatives of the owner, including lineal descendants, siblings and step-siblings, parents and step-parents, ancestors, uncles and aunts, nieces and nephews, and certain “in-laws,” are considered related individuals.
- Employers who claim both the mandatory paid leave credit and the employer retention credit will apply the paid leave credit first and then apply the employer retention credit to any remaining wages not taken into account for the paid leave credit.
- Certain employers with related commonly owned businesses may be required to determine eligibility for small employer status by aggregating their employees for the related businesses to determine if they are subject to the rules for large employers.
Claiming the Credit
The credit will offset the 6.2 percent employer portion of the social security (OASDI) payroll tax and is refundable to the extent it exceeds the payroll tax liability of the employer for the quarter.
In the case of wages paid by a certified professional employer organization (CPEO), the Employee Retention credit may be claimed by the customer, not the CPEO.
The credit is claimed on an employer’s quarterly Form 941. The IRS has advised that employers whose PPP loan forgiveness application was denied may claim credits for the 2nd and 3rd quarter of 2020 on their 4th quarter Form 941. It appears that other employers will need to file Adjusted Forms 941-X for prior quarters to amend their prior quarterly filings to claim the credit.
An advance on the credit may be claimed on Form 7200. For 2021, small employers, those with fewer than 500 full-time employees, may elect to claim the credit in advance in an amount not to exceed 70 percent of the average quarterly wages paid by the employer in 2019.
For employers who receive an Employee Retention Credit, the CARES Act requires that payroll deductions be reduced by the amount of the credit received.
An eligible employer may also opt out of claiming the credit simply by not claiming the credit.
Please contact us with questions regarding how this credit can benefit your business.