The original CARES Act in March 2020 provided much needed relief for small businesses in the form of Paycheck Protection Program (PPP) loans. But a lesser known component was the Employee Retention Tax Credit (ERTC), which allowed eligible employers – of any size – to earn a refundable tax credit against certain federal employment taxes. The problem for small businesses was that if they accepted a PPP loan, they could not also apply for the ERTC. Most took the PPP route, as it provided immediate funds at a critical time.
The rules have changed. The Consolidated Appropriations Act (CAA) signed into law in late December included provisions that funded a second round of PPP loans and significant changes to the ERTC that increased the tax credit amount for 2021, relaxed eligibility requirements, and made certain PPP loan recipients eligible retroactively for 2020.
ERTC Basics
The CARES Act permitted eligible employers to take a credit against applicable employment taxes in an amount equal to 50 percent of the first $10,000 of “qualified wages” per quarter for each employee. The maximum amount of qualified wages that could be taken into account for any employee for all quarters was also $10,000, so the maximum credit per employee was $5,000 in total. The credit could be taken for any single calendar quarter of 2020.
The ERTC has been extended into the first and second quarters of 2021 by the CAA. In addition, the $10,000 annual wage cap has been removed, and a credit of $7,000 per eligible employee can be taken for each of the first two quarters of 2021 ($14,000 per employee total).
To qualify for the ERTC, either the operation of an employer’s business for the period the ERTC is taken must be fully or partially suspended due to government orders limiting commerce, travel, or group meetings due to COVID-19; or there must be a significant decline in gross receipts for the selected period.
ERTC and PPP
Under the CAA, an employer that receives a PPP loan is no longer prohibited from claiming the ERTC, if they are otherwise eligible. It is important to note that wages and compensation paid with the proceeds of a PPP loan are not allowed to count as qualified wages for the ERTC up to, but not exceeding, the minimum amount of payroll costs, together with any other eligible expenses reported on the PPP Loan Forgiveness Application, necessary to support the amount of PPP loan that is forgiven. The IRS has provided guidance on multiple specific PPP Forgiveness and ERC interplay scenarios.
The relaxed eligibility rules are retroactive to the effective date of the ERTC under the CARES Act which applies to qualified activity post March 12, 2020. As a result, employers that received a PPP loan in 2020 (even if they are part of an aggregated group with a PPP loan), paid qualified wages, and are otherwise eligible to claim the credit, may be able to claim the ERTC by filing a Form 941-X for the relevant calendar quarters in which the employer paid qualified wages deemed ‘unused’ by PPP Forgiveness elections.
What are considered qualified wages? The definition is different depending on the size of the business. Small employers (100 or fewer employees during the final three quarters of 2020, including March 13-31, or 500 and fewer employees during the first two quarters of 2021) can use all wages paid to and qualified health plan expenses paid for all employees during the applicable quarter. Large employers (more than 100 employees during the final three quarters of 2020, including March 13-31, or more than 500 employees during the first two quarters of 2021) can only use wages paid to and qualified health plan expenses paid for employees for the period or periods during which the employee did not perform services for the employer (i.e. furlough or layoff).
Documentation
As with many IRS programs, substantiation of eligibility for the ERTC through documentation is a must. This includes copies of any governmental order suspending business operations, records that show that more than a nominal portion of business activity was impacted by the suspension, records demonstrating a significant decline in gross receipts, employee wages information and amounts, and (for large employers) records showing that the wages were paid for a time in which the employee was not providing service.
In addition, you will need to show how you determined the amount of allocable qualified health plan expenses, provide copies of Form 7200 you may have submitted to the IRS, and copies of federal employment tax returns (or records of information provided to third-party payers).
Tax Treatment
Receipt of employee retention credits disallows the employer’s deduction for qualified wages, including qualified health plan expenses,; and said expenses should be reduced by the amount of the employer retention credit (note – do not reduce employer’s share of Social Security or Medicare tax by any portion of the credit received). Since the employee retention credits reduce qualified wages and health plan costs allocable to the credit, the credit received is not included in the gross income of the employer.
Summary
Employers that did not claim the ERTC in 2020 and instead chose to accept a PPP loan should review ERTC eligibility to determine if they are now eligible to claim the ERTC for 2020 employment tax periods. It might be prudent to extend your 2020 tax return if you have an ERTC in process for 2020. Now is also the time to examine eligibility for the expanded 2021 ERTC program.
If you have questions about PPP or ERTC eligibility, want to review eligibility for 2020, or apply for 2021 ERTC credits, please contact Gray, Gray & Gray at (781) 407-0300.