By Martin E. Prendergast, MBA
Gray, Gray & Gray, LLP
As tough as the past year has been for many architectural, engineering and design firms, there have been a number of federal programs put in place to help retain employees and ease the burden imposed by the extended economic upheaval. While most people are familiar with Paycheck Protection Program (PPP) loans, some firms may also be able to benefit from the Employee Retention Tax Credit (ERC) program.
The ERC was introduced in 2020 as part of the federal government’s effort to provide relief to businesses whose revenue declined due to the COVID-19 pandemic. It has since been extended through 2021. Eligible employers can earn a refundable tax credit against certain federal employment taxes.
The ERC became even more appealing once it was opened to businesses that had also received a Paycheck Protection Program (PPP) loan. (It was previously an “either/or” situation.) Architects, engineers and designers that have not claimed an ERC either because they received a PPP loan, did not realize they had an eligible revenue loss (or simply did not know about the ERC) may be able to apply for the tax credit retroactively. In most cases, you can file up to two years after the eligible quarter.
Here’s what makes investigating your company’s eligibility for the ERC worthwhile. The credit for 2020 is 50% of the first $10,000 paid per eligible employee, for the year. This has been increased to 70% of the first $10,000 paid per eligible employee, per quarter for 2021.
Revenue Loss Requirements
The revenue decline threshold that must be met for 2020 is 50% compared to 2019 revenues, with a trailing auto qualifier until the end of the following quarter, where gross revenue comparison is restored to less than a 20% decline. The 2020 Retention Credits, once harvested through Form 941 / 941-X payroll filings, must be reported on your 2020 tax filings. The credits you generate must reduce wage expense equal to the amount of ERC you received, effectively making the ERC taxable. If you have extended your 2020 business tax filings, they should remain on extension while the 2020 ERC opportunity is explored. If you have already filed, an amendment can be filed.
With the extension through 2021, the ERC is also available to companies of any size that had their business fully or partially suspended or suffered a drop of 20% or more in gross quarterly revenues this year, compared to the same quarter in 2019. Each 2021 quarter must be calculated and tested individually. There are special rules for 2021 that allow for alternative prior quarter elections for the testing. The maximum ERC credit has been increased to 70% of the first $10,000 paid per eligible employee, per quarter. (The computation differs for companies with more than 100 full-time equivalent employees in 2020, and more than 500 full-time equivalent employees in 2021.) You cannot claim the ERC on wages that have been paid using the proceeds from a PPP loan. You can apply for the ERC with your quarterly payroll tax filings.
New Flexibility with PPP
With the ERC now available to PPP borrowers, you might consider adjusting the allocation of PPP payments between payroll and eligible business expenses. PPP loan forgiveness requires a minimum of 60% of funds be used for payroll purposes with the balance available for eligible non-payroll costs. But many companies simply used 100% for payroll. Now, however, using the full 40% allowed for expenses may “free up” payroll costs that could be applied toward the ERC. It may require more paperwork on a PPP forgiveness application, but the result could be worth the extra effort.
There are certain restrictions and provisions on which part of your payroll is eligible for ERC, and those rules differ in 2020 versus 2021, particularly for companies with more than 100 full-time equivalent employees. The rules surrounding the inclusion of business owner’s compensation in the eligibility formulas also remain unclear; and we are awaiting clarification from the IRS. For larger firms, those with multiple entities and attribution or affiliation rules, calculating ERC eligibility gets quite complicated and requires assistance from an experienced consultant. Finally, the strategic interplay with the PPP and the ERC requires planning and analysis to ensure your stimulus opportunities are maximized.
A Conflict Between ERC and R&D Tax Credits
While the ERC credit is a welcome payroll tax break to qualifying taxpayers, it does present a conflict with the R&D tax credits that are used by many architectural, engineering and design firms. If you are applying for an R&D tax credit you are not allowed to include wage expenses as eligible expenses for the R&D tax credit. For taxpayers who will be claiming both the ERC and R&D tax credits in 2021, additional calculations and evaluations will be required to separate wage expenses used for each credit.
How It All Might Work
If you are wondering if the investigation and analysis necessitated by the balancing act between PPP and ERC is worth the time and effort, these two examples may convince you. Keep in mind that the results for every architectural or engineering firm will be different, and not all firms may have the “numbers” to make it work.
Example 1: 7-person architectural firm
Received PPP 1 in May of 2020, which has been fully forgiven with approval from SBA. Received PPP 2 in February 2021 and have submitted the forgiveness application already pending approval from the SBA. In addition, we successfully navigated the PPP covered periods to harvest ERC credits.
PPP Round 1: $120,000 (fully forgiven)
PPP Round 2: 120,000 (forgiveness pending)
Q-4 2020: 32,500
Q-1 2021: 27,800
Q-2 2021: 30,000 (estimated)
Total: $330,300 (anticipated)
Q-4 2020 and Q-1 2021 have been submitted for Form 941 amendments already with the firm’s payroll provider. Q-2 2021 we tested revenue qualifications in advance and maximized PPP 2 Forgiveness using some rent and other eligible non-payroll costs which allowed us to still capture ERC on the back half of Q-2 2021.
Example 2: 25-person architectural firm
PPP 1 was fully forgiven with approval from SBA. PPP 2 in the process of working through the forgiveness application while simultaneously maximizing ERC for Q-2 2021. We will test and harvest ERC in Q-3 and Q-4 2021 if revenue continues to show a 20% or more comparative drop versus 2019.
PPP Round 1: $ 645,000 (full forgiven)
PPP Round 2: 645,000 (forgiveness pending)
ERC Q-4 2020: 132,000
ERC Q-1 2021: 151,500
ERC Q-2 2021: 168,000
Total to date: $1,741,500 (anticipated)
There is No Rush…Yet.
There are some companies taking advantage of the uncertainty surrounding the ERC by pressuring businesses to hurry through an application or risk losing the opportunity. That is inaccurate information. The fact is you have more than two years to file an amended Form 941 to take advantage of the ERC. In most cases you can correct overreported taxes on a previously filed Form 941 if you file Form 941-X within three years of the date Form 941 was filed or two years from the date you paid the tax reported on Form 941, whichever is later.
Despite these complexities and uncertainties, an Employee Retention Tax Credit could offer significant opportunities for tax savings and is an option worth investigating more fully. For additional information or help in calculating your potential for applying for the ERC, either this year or retroactively for 2020, please contact Gray, Gray & Gray at (781) 407-0300.
Martin Prendergast is a Manager in the Architecture, Engineering & Design Practice Group at Gray, Gray & Gray Certified Public Accountants and Advisors in Canton, Mass. He can be contacted at (781) 407-0300 or at mprendergast@gggllp.com